Portuguese Anti-money Laundering Policy: a Game Theory Approach

TLDR: In this paper, the authors adopt a game theory approach to study the efficiency of the combat against money laundering in Portugal, both with regard to the financial and the non-financial sector of the economy.

Abstract: The fight against money laundering has taken center stage in the global arena. The European Union (EU), in line with various international organizations, plays an active role in the fight against this crime and promotes anti money laundering directions to its member states. The statistics regarding Portugal (a member of the EU since 1986) indicate that it lags behind most of the EU members in terms of reporting of suspicions of money laundering. This paper adopts a game theory approach to study the efficiency of the combat against money laundering in Portugal, both with regard to the financial and the non financial sector of the economy. Additionally, the paper studies the impact of the increase of sanctions, as recommended by the 4th Directive 2015/849 of the European Parliament and of the Council of 20th May of 2015, on that combat. The results show that the low probability of the institutions being caught (and fined) for not complying with their reporting duties, coupled with the low conviction rates for money laundering crimes, justifies the reduced number of suspicious transactions reported. The findings highlight that an increase of sanctions, on both financial and non financial institutions, would tend to augment the efficiency of the combat against money laundering in Portugal.

Figures

Figure 1: The phases of money laundering

Table 1: Number of STR the FIU received, from 2008 to 2013

Figure 3: The stages and respective responsible agencies in the combat of money laundering in Portugal

Figure 4: Game 1 Tree representation for the banking sector

Figure 2: Number of suspicious transactions reports in the EU in 2008

Figure 5: Game 2 Tree representation for the Non Financial Institutions

Full text

Portuguese anti-money laundering policy: a game theory
approach
Shital Jayantilal
Universidade Portucalense
Portucalense Institute for Legal Research – IJP,
Research on Economics, Management and Information Technologies – REMIT
Portugal
Email: shital@upt.pt,
+ 351 934081258
Corresponding Author
Sílvia Ferreira Jorge
Universidade de Aveiro
Departamento de Economia, Gestão e Engenharia Industrial / GOVCOPP
Portugal
Email: sjorge@ua.pt
Ana Ferreira
Portugal
Email: anasferreira.portugal@gmail.com

1
Portuguese anti-money laundering policy: a game theory approach
ABSTRACT
The fight against money laundering has taken centre stage in the global arena. The
European Union (EU), in line with various international organizations, plays an active
role in the fight against this crime and promotes anti money laundering directions to its
member states.
The statistics regarding Portugal (a member of the EU since 1986) indicate that it lags
behind most of the EU members in terms of reporting of suspicions of money
laundering. This paper adopts a game theory approach to study the efficiency of the
combat against money laundering in Portugal, both with regards to the financial and the
non financial sector of the economy. Additionally, the paper studies the impact of the
increase of sanctions, as recommended by the 4
th
Directive 2015/849 of the European
Parliament and of the Council of 20
th
May of 2015, on that combat.
The results show that the low probability of the institutions being caught (and fined) for
not complying with their reporting duties, coupled with the low conviction rates for
money laundering crimes, justifies the reduced number of suspicious transactions
reported. The findings highlight that an increase of sanctions, on both financial and non
financial institutions, would tend to augment the efficiency of the combat against money
laundering in Portugal.
Keywords: Banking Sector, Non financial Institutions, Money Laundering, Game
Theory
JEL: G21, G23, C78, K42

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1. INTRODUCTION
In the last decades of the 20
th
century, money laundering has become a problem of
global dimension driven by a series of worldwide tendencies such as: the progressive
liberalization of capital movements and international trade; the surge of new and
complex financial instruments; the creation and development of new technologies and
telecommunications and the existence of tax havens (Vaithilingam, Nair &
Thiyagarajan, 2015). Money laundering is seen as the dark side of the globalization
process (Brandão, 2002).
Although the exact dimension of the problem is difficult to quantify, given its very
nature, various estimates indicate that it has a significant impact. This criminal
phenomenon affects all countries and Portugal is no exception.
Portugal is a small country situated at the western tip of Europe. The establishment of a
democratic regime in 1974 was followed by a decolonization process and slowly
Portugal traded its Atlantic orientation for Europe, integrating the European Union (EU)
in 1986. After joining the EU, Portugal began to register high levels of growth but
structural deficiencies persist (Becker, Philipson & Soares, 2003). More recently, the
Portuguese economy, like so many others worldwide, was shaken by the global
financial crisis of 2010. In order to cope, Portugal’s prime minister at the time, José
Socrates, requested financial assistance to the IMF and the EU and in 2011, he oversaw
the negotiations which ensured the 78 billion euro bail-out. Subsequently, José Socrates
lost the general election but, in November of 2014, he was back in the headlines when
he was arrested on suspicion of money laundering and other criminal activities.
1
Another scandal implicates Ricardo Salgado, head of one of the oldest and most
influential families in Portuguese banking, who was also detained on money laundering
suspicions, in 2014. Ricardo Salgado was in charge of Espírito Santo Group, which,
among various business interests worldwide, held one of the largest and oldest banks in
Portugal – Banco Espírito Santo (BES) – which was later split in two banks: Novo
Banco, which kept its healthy operations, and a "bad bank" to keep its toxic assets.
1
Retrieved from http://uk.reuters.com/article/uk-portugal-corruption-socrates-idUKKCN0J606D20141122/.

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Shareholders and investors in the family companies and BES have lost many billion
euros, making this one of the biggest corporate collapses in the history of Europe.
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Earlier, in 2008, another Portuguese banker –José Oliveira e Costa – president of Banco
Português dos Negócios (BPN), was also arrested, on suspicion of money laundering
among other crimes. The bank was later nationalized, although it represented a marginal
share of the banking sector. The justification given for the bail-out was to prevent any
contamination to the financial system. Yet many speculated that more than 7billion
euros of tax payers money was used to save the bank where many politicians (including
the president Cavaco Silva) had interests.
3
It has not only been banks and bankers and politicians who have been in the lime light
in Portugal, due to money laundering suspicions. A complex investigation, code named
‘Matryoshkas’ uncovered ties to the Russian mafia and to off-shore shell companies,
and led to the detention, in mid 2016, of Russian businessman, Alexander Tolstikov,
owner of a third-tier Portuguese football team, União Desportiva de Leiria, detained on
money laundering suspicions.
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These are just a handful of cases which have been brought to the attention of the general
public given the notoriety of the key individuals involved, and have highlighted the
importance of combating money laundering in Portugal.
The objective of this paper is two-fold. Firstly, to study the efficiency of the money
laundering combat Portugal, both with regards to the financial and the non financial
sector of the economy. Secondly, to analyze the impact on that efficiency of the
application of the 4
th
Directive, Directive 2015/849 of the European Parliament and of
the Council of 20
th
May of 2015, in particular, the reinforcement of sanctions to the
institutions who do not comply with the anti-money laundering measures. In order to do
so we model two games which describe the institutional process under money
laundering combat, first on the financial institutions, focusing on banks, and then on the
non financial institutions. Our paper contributes to the analysis of the efficiency of anti-
2
Retrieved from http://www.reuters.com/article/us-portugal-bes-salgado-idUSKBN0FT0XS20140724/.
3
Retrieved from http://uk.reuters.com/article/portugal-bpn-idUKLDE76K0KP20110721/.
4
Retrieved from http://edition.cnn.com/2016/05/04/europe/portugal-russian-mafia-allegations/.

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money laundering policies, using an economic modeling methodology, game theory
model, which predicts the rational behavior of the institutional players in this process.
The Nash equilibrium results show a higher propensity to report, in equilibrium, for the
banks, when compared to the non financial institutions. Our findings illustrate that the
raise in sanctions will increase the propensity of all obliged institutions to report any
suspicion of money laundering. Additionally, our results emphasize that an effective
inspection and supervision process will also augment the propensity of all obliged
institutions to report such suspicions.
This paper begins with the presentation of the money laundering combat in the
Portuguese context, which is then followed by the presentation of the model and
discussion of the results. The paper finalizes by, reflecting on the implications, and
limitations, of our findings in terms of the efficiency of the anti-money laundering
policy in Portugal, and suggests future avenues of research.
2. ANTI-MONEY LAUNDERING IN PORTUGAL
Although there is not a consensus on exactly what is the definition of money laundering,
it is generally accepted that it is a process through which criminals conceal the real
origin of the revenue/property, obtained through illicit means, endowing it with some
legitimate appearance to make it legally reusable (Masciandaro, 1999). This process
encompasses three stages: (1) Placement: the illegally derived funds are placed into the
financial system, usually through a financial institution; (2) Layering: that
revenue/property is used in multiple transactions to conceal its origin; (3) Integration:
the ‘washed’ revenue is reintroduced in the legitimate economy. Figure 1 illustrates
these phases.

Frequently asked questions

Q1. What are the contributions in "Portuguese anti-money laundering policy: a game theory approach" ?

The statistics regarding Portugal ( a member of the EU since 1986 ) indicate that it lags behind most of the EU members in terms of reporting of suspicions of money laundering. This paper adopts a game theory approach to study the efficiency of the combat against money laundering in Portugal, both with regards to the financial and the non financial sector of the economy. Additionally, the paper studies the impact of the increase of sanctions, as recommended by the 4 Directive 2015/849 of the European Parliament and of the Council of 20 May of 2015, on that combat. The results show that the low probability of the institutions being caught ( and fined ) for not complying with their reporting duties, coupled with the low conviction rates for money laundering crimes, justifies the reduced number of suspicious transactions reported. 

Q2. What future works have the authors mentioned in the paper "Portuguese anti-money laundering policy: a game theory approach" ?

This article resorts to mathematical and solid foundations of game theory, to study the efficiency of anti-money laundering policy and extends it to predict the impact that a possible increase in sanctions, as recommended by the 4th EU Directive, could have on that efficiency, in Portugal. An opportunity for future research would be to resort to other type of games, such as those of imperfect information games. Finally, future work may consider other potential factors that might influence the decision making ( following Levi ( 2006 ) the model could capture the role of information exchange between institutions and also from Harvey ( 2005 ) the model setup could study what might be regarded as deterrent for cooperation between the institutions and law enforcement agencies ). The findings further demonstrate that adopting the recommendation of increasing sanctions will induce an increase in the propensity of reporting not only for banks but also for NFI, where these were very low or nonexistent. 

Q3. What is the critical stage for the money launderer?

The Placement stage is the most critical for the money launderer as it is the closest to the origin and also where it is easiest for the revenue flows to be detected. 

Q4. What is the purpose of this paper?

In this paper the authors will use game theory to contribute to a better understanding of the Portuguese reality, as reflected by the statistics, and also study the impact that the increase of sanctions for not reporting suspicious transactions can have on the efficiency of the fight against money laundering. 

Q5. What is the purpose of this article?

This article resorts to mathematical and solid foundations of game theory, to study the efficiency of anti-money laundering policy and extends it to predict the impact that a possible increase in sanctions, as recommended by the 4th EU Directive, could have on that efficiency, in Portugal. 

Q6. What is the effect of the r on the derivative of the darker shaded grey areas?

15 Notice that before the recent EU Directive, there was no Nash equilibrium where NFI reports but as ∆ increases, NFI starts to report in equilibrium, for high f and c. 16 The authors show that the derivative of the darker shaded grey areas in terms of r is also always positive. 

Q7. What is the importance of increasing sanctions?

In practical terms, and for the policy makers, their findings highlight the importance of implementing the EU Directive recommendation of increasing sanctions but also ensuring their effective implementation, through more efficient supervision and inspection. 

Q8. What is the payoff of the PPO when the bank decides not to pursue the case?

When the PPO does not pursue the case to the judicial stage the payoffs of the PPO are (– 2), due to the loss of reputation PPO suffers for having decided to stop the process but the payoffs of the FIU are (– 3) since there is an extra loss due to the end of the process after the FIU decision to investigate further. 

Q9. What is the importance of the analysis?

In other words, this analysis emphasizes the importance of the Bank of Portugal being more vigilant (higher probability of catching any possible not compliance) to ensure that the banks do report any suspicion of money laundering they may come across. 

Q10. What is the payoff of the bank when it does not report?

The authors assume that, when the bank does not report, both FIU and PPO get a payoff of (– 1) when the Bank of Portugal does not apply a fine and (1) otherwise, since FIU and PPM aim to combat money laundering.