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El Salvador -- led by President Nayib Bukele  -- will be the first nation to formally adopt bitcoin as legal tender.  (Photo: El Salvador President's Office)
Wednesday, July 28, 2021
Trade Talk

El Salvador: Money Laundering Risk Grows


Latin America competitiveness worsens.

BY LATINVEX STAFF

El Salvador's recent legislation establishing bitcoin as a legal tender would increase financial institutions' regulatory, financial and operational risks, including the potential of violating international anti-money laundering (AML) and terrorist financing standards, Fitch Ratings says.

Meanwhile, noted currency expert Steve Hanke warns that international money laundering officials will be closely examining El Salvador from now on.

“The Financial Action Task Force (FATF), the international money laundering and terrorist financing watchdog, will be all over El Salvadoran banks, businesses, and other financial institutions like a wet blanket,” he argues in an article in National Review.

Last month, The World Bank rejected a request from El Salvador to help with the implementation of Bitcoin as legal tender, the BBC reported. The international lender cited concerns over transparency and the environmental impact of Bitcoin mining.

Regulators have yet to announce detailed implementation guidance, however, the high level of bitcoin price volatility will challenge its use as a store of value and means of payment, Fitch argues.

The recently passed bill will make bitcoin a legal tender along with the USD on Sept. 7, 2021, if the recent appeal of unconstitutionality does not modify its implementation.

“During this ambitious timeframe, the country must create the regulatory framework pertaining to bitcoin, and finalize payment platforms and systems for the conversion of bitcoin to USD,” the ratings agency says. “All businesses must accept bitcoin as legal tender unless they do not have access to the technology needed to process the transactions. The actual rate of acceptance may be muted given the implementation challenges, as well as the country's low levels of financial inclusion and internet access.”

All existing obligations in the country may be payable in either bitcoin or USD, including bank loans. Capital gains will not be taxed and taxes can be paid in bitcoin, which could attract foreign inflows of bitcoin to the country.

“This may increase the risks that proceeds from illicit activities pass through the Salvadorean financial system,” Fitch says. “Bitcoin's lack of transparency could increase the risk of money laundering if regulations do not fully comply with Financial Action Task Force (FATF) standards. Correspondent banks could require more detailed due diligence and checks on El Salvador's financial institutions if regulations and controls are not robust enough to avoid tax evasion, money laundering and terrorist financing. The ratings of El Salvador's largest banks are support driven. Fitch believes foreign parent banks would provide operational and technical support to manage the risks associated with the implementation of bitcoin as all operations are consolidated at the parent level. However, the impact of reputational and regulatory risks will be incorporated in Fitch's assessment of parent support propensity once the scope of the new regulation is defined.”

Meanwhile, El Salvador has yet to meet Basel II or Basel III standards (with no capital requirements for market or operational risk) or IFRS accounting standards, which increases the likelihood of an inadequate accounting and/or risk-management framework, the ratings agency points out.

“Financial institutions could face potential volatility in the USD value of their balance sheets if bitcoin assets/liabilities are not quickly converted to USD or if positions remain open,” Fitch warns. “The lack of adequate regulations to manage banks' balance sheet exposure would be a credit negative based on a recent Basel prudential consultation. This would effectively fully deduct open positions from banks' regulatory capital.”

Hanke, who helped draft El Salvador’s dollarization law in 2001, says the bitcoin law in reality is a forced tender law, which will destroy the country’s competitive currency regime as it robs those being offered bitcoin a choice.

In addition, it will create a regulatory nightmare, he points out.

“From an FATF regulatory perspective, El Salvador has been as clean as a hound’s tooth,” Hanke says. “That will change if the Bitcoin Law is implemented on September 7. It will be nearly impossible for El Salvadoran banks, businesses, and their customers to comply with many FATF regulations relating to virtual-asset transactions. For example, it’s inconceivable that bitcoin transactions will meet the FATF’s know-your-customer requirements. If you are wondering whether the FATF will stick its nose into El Salvador’s forced tender of Bitcoin come September 7, the answer is an unambiguous “yes.” Just look at what the U.S. State Department has recently done. On July 1st, it identified 14 prominent El Salvadorans, including high-level members of President Bukele’s government, as corrupt and/or undemocratic actors. The Bitcoin Law, which was heavily supported and hastily passed by the Bukele government, promises to invite more sanctions.”

LATIN AMERICA LOSES COMPETITIVENESS

Latin America saw deteriorating competitiveness the past year, according to the latest ranking from Swiss-based business school IMD. 

All eight Latin American countries included on the 64-country ranking worsened.

Chile and Peru saw the worst declines (down six spots each), followed by Mexico and Colombia (down two spots each).

Brazil, Argentina and Venezuela all fell one spot. However, the decline of Argentina and Venezuela is also due to Botswana entering the list at 61st place, automatically pulling countries below down.  

Chile remains the most competitive and Venezuela the worst, according to the latest IMD ranking.

 


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