Nepal moves closer to FATF’s greylist for not doing sufficient on anti money laundering

There are both murmurs and clamour in the streets and across social media alleging that political and corporate nexus is openly engaged in laundering illicitly earned funds into legitimate financial systems, real estate and hotel investments and even offshore accounts.

With growing concerns that Nepal is not doing enough to combat money laundering and enforce strict oversight on financial crimes, including corruption, illicit acquisitions, dubious investments and tax evasion, the country now faces the risk of greylisting at the hands of Financial Action Task Force (FATF), the inter-governmental global money laundering and terrorist financing watchdog.

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This is expected to have some serious implications for an economy which is in desperate search of stability.

One of the reasons the country faces this looming risk is its long impunity with corruption scams and financial crimes.

In this context, the Asia-Pacific Group on Money Laundering (APG) gave Nepal an observation period of a year to do the necessary to prevent itself from falling into greylist for money laundering risks. The report noted that “Nepal has few money laundering investigations, prosecutions and convictions for other high-risk predicate crimes”.

What is the Financial Action Task Force (FATF)?

The Financial Action Task Force (FATF) is the inter-governmental global money laundering and terrorist financing watchdog. 

The body sets international standards and works to generate the necessary political will to bring about relevant national legislative and regulatory reforms — to ensure national authorities can effectively go after illicit funds linked to drugs trafficking, the illicit arms trade, cyber fraud and other serious crimes. 

More than 200 countries and jurisdictions have committed to implement the FATF’s standards as part of a co-ordinated global response to preventing organised crime, corruption and terrorism.

Its key recommendations included passing bills on anti-money laundering (AML) and business promotion, enhancing the capacity of authorities, improving inspections of financial institutions, and implementing Targeted Financial Sanctions (TFS) for individuals and businesses suspected of terrorist activities.

The report also flagged corruption, human trafficking, tax evasion, and financial crimes as key risk factors pushing Nepal toward the grey list. It urged high-level commitment, legal reforms, and improved coordination between government agencies to combat money laundering effectively.

One year from then, the country now sits at the verge of being greylisted.

How does the country fare in the AML evaluation?

The current precarious situation demonstrates Nepal’s legislative compliance but lack of a strong commitment to enforcement.

The APG assessment divides compliance standards into two main categories — ‘technical rating’ which evaluates institutional and legal frameworks and ‘effective rating’ which measures the enforcement and investigative efficiency of anti-money laundering and counter-terrorism financing mechanisms.

While Nepal meets the necessary threshold in technical compliance, its abysmal performance in effectiveness remains a significant roadblock.

The technical compliance rating consists of 40 standards, classified into four levels: ‘largely compliant,’ ‘compliant,’ ‘partially compliant,’ and ‘non-compliance’.

Nepal has achieved ‘high compliance’ in 16 standards, ‘compliance’ in five, ‘partial compliance’ in 16, and ‘non-compliance’ in three.

To avoid being placed on the grey list, a country must meet at least 21 criteria at either ‘compliant’ or ‘highly compliant’ levels — which Nepal has met. With a few more legislative reforms after the APG evaluation came out last year, the number of fully met criteria has now reached 31, reportedly.

Although this marks progress, it does not shield Nepal from greylisting. The real issue lies in the ‘effective rating’ category, where the performance is really dismal.

Under the ‘effective rating’ category, 11 key criteria are measured using three levels of compliance: ‘High/Substantial’, ‘Moderate’ and ‘Low’ — where a country must achieve ‘High/Substantial Compliance’ in at least three of these criteria but Nepal has none.

It has secured moderate ratings in four areas and low in seven — a performance that practically seals its fate on the FATF’s watchlist.

Outcomes where Nepal has secured low rating include supervision, preventive measures, legal persons and arrangements and confiscation all relating to criminal financing, while others include investigation and prosecution on terrorism financing, preventive measures and financial sanctions related to terrorism financing and financial sanctions related to proliferation financing.

What can lie ahead for Nepal?

If Nepal is grey-listed, it could tarnish the country’s global financial reputation — the term “grey” alone carries significant negative connotations. Surface-level indicators are crucial to potential partners and collaborators and a grey list designation can have significant financial setbacks with impact on the banking sector and the external sector, including cross-border transactions, trade and foreign direct investment (FDI) and even foreign loans.

For instance, securing international trust for trade, including opening letters of credit, could become more difficult. The worst case scenario — potentially resulting in the rejection of letters of credit issued by the Nepali banks.

The quest for foreign investment may also become further difficult. As Nepal’s risk perception worsens, potential collaborators look for further due diligence. While this is about to come at a critical moment — just a few months after the country received its first-ever credit rating of BB-, a key milestone in the country’s effort to attract foreign capital which investors and bureaucrats both hailed as impressive.

If the listing is not addressed immediately, the country is set to face prolonged international monitoring, which could strain its financial system and growth prospects for years to come.

A 2021 study conducted by the International Monetary Fund (IMF) found a large, significant negative effect of grey-listing on capital inflows: a decline on average of 7.6% of GDP. It further noted that FDI inflows decline on average by 3.0 percent of GDP, portfolio inflows decline on average by 2.9 percent of GDP, and other investment inflows decline on average by 3.6 percent of GDP.

Last-minute efforts

Last week, Prime Minister Oli informed the Parliament about the high-possibility of Nepal’s greylisting. He blamed the previous government’s ignorance in delays in formulating the relevant legal and regulatory framework.

He had also presided over a high-level meeting in December last year along with coalition partner Nepali Congress President Sher Bahadur Deuba to discuss the matter and accelerate efforts.

And hoping that it can still avoid the greylisting, the Nepalis delegation led by the Nepal Rastra Bank (NRB) Governor Maha Prasad Adhikari had participated in a face-to-face discussion in The Philippines a week ago, before the PM addressed the Parliament. Reportedly, the international watchdog remained unconvinced.

The FATF will now make rulings on the grey list during the evaluation scheduled from February 17 to 21 in its headquarters Paris and that on black list which currently includes Iran, Myanmar and North Korea.

Chances are that Nepal will make one more effort at the assembly. The odds however remain unfavourable.

Meanwhile, Governor Adhikari has expressed his optimism stating that the country has completed sufficient groundwork and will get out of the greylist quickly even if it ends up there in the upcoming assembly.

Yet, with such a lackluster performance in the immediate outcomes where the country is yet to achieve a single ‘High/Substantial Compliance’ out of the required three, skepticism persists.