Dirty Money: How Banks Influence Financial Crime

43 Pages Posted: 23 Nov 2020

See all articles by Janet Gao

Janet Gao

Indiana University - Kelley School of Business

Joseph Pacelli

Indiana University - Kelley School of Business - Department of Accounting

Jan Schneemeier

Indiana University - Kelley School of Business - Department of Finance

Yufeng Wu

University of Illinois at Urbana-Champaign - Department of Finance

Date Written: October 30, 2020

Abstract

On September 21st, 2020, a consortium of international journalists leaked nearly 2,500 suspicious activity reports (SAR) obtained from the U.S. Financial Crimes Enforcement Network, exposing nearly $2 trillion of money laundering activity. The event raises important questions regarding what role banks play in facilitating financial crime and the effectiveness of SAR reporting. In this study, we examine the incentives that banks face to report money laundering activity via SAR reports, and the implications of a bank’s reporting strategy for criminal activity. We first analyze banks' SAR reporting decisions using a stylized model, which predicts that banks facing depressed revenues from their routine business lines and more profit-seeking pressure adopt more lax reporting policies. These reporting policies help to attract criminals, thus increasing the underlying amount of suspicious activities that banks need to examine and report. Empirically, we test the relation between risk-taking incentives and SAR volume at the county level. We find that counties in which banks face higher competition, lower profitability, and lower market-to-book ratios generate higher volumes of SAR activity. These effects are more pronounced for public banks that face greater risk-taking incentives vis a vis earnings pressure. We establish causality using shale gas expansion in unrelated states. Consistent with risk-taking incentives influencing SARs, we find that banks experiencing shale growth increases (decreases) generate fewer (more) SAR reports. Overall, our results provide important insights regarding the role of banks in influencing financial crime, and suggest that a bank’s reporting policy has indirect implications for local criminal activity.

Keywords: Banks, Risk-taking Incentives, Deposit Competition, Government Policy and Regulation, FinCEN Money Laundering

JEL Classification: G21, G28

Suggested Citation

Gao, Janet and Pacelli, Joseph and Schneemeier, Jan and Wu, Yufeng, Dirty Money: How Banks Influence Financial Crime (October 30, 2020). Available at SSRN: https://ssrn.com/abstract=3722342 or http://dx.doi.org/10.2139/ssrn.3722342

Janet Gao (Contact Author)

Indiana University - Kelley School of Business ( email )

1309 East Tenth Street
Indianapolis, IN 47405-1701
United States

Joseph Pacelli

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Jan Schneemeier

Indiana University - Kelley School of Business - Department of Finance ( email )

1275 E 10th St
Bloomington, IN 47405
United States

HOME PAGE: http://www.jan-schneemeier.com

Yufeng Wu

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

HOME PAGE: http://https://business.illinois.edu/profile/yufeng-wu2/

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