BEIJING Chinese banks must rate their clients' risk of criminal conduct on a scale of 1-5 as part of the central bank's moves to curb money laundering and fraudulent transactions estimated at hundreds of billions of dollars a year.
The new rules come as some experts cite China as the world's biggest source of 'dirty' funds and as it faces growing foreign pressure to scrutinize its financial links with North Korea and block cash transfers tied to Pyongyang's nuclear ambitions.
Global Financial Integrity, a Washington-based financial watchdog, estimated in December that China accounted for almost half of the $858.8 billion of illicit funds flowing into tax havens and western banks in 2010 - more than eight times the amounts for runners-up Malaysia and Mexico.
Over an 11-year period from 2000, China was home to $3.8 trillion worth of illicit financial flows originating from corruption, crime or tax evasion, the watchdog said. The numbers cannot be verified as there are few estimates in the market.
The People's Bank of China (PBOC), the central bank, issued its new anti-money laundering rules to financial institutions in December, requiring them to rate clients' risks based on their location and the nature of their businesses, including their levels of transparency, five accountants and bankers with knowledge of the rules said.
The rules were not publicly announced, and banks and insurance firms have to implement them by December 2015, the accountants and bankers said.
A person at the central bank, which oversees China's fight against money laundering, said the changes are intended to finesse regulations and improve monitoring efficiency. "One of the main goals is to change the method of regulation. Initial regulations were very cumbersome," he said, declining to be named due to the sensitivity of the subject.
Financial institutions must now identify their riskiest clients and exercise discretion when reporting suspect deals. In the past, clients were rated against a checklist of money laundering traits without differentiating risk levels. That led financial institutions to inundate authorities with information and false leads that impeded checks, experts said.
The Financial Action Task Force (FATF), an international money-laundering watchdog, said in 2012 after a review of China that the central bank received 8 million reports in two years from financial institutions flagging possible criminal conduct.
About 87 percent of those reports were filed because they fitted a type of transaction defined in the checklist and lacked any "subjective element of suspicion", the FATF said.
"In the industry, there is a term for this. It's called vengeful reporting of data: since I don't want to be held responsible, I'll report everything to you," the central bank source said.
The PBOC had no comment when contacted for this article.
While the FATF's review praised China's "good progress" in tightening money-laundering controls in more than a dozen areas, it raised concerns about inadequate efforts to freeze what it called terrorist-related assets and comply with international agreements on terrorism financing.
The number of money-laundering convictions in China, which the FATF had previously said was too low, was shown to have improved in the review, but with qualifications. Total convictions rose to 32,510 in 2008-10, up from just 150 in 2002-06, the FATF said, noting, the increase was driven by convictions for "receiving stolen goods", not money laundering.
Article 191 of the criminal law, which covers the laundering of proceeds from smuggling, corruption, terrorism, organized crime, drug crimes, financial fraud and the disruption of financial order, was invoked 20 times in 2008-10, the FATF said.
The central bank source said this is in part because Chinese courts tend to prosecute other criminal acts underpinning money laundering, such as corruption, while opting to drop money laundering charges to avoid exhausting legal resources. That infrequent enforcement of anti-money laundering laws has prompted criticism that China is not trying hard enough.
"Anti-money laundering laws in China are a joke," said a banker at a Chinese bank, who didn't want to be named due to the sensitivity of his comments. "They only go after a few cases."
Pressure on China to tighten controls is growing.
China's banking links with North Korea have drawn increasing attention, especially after the United Nations, with China's support, tightened financial sanctions against Pyongyang last month following its third nuclear test in February.
The sanctions require governments to block cash transfers to North Korea if they are tied to its nuclear and ballistic missile programs, and China - North Korea's sole diplomatic ally and largest trade partner - says it wants sanctions fully implemented. Still, diplomats say sanctions in North Korea have not been as successful as those in Iran, and depend largely on China if they are to be effective.
Chinese financial regulators had no comment in response to a report on South Korea's Yonhap news agency last month saying Beijing had warned North Korean banks to stay within the remit of their permitted operations in China or risk penalties.
SCORE AND RATE RISKS
Major accounting firms say they are now advising Chinese banks on how to design their own risk assessment models, which must be submitted to the central bank by December and comply with official guidelines.
Financial institutions are required to score their customers' risk profiles according to their geography, characteristics, business and industry from 0-100, and rate their risk levels from 1-5, accountants say.
Christopher Peter Wilson, principal of Deloitte's anti-money laundering and sanctions services for China, said the risk approach mirrors those in the United States and Britain, and shows China's rules are maturing.
Western regulators made a few high-profile catches recently, with HSBC fined $1.9 billion in December after U.S. investigations into its Mexican and U.S. operations found two drug cartels had moved $881 million through the bank. [ID:nL4N09L1YE] And Standard Chartered Bank had to pay $340 million to New York's banking regulator to settle allegations it hid transactions with Iran from authorities.
Addison Everett, a financial services partner at PwC, said global regulators are raising the bar on the effectiveness of the anti-money laundering and economic sanctions compliance processes of international banks. Besides the ballooning cost of violations, large global banks are increasingly concerned about business lost through damaged reputations, he added.
"The challenge (Chinese banks) are going to have as they expand is driving consistent risk assessment, monitoring, and reporting practices across different jurisdictions," he said.
(This story amends Deloitte job title in paragraph 24)
(Reporting by Koh Gui Qing; Editing by Ian Geoghegan)