Compliance: Major factors affecting the risk rating of a country
06 Nov 2018

A question I often hear asked by compliance workers is ‘what are the factors that determine the risk rating of a country?’

When performing customer due diligence (CDD), we look at data points pertaining to the customer and weigh the customer risk based on certain criteria such as geographical risk, industry/occupation risk, and product risk.

Understanding the risk factors is really important, so is understanding the factors on which risk buckets are categorised.

Let us look at the major factors that govern the risk rating of a country in the field of compliance.

1. Supporting terrorism

Countries that support of fund terrorism in any way have always found themselves in trouble on a global scale, and lose the trust of other countries, forcing them to cut all sorts of trade or business relationships. These countries are rated high on risk grounds.

Terrorist organisations are funded through various means, including money transfers, donations, trafficking, extortion, ransoms, taxation and so on, especially from countries that do not have proper anti-money laundering (AML) regulations in place.

According to a recent report from the Institute for Economics and Peace, the number of deaths from terrorist attacks in 2017 was 25,673 and cost around US$84 billion to the global economy, which is a massive number in itself.

2. Political stability

Economic growth and political stability are strongly connected, an unstable political environment may diminish investment and the pace of economic growth on one hand.

On the other hand, it can lead to misusing or mismanaging the country’s resources, weaving a path for corruption and leaving behind a disastrous impact on an economy.

Fragile governments frequently suffer from weak internal governance and lack the ability to develop constructive relationships with other governments.

In such an environment, people feel unsatisfied and put their own interests above that of the country, which ultimately gives rise to anti-social actions, and such countries are always rated high on risk.

3. Economic sanctions

Post-cold war, economic sanctions have been one of the defining features of the political landscape.

The political intentions behind such sanctions are diverse and aggressive, and the reasons for imposing them can range from lessening of weapons of mass destruction to the improvement of fundamental human rights i.e. they are imposed mostly for bringing about what is considered to be positive change in a specific policy or behaviour of a country.

However, there is a widespread academic debate over the efficiency of a sanctions program and, as per a report from World Finance Magazine, the success rate of sanctions has been ‘very poor’ over the last few decades.

Nevertheless, it has certainly worked for the benefit of the global community however, the country which has sanctions imposed on it can suffer significant negative effects, including damages to its economic growth, as the country is viewed as a high risk by the world which eventually cuts down the investment opportunities that would have been there if the country wasn’t sanctioned.

4. Non-compliance with international bodies

Every country has to try and fulfil international commitments so as to avoid the risk of being punished by the global community.

Countries should take measures to comply with international bodies such as the United Nations or the Financial Action Task Force (FAFT) recommendations as these can help financial institutions achieve stability and reduce exposure to reputational risk.

Countries that do not show interest in complying with such international bodies are viewed as jurisdictions that pose a higher risk as they are deemed to have inadequate AML policies in place.

5. Regulatory standards

Regulatory standards capture the perception of the ability of the government to formulate and implement policies and promote economic development, adequate regulations achieve the social welfare goals laid by the government.

A good regulatory regime will help the economy boom by improving trade policies, making it easier for citizens to start a new business, bringing in fair price controls, promoting the participation of the private sector in infrastructure projects and strengthening of the banking system, and so on.

On the contrary, a bad regulatory regime can prove disastrous for a country, by shutting down investment opportunities and draining the money out of the economy, forcing a country to tumble in the global market.

Countries with bad regulatory policies are not trusted by the global community, and they usually end up being blacklisted and considered as ‘risky.’

6. Governance

A regime with poor governance issues is a hotbed for corruption to flourish, and it also erodes economic development and ethical values of any country, violating the very rule of law.

It brings in political instability and creates obstacles for local and foreign direct investment, global competitiveness and economic growth. It eventually hits development, leading to rising levels of poverty and income inequality.

In such cases, the corporate sector is also severely hampered as international organisations can reduce ratings due to factors such as high corruption levels and the international community may decide against doing business with such companies. Such countries are often regarded as riskier by other countries.

7. Illicit industries

Illegal industries can interfere with legal business activities in many different ways, there-by causing significant damage.

These industries often use front companies, which specialise in blending the proceeds of illicit activity with legitimate funds, to hide the ill-gotten gains.

Many front companies have an abundance of illicit monies, which enables those involved in trade to offer products or services at a discount price compared to legally operating firms.

Over a period of time, it can lead to a situation where the private sector is largely controlled by illicit businesses. An example of such and industry is the drug trade in Mexico.

The negative reputation that results from these activities diminishes genuine global opportunities and sustainable growth while attracting criminal organisations and eventually becoming a high-risk country.

To conclude, the geographical risk is a very important criterion for deciding the risk factor of a client and should not be overlooked by financial institutions.

Since we live in a world where trade is highly competitive, countries cannot afford to establish themselves as ‘high-risk’ and lose any opportunities, they should be constantly trying to implement proper policies in place so that they are on the path of progress and taken as an inspiration by other countries.

About the author: Suresh Chavali is a subject matter specialist in the risk and compliance sector, focusing on know your customer (KYC), risk management, money laundering and terrorist financing schemes and trends. He has worked for various firms, including Barclays and Deutsche Bank.

This article is expressing personal opinions and is meant for information purposes only. The article does not intend to replace professional or legal advice. It is recommended that readers seek independent professional or legal advice, or speak to authorised persons/organisations.

Read more:

AML expert Denis O’Connor: Advice to new compliance staff

ECB orders Pilatus Bank to shut down after money laundering scandal

Confessions of a compliance officer: The risk-based approach goes wrong

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