Are Bankers Crying Wolves? The Risk-Based Approach in Money Laundering Regulation and its Effects

Abstract

Excessive and useless reporting, called “crying wolf effect”, is a crucial shortcoming that any anti-money laundering (AML) design aims to address and fix. For this reason, in these years the AML policy has switched both in the US and in Europe from a rule- to a risk-based approach. This study investigates theoretically and empirically whether the risk-based approach delivers the expected results. The theoretical model shows that a tradeoff can emerge between accuracy – less type-I and type-II errors – and deterrence. The empirical analysis, conducted in the aftermath of the introduction of the risk-based approach confirms such a tradeoff in the case of Italy, where deterrence is maximized while sacrificing accuracy. In this respect, data suggest that Italian bankers are likely to act as crying wolves.

Keywords: Anti-Money Laundering; Suspicious Transaction Reporting; Standard of evidence; Type-I error; Type-II error; Deterrence; Italy

JEL Classification: G2, K2, K4