The Treasury Designation



After a delay as a result of a required comment period, Treasury has now issued its much-anticipated final rule on North Korea's indirect access to US financial markets (the full Federal Register explanation of the rule can be found here, and makes for a pretty dense read). A natural experiment is about to start. Will so-called “secondary sanctions” have a substantial effect on North Korea’s political economy, as proponents such as Josh Stanton have argued (see his analysis of the rule here)? Or will a combination of risk-taking small banks, unregulated jurisdictions, borrowed-name accounts, Chinese pushback and lax Treasury enforcement provide space for North Koreans to survive? I wish I could say I even had a prior on this one, but I can honestly imagine it going either way or most likely somewhere in the middle, with costs imposed but not fatal ones.

It is important to understand that the new measure is not a “sanction” in the traditional sense of being a policy measure that is directly under the control of the US. Rather, it is a designation of the entirety of North Korea as a jurisdiction of primary money-laundering concern and the introduction of the so-called fifth set of “special measures” which are explained in more detail below. The ruling means American banks are required to inform their correspondent banking partners that they—in turn—must conduct due-diligence to assure that they are not conducting business with North Korean financial institutions (including both existing ones and new ones that might proliferate; this is the advantage of designating the entire jurisdiction). Not only do such correspondent-banking clients put their access to the US financial market at risk by doing business with North Korean banks. The ruling also appears to require that correspondent banks undertake due diligence with respect to entities such as Hongxiang that effectively provide shadow-banking services to North Korean state-trading companies. The new measure did not deploy all of the special measures under Section 311 of the Patriot Act that it might have, including one involving the requirement to probe the beneficial ownership of accounts held directly in US institutions that might be suspect. But nonetheless, there is little question that this could squeeze North Korean banks’ access to banking services globally because of the significance of access to the American market.

The new measure did not deploy all of the special measures under Section 311 of the Patriot Act that it might have...But nonetheless, there is little question that this could squeeze North Korean banks’ access to banking services globally...

But there are a number ways in which this might have less effect than expected, and I will simply tick them off:

  • The Financial Action Task Force (FATF) has done its level best to identify and pressure jurisdictions with weak regulations on money-laundering. But there are nonetheless about a dozen countries that are deemed high-risk and non-cooperative. On that list: Iran. Could this even push the North Koreans toward greater reliance on Tehran?
  • Within countries that nominally are cooperative with respect to FATF standards, there may nonetheless be smaller regional or provincial banks that either don’t have significant exposure to the American market (doubtful, I suspect), think the risks are worth taking or simply don’t meet global compliance standards. Bank compliance costs have been rising in the advanced industrial states, and it is easy to imagine smaller banks in middle- or low-income jurisdictions taking a laissez-faire attitude towards transaction monitoring or customer identity (“Know Your Customer”) norms. Think Laos (one of the uncooperative jurisdictions by the way).
  • But it is not just Laos; it is also China. North Korea borders on an area with a dense population of Korean-Chinese who might well believe they can make money by opening what might be called “borrowed name” accounts. If my 20-year old son can get a credible fake ID in the US, what do we think it is like to get one in China? Chinese authorities ultimately need to be brought on board this effort as well, as they ultimately were in the Hongxiang case when the information on the group was made public.
  • The way the designation “works” is through the incentives it creates for US banks, but ultimately for the corresponding banks with which they deal. Do those banks have the same incentives? That will depend in no small measure on Treasury calling out violators and swiftly assuring they are cut off from the US market; this was why the designation of Banco Delta Asia had such swift effect. If violators are not identified and punished, then the incentives to skirt the rule increase. In short, while often thought to be completely self-enforcing, the ruling isn’t. It will depend on banks believing that the US really will act, perhaps supported by China.
  • The idea that a country of this size can operate on a cash basis may seem preposterous, and anywhere else it might be. But if you have to operate with cash, you operate with cash. I can certainly imagine enterprises that would be willing to do business on the basis of couriers and cash, even if the scale of such operations is necessarily limited.
  • Finally, we don’t know if the Chinese government or local authorities might be willing to avert their eyes from such practices or even push back against them by informing banks that they are not to comply. Of course, this runs the risk of a direct confrontation because Treasury has the discretion to act if the offending banks are caught out. But we cannot rule out counter-strategies to limit the effects the sanctions might otherwise have.

North Korea has brought this ruling on itself, and I am not opposed to it. But whether it will work economically remains an open question. And in any case it is not likely to work politically in terms of getting back to negotiations unless there is a process through which that can transpire. That, in turn, will require that South Korea, China and the US put their heads together.

From the Federal Financial Institutions Examination Council Special Measures Overview: Prohibitions or Conditions on Opening or Maintaining Certain Correspondent or Payable Through Accounts

“Under the fifth, and strongest, special measure, banks may be prohibited from opening or maintaining in the United States any correspondent account or payable through account for, or on behalf of, a foreign financial institution if the account involves a jurisdiction, financial institution, class of transactions, or type of account that is of primary money laundering concern. The imposition of this measure can prohibit U.S. banks from establishing, maintaining, administering, or managing in the United States a correspondent or payable through account for, or on behalf of, any financial institution from a specific foreign jurisdiction. This measure may also be applied to specific foreign financial institutions and their subsidiaries.

The regulations that implement these prohibitions may require banks to review their account records to determine whether they maintain no accounts directly for, or on behalf of, such entities. In addition to the direct prohibition, banks may also be:

  • Prohibited from knowingly providing indirect access to the specific entities through its other banking relationships.
  • Required to notify correspondent accountholders that they must not provide the specific entity with access to the account maintained at the U.S. bank.
  • Required to take reasonable steps to identify any indirect use of its accounts by the specific entity.”

More From

Related Topics