Money Laundering/Terrorist Financing in Nepal PDF

**Chapter 3** ============= **Money Laundering /Terrorist Financing (ML/TF) Risk and Nepalese Context** =========================================================================== The risk associated with ML/TF is the possibility that financial institutions and systems will be used to wash money o...

**Chapter 3** ============= **Money Laundering /Terrorist Financing (ML/TF) Risk and Nepalese Context** =========================================================================== The risk associated with ML/TF is the possibility that financial institutions and systems will be used to wash money obtained illegally or fund terrorist endeavors. For the purpose of creating effective counterterrorism financing (CFT) and anti-money laundering (AML) policies, it is imperative to comprehend these threats. The integrity and stability of the global financial system, as well as the economy of member nations, depend on the implementation of effective anti-money laundering and countering the financing of terrorism (AML/CFT) laws and regulations. Terrorist financing (TF), the financing of the proliferation of weapons of mass destruction (WMD) or proliferation financing (PF), money laundering (ML), and related underlying crimes (also known as \"predicate offenses) are all regarded as economic crimes that can endanger both the external stability of a country and the integrity and stability of its financial system in general. They may lead to banking crises, inefficient revenue collection, wider governance flaws, reputational hazards for global financial hubs, loss of correspondent banking relationships (CBRs), and destabilizing \"hot money\" coming from inflows and outflows (IMF, n.d.). **3.1 National Context** ------------------------ 1. ### **Nepal ML/TF Risk and Context** 1. #### **Money Laundering (ML) Risk** Money laundering risk is the possibility that financial institutions, companies, or individuals will be used as a conduit for illegal activities, such as drug trafficking, financing of terrorism, or other criminal activities. The main money laundering risks in Nepal is associated with the crime of human trafficking, tax evasion, and corruption since they have the biggest potential to produce profits. Both direct and indirect tax evasion are caused by a culture of noncompliance, high compliance costs, and lax enforcement. Nepal is a source, transit, and destination country for human trafficking, an estimated 1.5 million Nepalese people are at risk of being victims of human trafficking. Nepal\'s border region poses a serious risk because it is closely linked to both domestic and manufacturer of drugs in the country. The permeability of the border facilitates the smuggling of individuals, money, fake bills, gold, and other valuable metals. Also, the fact that Nepal is a source and transit country for the illegal wildlife trade increases the possibility of money laundering. Because of the country\'s close ties to India and other countries in the area, domestic proceeds are mostly laundered there and abroad. According to (Mutual Evaluation Report, 2023), the banking industry (including remittances), the insurance sector, the DPMS and real estate sectors, and cash laundering are highlighted in Nepal\'s data and statistics on money laundering instances #### **Terrorist Financing (TF) Risk** Terrorist Financing risk refers to the probability of resources or money be systematically directed toward terrorist groups or operation. This risk entails a variety of strategies and tactics, both legal and illicit, that are employed to obtain, move, or use money in support of terrorism. Nepal is not a jurisdiction with a high TF risk. There haven\'t been any instances of international terrorism during the review period and does not contain any citizens or individuals or entities based in Nepal that have been designated in accordance with UN Security Council Resolutions (UNSCR). Nepal is not recognized as a significant source or transit area for foreign terrorist combatants. There are reports that suggest Nepal may be used as a staging area or transit area for terrorists looking for a place to hide, making its porous border a major risk factor in the relationship to regional terrorism and TF activity. Additional open-source reports from the region show that extremists driven by religion and supported by foreign powers. Recently, organizations have become more prevalent in Nepal, especially around the border between India and Nepal (Asian News International , 2023). ### **Major Predicate offence generating financial proceeds** Crimes that lead to illegal gains that are subsequently laundered to give the impression that the money is lawful are referred as Predicate offences. Drug trafficking, human trafficking, arms trafficking, cooperatives, counterfeit money, tax evasion, and gold smuggling are among the most occurring financial crimes in Nepal. These infractions have a serious negative effect on integrity and financial stability in the financial industry including insurance industry (Nepal Bank Limited, 2019). The following are some significant predicate offences that are generating financial proceeds in Nepalese context: 1. **Corruption and Bribery:** Corruption is the misuse of authority for personal benefit. It damages democracy, undermines confidence, impedes economic growth, and exacerbates social division, poverty, inequality, and environmental crises. In addition, it increases transaction costs, erodes fair competition, blocks long-term inward and outward investment, and reorders the objectives for development. Corruption is a key cause of Nepal\'s underdevelopment. Corruption is pervasive in Nepal, with high-ranking officials and politicians embezzling public cash and bribes. In 2021, the Commission for the Investigation of Abuse of Authority brought corruption accusations against 1,040 people, including government officials (Kharel, 2021). 2. **Environmental Crime:** Significant obstacles face the protection of species when it comes to the poaching and illegal trading of highly sought-after species, which are carried out by multinational organized crime syndicates. The illegal trade in wildlife animal parts and products is estimated to be worth between US\$7 to US\$23 billion annually worldwide, according to a 2016 UN assessment. According to examples of illegal wildlife parts and products being seized, Nepal is mostly utilized as a transit nation and is also sought after as a source for animals including pangolins, tigers, rhinos, snow leopards, and red pandas (Wildlife Crime, n.d.). 3. **Tax Evasion and Fraud:** When an individual or corporation knowingly neglects to pay their true tax responsibilities, it is considered as tax evasion and is a criminal offense. Criminal prosecution and harsh fines await those who avoid taxes. Clause 2 of the Asset (Money) Laundering Prevention Act (ALPA), 2008, lists tax evasion as one of the 32 predicate offenses. Tax evasion has been cited in both NRA studies as one of Nepal\'s top dangers. Tax evasion is a big issue in Nepal, with many enterprises underreporting income and avoiding taxes. In 2021, the Inland Revenue Department found tax evasion worth more than \$10 million. 4. **Cybercrime:** Cybercrime is any criminal activity related to or carried out through a computer system or network, including crimes like illicit information distribution or possession through a computer system or network. Cybercrime is, to put it briefly, criminal activity conducted online. Cybercrime is classified as a predicate offense because it produces illicit proceeds that must first be covered up through money laundering in order to be incorporated into the established financial system. 5. **Counterfeiting (imitating) currency, Infringement of intellectual property rights:** Making unauthorized copies of real goods with the intention of misleading or defrauding is known as counterfeiting, and it is a serious offence. One example of this is when a company\'s trademark is a word, phrase, or symbol used to identify a good or service is stolen. Making fictitious money or other objects, such documents, is another form of counterfeiting. 6. **Drug trafficking:** It is the illegal commerce and distribution of narcotic drugs and psychotropic substances, which results in substantial illicit earnings. Nepal is a transit country for drug trafficking, with large volumes of heroin and hashish traveling through its borders. In one instance, the Narcotics Control Bureau recovered 72 kg of hashish worth more than \$1 million from a vehicle near the Indian border in 2021. 7. **Human trafficking:** It is defined as the recruitment, transportation, transfer, harboring, or reception of people for exploitation using threats, force, coercion, abduction, fraud, or payments. Nepal serves as a source, transit, and destination country for human trafficking. Traffickers frequently attract victims with false promises of employment before exploiting them in the sex trade or forced labor. The National Human Rights Commission of Nepal said that in 2022, police rescued 1,279 victims of human trafficking, including 276 children and 1,003 women. 8. **Gold smuggling:** Gold smuggling is the unlawful trading and movement of gold across borders without disclosing it to customs authorities, typically in order to avoid taxes, tariffs, or regulatory regulations. Gold smuggling has become a major concern in Nepal, with the country acting as a transit hub for smuggling operations largely linked to India and China. In 2022, customs authorities confiscated over 100 kg of gold worth \$5 million from the Tribhuvan International Airport (Ojha, 2024). **3.2 Insurance Sector Related Risk Factors** --------------------------------------------- In Nepal, the insurance business faces a number of risks relating to money laundering and terrorism financing (ML/TF). These hazards have a substantial impact on insurance firms\' operational integrity and financial stability. National Risk Assessment of Nepal determined that the insurance sector\'s overall level of ML vulnerability as medium. The broad AML controls also have a medium-low level of quality. Both the life and non-life industries are subject to AML/CFT regulations; however, the life insurance industry is given particular emphasis. Other findings found in the banking industry are mostly comparable to those found in the insurance industry. Thus, it has been determined that the insurance industry\'s susceptibility is a cause for increasing concern. The following are key definitions and descriptions of various risk factors. ### **Product related Risk** #### **Life Insurance Product** Nepal\'s insurance business faces a complex terrain of AML/CFT risk factors, which can have a substantial influence on its operations and image. To reduce these risks, insurers must take a proactive approach, building strong compliance frameworks, improving employee training, and investing in technology to properly monitor and detect suspicious behavior. By addressing these issues, the insurance industry can help Nepal\'s financial system become more stable. Some of the Life Insurance Products, which are highly at risk, are as follow: ##### **3.2.1.1.1 Endowment Life Insurance** Endowment Policy is designed to pay a lump sum with a bonus after a specific term or on the death of the insured. Usually, this type of policy covers five years to thirty years of coverage. Policies in this segment are typically of traditional nature and are most popular in Nepal. This Policy can be purchased by an individual or group. The size of this product covers more than fifty percent of the total life insurance market. It is one of the prominent portfolios with significant annual premium. Endowment Policies are sold through the corporate or an individual agent. The insured does not have an option to link the policy to investment products. However, the insured can obtain 90 percent loan of the premium paid and the policy can be surrendered after three years of continuation of the policy. This policy is purchased mostly by the people who tend to use insurance as a means of saving and the coverage of the risk. The permissible cash activities, as per the AMLCFT directives, are limited to NRs one hundred thousand for the payment of premium; the premium more than this has to be paid using the banking instruments. The payment for the claims has to be made through the banking channel for the payment of more than NRs fifty thousand. The cross-border payment of the Policy has not been allowed and the beneficiary has to be properly verified for the payment of the claims. Reasons for Vulnerability: - Cash payment up to NRs. 100 thousand is allowed - Loan and payment of surrender value can be obtained - Sold through Insurance agent, the clients are behind the scene. So, non-face to face transaction possible. - Single premium payment of premium is also permissible. - Can be subscribed as a beneficial owner in the name of family members and close associates **Anticipated Endowment Life Insurance Policy** Anticipated Endowment Policy is similar to the Endowment Policy except that a part of the sum assured is paid at certain intervals during the term of the policy and the balance of the sum assured together with the accrued bonus at maturity. This Policy can be purchased by an individual or group. This product covers considerable size of premium income in a total life insurance market. Anticipated Endowment Policies are sold through the corporate or an individual agent. The reasons for this product being vulnerable to ML/TF abuse being the same as Endowment Life insurance Policies. **Modified Endowment Life Insurance Policy** Modified Endowment Policy is similar to the traditional Endowment Policy except that some additional benefits like accidental benefits, critical illness coverage, and educational expenses coverage are added to the insurance contract by adding riders. The policyholders have the option to select the riders as per their need and an additional premium is loaded accordingly. This Policy can be purchased by an individual. Modified Endowment Policies are sold through the corporate or an individual agent. The insured does not have an option to link the policy to investment products. The reasons for this product being vulnerable to ML/TF abuse being the same as Endowment Life insurance Policies. ##### **3.2.1.1.2 Whole Life Insurance** Whole life insurance provides coverage for the life of the insured. In addition to providing a death benefit, whole life also contains a savings component where cash value may accumulate. These policies are also known as permanent or traditional life insurance. This product is comparatively cheaper in terms of the premiums to be paid and the benefits are provided to the dependents of the life assured only after the death of the insured. This type of policy is generally sold by the use of agents and covers significant premium collection. As long as payments are paid, whole life insurance is a sort of permanent life insurance that covers the policyholder for the duration of their life. It is possible to misuse whole life policies by taking out loans against their cash surrender value or using them as collateral. A combination of weak KYC procedures, lax regulatory enforcement, and increase the risks associated with ML and TF to whole life insurance policies in Nepal. ##### **3.2.1.1.3 Pension Products** Life insurers in Nepal offer pension plans that assist people in saving for retirement and guarantee a steady income stream after retirement. They provide freedom in selecting between lump sum and annuity alternatives, as well as tax benefits. Although life insurance is one area where there are general ML/TF risks in the insurance industry, pension products are not expressly mentioned as high-risk areas. The legislative frameworks and designation of pension plans as low-risk transactions in Nepal make them typically regarded as low-risk for ML/TF. ##### **3.2.1.1.4 Term Life Insurance** Term life insurance provides coverage at a fixed rate of payments for a limited period of time. In Ordinary Term Life Insurance if the life insured dies during the term, the death benefit is paid to the [beneficiary](https://en.wikipedia.org/wiki/Beneficiary). Term insurance is typically the less expensive way to purchase a substantial death benefit on a coverage amount per premium basis over a specific period of time. Largely this type of product is sold by the use of corporate as well as individual agents. Since this product involve less premium and the benefits are payable only at the occurrence of the event, there involves less possibility of money laundering. There are also some Special purpose Term Life Insurance policies sold in Nepali insurance market for the specific purpose like foreign employment, credit security for the repayment of the loan. The other conditions for this type of policy are similar to the terms of Term life insurance. The basis for term life premiums is on a person's age, health, and life expectancy, which is set by the insurer. If the person dies within the specified policy term, the insurer will pay the face value of the policy. ##### **3.2.1.1.5 Single Premium Policies** Single-premium life Insurance Policies are the type of insurance in which a lump sum of money is paid as premium at once.  The benefits can be claimed at the maturity of the policy or at the death of the life assured. It is observed that this type of policy covers the medium volume premium in the insurance Sector. The premium is paid at once but there are provisions of loan against the policy. The maximum permissible loan amount is 90 percent of the premium paid. Insurance Companies at their discretion offer discounts to the premium as per their underwriting guidelines. In Nepal, single premium life insurance policies pose special dangers connected to money laundering and terrorism financing. Individuals wishing to launder criminal money or support terrorist activities may take advantage of these plans, which require the entire premium to be paid upfront for coverage over a predetermined duration. **Micro Life insurance Policies** Micro insurance is the type of insurance which covers low income household or to individuals who have little saving. It provides affordable insurance product to help them cope with and recover from financial losses. Insurance Act 2022 Part 8 Sec 75 has the provision of Micro insurance which mentions that every insurer shall carry on micro insurance business targeting low-income groups and backward areas. It is observed that this type of policy covers the low volume of premium in insurance sector. Micro insurance policies are specially designed for low income people and as there is a cap of maximum amount of sum assured per policy, there is a low risk of ML/TF involved. However, multiple policies at different companies can be subscribed by a single client pose a significant risk. ##### **3.2.1.1.6 Provisions on Loan and early surrender of the Life Insurance Policies** Policies that allow third-party payments may hide the source of funding. Criminals may exploit this feature to conceal the source of their money, affecting the insurer\'s ability to conduct proper due diligence. Nepal\'s insurance sector is still building AML/CFT frameworks. Insurers may struggle to put in place effective compliance controls, particularly in terms of client due diligence and monitoring of high-risk actions such as policy loans and early surrenders. **Examples of life insurance products and indicative risk ratings** (without prejudice to the other ML/TF risk factors such as transaction, distribution, geographical or customer risks) +-----------------------+-----------------------+-----------------------+ | **EXAMPLE OF PRODUCT | **TYPICAL FEATURES** | **INDICATIVE RISK | | DESCRIPTION** | | RATING** | +=======================+=======================+=======================+ | | - - - - | - | +-----------------------+-----------------------+-----------------------+ | | - - - | - | +-----------------------+-----------------------+-----------------------+ | | - - - - | - | +-----------------------+-----------------------+-----------------------+ | | - - | - | +-----------------------+-----------------------+-----------------------+ | | - - - | - | +-----------------------+-----------------------+-----------------------+ | | - - | - | +-----------------------+-----------------------+-----------------------+ #### **b. Non-life Insurance Product and associated risk** Non-life insurance products in Nepal are subject to a variety of risks that might have an influence on performance and growth. Here are some important non-life insurance products and their associated dangers. I. **Motor Insurance** It provides coverage for vehicle-related damages and liabilities. Risks include fraudulent claims for accidents or damages, which can be used by criminals to launder money. Underreporting of Vehicle Values where Insurers may struggle to effectively appraise the worth of automobiles, thus leading to underpricing and greater risk of fraudulent claims. II. **Property Insurance** Property insurance covers damage caused to property. People may intentionally create damages to claim insurance claims, which can be used to launder money. Policyholders may fail to reveal the true worth of their properties, resulting in insufficient coverage and potential exploitation. III. **Maritime Insurance** Marine insurance covers losses incurred by ships and cargo. Risks include cargo theft, which can be used by criminals to claim insurance and facilitate money laundering. Insurers may receive fraudulent claims for non-existent shipments or inflated cargo. IV. **Aviation Insurance** Aviation insurance covers losses incurred during aircraft operations. Catastrophic Losses create major accidents can result in large claims that can be exploited for money laundering. Insurers may face hefty liability claims from passengers or third parties that engage in fraudulent actions. **Case Study** +-----------------------------------------------------------------------+ | **Box A.1 Non-life insurance fraud, money laundering and terrorism | | financing in the context of organized crime and terrorism in France** | | | | An insurance contract policy is signed with a brokerage company | | dealing with second-hand cars. The purpose of the contract is to | | ensure vehicles and refund the purchase in case of total loss. Less | | than two years after the creation of the company, 10 vehicles are | | damaged by a fire (all of those vehicles were held for resale only). | | The prejudice of the company amounts to EUR 85 000. The purchase book | | of the company shows that the vehicles had been all purchased in | | cash. | | | | Further investigations uncovered new elements: the company's owner | | belongs to a criminal network who handles large amounts of cash | | (generated by violent money extortion, burglaries, theft and | | concealment, drug trafficking) to be laundered notably through | | insurance fraud. The CEO is in relation with another individual (from | | the same criminal community), who is a taxi driver that occasionally | | deals with purchase and resale of undeclared vehicles. The analysis | | of financial flows showed that this taxi driver transmitted part of | | the cash generated to a transferee of funds based in a country near | | the Syrian border. This individual is suspected of channelling funds | | to jihadist fighters. | +-----------------------------------------------------------------------+ **Examples** +-----------------------+-----------------------+-----------------------+ | **Attribute** | **Lower risk | **Higher risk | | | example** | example** | +=======================+=======================+=======================+ | Ability to hold funds | Product design that | Product design that | | | does not hold a | allows funds to be | | or transact large | balance or can't be | held on behalf of the | | sums | withdrawn against, | customer; high-value | | | such as group | or unlimited-value | | | benefits | premium payments, | | | | overpayments or large | | | | volumes of lower | | | | value premium | | | | payments | +-----------------------+-----------------------+-----------------------+ | Customer anonymity or | Product design that | Product design that | | third-party | only allows | allows deposits and | | transactions | transactions from | payments by third | | | customers with | parties or unknown | | | identification, or | parties or that | | | where all funds flow | provide for | | | back to customer | non-face-to-face | | | | transactions (for | | | | example, mobile apps | | | | if payment source | | | | unknown) | +-----------------------+-----------------------+-----------------------+ | Liquidity | Product design that | Product design that | | | includes significant | has no (or no | | | fees or other | significant) fees or | | | penalties for early | other penalties for | | | withdrawals | early withdrawal | +-----------------------+-----------------------+-----------------------+ | Time horizon | Products that are | Products that are | | | typically held for a | typically held for a | | | long period of time, | shorter time period | | | such as years, until | | | | retirement or death | | +-----------------------+-----------------------+-----------------------+ | Purpose and intended | Product design makes | Product design makes | | use of product | it easy to identify | it difficult to | | | if products are not | identify if products | | | being used as | are not being used as | | | intended | intended | +-----------------------+-----------------------+-----------------------+ The above table describes attributes used to assess the vulnerability of product offerings and provides lower and higher risk examples. **3.2.2 Customer Related Risk Factor** -------------------------------------- A certain amount of risk is associated with both natural and legal persons attempting to build relationships with the Insurance companies, depending on their background, profession, industry affiliation, subscribing goods and services, and channels of distribution and transactions. Every customer\'s risk profile is created during the customer onboarding process, transaction processing, and other standard procedures like updating their profile on a regular basis, updating their PEP database, updating their sanction lists, etc. Corruption, tax evasion, financial sector crimes, and the vulnerability of certain industries like banking, real estate, and informal money transfer channels are the main risk concerns associated with ML/TF customers in Nepal. Based on the data, Nepal\'s comprehension and evaluation of ML/TF risks, particularly customer-related aspects, in the insurance sector seem to be limited. ### 3.2.2.1 **Politically Exposed Persons** \"PEP\" refers to a person who is politically exposed. PEPs are people who currently hold or have held important public positions in Nepal and other nations. The phrase will also apply to others who are close to and related to these individuals. Members of a family can have any of the following kinds of relationships: 1. Grandparents, Parents and Children 2. Spouse/Partner 3. Siblings 4. In-Laws Close associates include the following types of relationship/s:Amended as per the decision of Board of Directors dated 2078/06/25 B.S. AML / CFT AND KYC POLICY (2019) 5. Partners outside the family unit 6. Prominent members of the same political party, civil organization, labor or employee union as the PEP 7. Business partners or associates, especially those that share (beneficial) ownership of legal entities with the PEP who are otherwise connected (e.g., through joint membership of a company board) 8. Anyone who has the sole beneficial ownership of a legal entity - Domestically Politically Exposed Persons (PEPs): People who are or have been entrusted with important public tasks on a domestic level. For example The President, Vice President, Prime Minister, Chief Justice, Speaker of House of Representatives, Chairperson of National Assembly, Chief of Province, Council of Ministers, Chief Ministers, Members of Federal Legislature, Members of Constitutional Bodies, Speaker of Province Assembly Provincial Council of Ministers, Officers of Special Class or equivalent to Special class or above Special Class of Government of Nepal, Judges of Supreme Court and High Courts, Deputy Speaker of Provincial Assemblies, Members of Provincial Assemblies, ------------- ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Central Committee Members of National Level Political Parties, Chiefs and Deputy Chief of District Coordination Committees, Mayors and Deputy Mayors of Metropolitan Cities, Sub Metropolitan Cities and Municipalities, Chairperson and Deputy Chief of Rural Municipalities and Higher Level Office Bearers of Institution partially of fully owned by the Government of Nepal. - **Foreign Politically Exposed Person**: People who hold prominent public positions in a foreign country, such as Heads of Nation, Heads of Government, Senior Politicians, Central Members of National Political Parties, Senior Government Officials, Chief Administrative Officers, Chief Judicial or Military Officials, and higher-level office bearers of state-owned corporations. - **Politically Exposed Person in International Organizations**: This term refers to individuals who are or have been entrusted with a prominent function by an international organization, such as members of senior management or individuals entrusted with equivalent functions, such as directors, deputy directors, and members of the board of equivalent functions. 1. **Access to Illicit Funds:** PEPs frequently have access to significant financial resources, which may include the results of corruption or other illegal acts. Their public positions may assist the misuse of state funds, making them prime targets for money laundering operations. 2. **Anonymity and Transaction Complexity:** Life insurance products are especially appealing for money laundering because of their potential to provide secrecy and complex transaction patterns. PEPs may use these items to hide the source of illegally obtained funds. For example, they can transfer ownership of policies or accept loans against the cash value of their policies without facing significant scrutiny. 3. **Geographical Risk:** The risk connected with PEPs can vary greatly depending on their country of origin. Countries with high levels of corruption pose larger dangers since PEPs from these regions are more prone to participate in illicit financial activities. Understanding the regional context is critical to risk assessment. 4. **Transaction Volumes and Patterns:** The volume and character of transactions undertaken by PEPs can reveal possible dangers. High transaction volumes or unexpected transaction patterns may necessitate more inspection. For example, a PEP with a modest transaction volume and genuine funding sources may be deemed less risky, whereas those with high volumes or suspect activity may be reported for further examination. 5. Their high profile and power to influence or assert the pressure to not to disclose the source of the fund 6. **Close Associates and Family Members:** PEPs may utilize relatives or close associates to carry out transactions that could avoid detection. This technique further complicates the risk landscape because these individuals may be participating in money laundering activities. Insurance firms must guarantee that their due diligence includes these related individuals. 7. **Regulatory Compliance Challenges:** Insurance businesses must comply with severe AML/CFT requirements, which necessitates more due diligence on PEPs. Failure to properly identify and monitor PEPs can result in severe regulatory penalties. Firms must build strong compliance structures to successfully reduce these risks. 8. **Reputation and reputational risk:** Insurance Industry may face reputational damage because of their association with PEPs. Being engaged with people linked to corruption or financial crimes can harm an organization\'s reputation, result in legal and regulatory implications, and diminish public trust. 2. ### **Non-Residential Clients** Clients who do not live in the nation in which a financial institution or business is based but who transact or maintain relationships are known as non-residential clients. These clients may be foreign individuals or organizations that conduct business or deal with money in a separate jurisdiction. Non-residential clients in Nepal\'s insurance market are diversified, embracing a wide range of sectors and demands. Insurance companies must customize their products and services to fit the unique needs of these clients, ensuring proper coverage and risk management solutions. As the market grows, insurers operating in Nepal will need to understand the particular characteristics and needs of non-residential clients. It becomes a very challenging job for insurance companies to keep an eye on the business activities of non-residential client and hence pose high risk of ML/TF. **Types of Non-Residential Clients**. - **Foreign Entities** Non-resident foreign companies or people doing business in Nepal can also be characterized as non-residential clients. They frequently demand tailored insurance policies that fit to local rules while preserving their interests. - **Non-Profit Organizations**\ Non-profit organizations in diverse areas may require insurance coverage for their facilities, liability, and volunteer activities. These organizations frequently have distinct insurance requirements that differ from commercial enterprises. - **Commercial entities**\ These include firms that require a variety of insurance coverages, such as property, liability, and business interruption insurance. They may range from small businesses to major organizations. **Risks Factors Associated with Non-Residential Clients** 1. **Use of Shell Companies**\ Non-residential clients may use shell corporations to facilitate transactions. These entities can be used to conceal the source of funds, making it harder for insurers to assess the transactions\' authenticity and associated risks. 2. **Limited Regulatory Oversight**\ Non-residential clients in Nepal may face less stringent regulatory requirements than domestic clients. This can result in gaps in compliance and monitoring, increasing the possibility of ML/TF actions remaining unnoticed. 3. **Cross-border transactions**\ Non-residential clients frequently conduct cross-border transactions, which complicates the monitoring procedure. Multiple jurisdictions might make it difficult to follow the flow of funds and verify the validity of transactions. 4. **Complex ownership structures**\ Non-residential clients, particularly corporate entities and foreign investors, may use sophisticated ownership structures to conceal the true beneficial owners. This can make it difficult for insurance companies to do full due diligence and detect potential risks related to ML and TF activities. 5. **Geographical Risk**\ Non-residential consumers frequently originate from nations with diverse regulatory control and levels of corruption. Clients from high-risk countries may have a higher risk of engaging in ML/TF operations, demanding further inspection and surveillance. 3. ### **Foreigner and person from vulnerable jurisdiction** Foreigners pose greater risk of ML/TF for the reason that it is difficult to verify the documents submitted by such client and also challenging for ongoing due diligence. It may be difficult to verify their identity, profession, income source and so on. Similarly the client from vulnerable jurisdiction also poses greater risk. FATF, for instance, by the means of mutual evaluations monitors the compliance status of its member states and enlist such nations who have low level compliance as "jurisdiction under increased monitoring" and "high risk jurisdiction subject to call for actions." Currently, as of July 2024, there are 21 countries listed as jurisdiction under increased monitoring and 3 are listed as high risk jurisdiction subject to call for action.[^1^](#fn1){#fnref1.footnote-ref} Whenever an Insurance company tries to establish a business relation with clients from vulnerable jurisdiction, such clients are subject to enhanced due diligence. Further information regarding the nature and purpose of transaction, source of income has to be obtained. ### **Other specified categories of clients and risk factors** There are several other specified categories of clients that insurance Industry need to consider, each with unique risk factors. These categories often require special attention due to their inherent risks, regulatory requirements, or the nature of their transactions. Here is a comprehensive overview: A. **High-Risk Client** Clients who are deemed high-risk due to their activities, the nature of their transactions, or their geographical location. - *Complex Transactions*: Engaging in large or complex transactions that might be indicative of money laundering or fraud. - *Source of Wealth:* Unclear or suspicious sources of wealth, including cash-intensive businesses. - *Unusual Patterns:* Irregular or unexpected transaction patterns that deviate from the client's known business activities or financial profile. B. **Shell Companies** Entities that have no significant assets or ongoing business activities but are used for specific financial transactions or to conceal ownership. - *Lack of Transparency:* Difficulty in determining the true beneficial owners and the purpose of the company. - *Money Laundering:* Commonly used to launder money or evade taxes due to their opaque nature. - *Regulatory Scrutiny:* Higher scrutiny from regulators due to their potential use in illicit activities. C. **Non-Profit Organizations (NPOs)** Organizations that operate for charitable, religious, educational, or other non-profit purposes. - *Misuse of Funds:* Risk of funds being diverted to terrorist activities or illicit purposes. - *Lack of Transparency:* Potential for less rigorous financial oversight and reporting. - *Geographical Risks:* Operating in regions with high political instability or conflict can add risk. D. **High Net-Worth Individuals (HNWIs)** - *Complex Financial Structures:* Use of complex financial products or structures that can be difficult to monitor and assess. - *Tax Evasion Risks:* Potential for tax evasion or avoidance through sophisticated financial maneuvers. - *Regulatory Compliance:* Need for rigorous compliance and reporting requirements to manage potential risks. E. **Small and Medium-Sized Enterprises (SMEs)** **Risk Factors** - *Financial Stability:* Potentially less financial stability and limited resources for compliance. - *High Cash Usage:* Increased risk of cash transactions, which can be used to conceal illicit activities. - *Regulatory Compliance**:*** Variable compliance levels and less sophisticated AML measures. By understanding and addressing the risks associated with these specified categories of clients, institutions can better manage their compliance responsibilities, mitigate potential risks, and maintain robust financial practices. **Distribution Channel related Risk Factors** --------------------------------------------- In the insurance industry, distribution channels are the numerous techniques used to market and sell insurance products to customers. Insurers, agents, brokers, internet platforms, and other middlemen may use these channels to sell directly. The risk considerations connected with these channels are assessed to identify their potential for use in money laundering or terrorist financing. ### **3.2.3.1 Distribution through Insurance Intermediaries** Distribution through Insurance Intermediaries is the process of marketing and selling insurance products to customers through a variety of intermediaries such as agents, brokers, and digital platforms. These intermediaries act as a link between insurance firms and their clients, handling customer relations, premium collecting, and claims processing. Understanding distribution via insurance intermediaries and its associated ML/TF risk factors is critical for insurance companies operating in Nepal. **Risk Factors** 2. ***Varied Compliance Standards*** 3. ***Inadequate Due Diligence*** 4. ***Complex Distribution Networks*** 5. ***High-Volume Transactions*** 6. ***Fraudulent Practices*** 7. ***Client Confidentiality and Data Privacy*** 8. ***Insufficient Training and Awareness*** 9. ***Inadequate Record-Keeping*** 10. ***Reputation Risks*** ### **3.2.3.2 Direct Sales** Insurance companies' market and sell their products directly to consumers in this process. This can happen through a variety of channels, such as company websites, phone centers, and direct marketing initiatives. In the context of Nepal\'s insurance business, defining money laundering (ML) and terrorist financing (TF) risk factors for direct sales entails recognizing the vulnerabilities associated with selling insurance products directly to consumers without intermediaries. This form of distribution can create specific dangers that must be identified and managed efficiently. **Risk Factors** 1. ***Limited Customer Interaction*** *Risk*: In direct sales models, interactions with customers are often limited to digital or remote channels, which can restrict the ability to fully understand their background and financial situation. *Impact*: This limitation can lead to insufficient due diligence and an increased risk of onboarding clients involved in money laundering or terrorism financing. 2. ***Higher Transaction Volumes*** *Risk:* Direct sales channels can lead to a high volume of transactions due to the broad reach of digital platforms. *Impact:* A large number of transactions can make it challenging to monitor and identify suspicious activities effectively, potentially allowing illicit transactions to go unnoticed. 3. ***Fraudulent Applications*** *Risk:* Direct sales often involve online applications, which may be more susceptible to fraudulent activities such as identity theft or false information. *Impact:* Fraudulent applications can lead to the issuance of insurance policies based on misleading or false information, increasing the risk of financial crime. 4. ***Inadequate Customer Verification*** *Risk:* The ease of online access may result in less stringent customer verification processes compared to face-to-face interactions. *Impact:* Inadequate verification can facilitate the entry of individuals using false identities or ilicit funds into the insurance system. 5. ***Difficulty in Monitoring Suspicious Activity*** Risk: Monitoring and tracking suspicious activities can be more challenging in direct sales models, particularly if transactions are processed through automated systems. *Impact:* Increased difficulty in monitoring can result in a delay in detecting and addressing suspicious behavior, increasing the risk of compliance breaches. 6. ***Cybersecurity Risks*** *Risk:* Direct sales through digital channels can expose insurers to cybersecurity threats such as data breaches or hacking. *Impact:* Cybersecurity incidents can compromise sensitive customer data, leading to potential misuse and financial crime. 7. ***Compliance with AML/CFT Regulations*** *Risk:* Direct sales channels must comply with AML/CFT regulations, which can be complex and vary by jurisdiction. *Impact:* Ensuring consistent compliance with these regulations in a direct sales model can be challenging, particularly with cross-border transactions. 8. ***Challenges in Customer Due Diligence (CDD)*** *Risk:* Conducting effective customer due diligence can be more challenging without face-to-face interactions. *Impact:* Poor CDD practices can result in insufficient understanding of the customer\'s financial behavior and risk profile. 9. ***Limited Personalization*** *Risk:* Direct sales channels may offer less personalized service compared to traditional sales methods, potentially overlooking risk indicators. *Impact:* Limited personalization can result in a failure to recognize and address specific risks associated with individual clients. 10. ***Regulatory Oversight*** *Risk:* Regulatory oversight of direct sales channels may vary, and insurers must ensure that their direct sales practices meet all regulatory requirements. *Impact:* Non-compliance with regulatory requirements can lead to penalties and reputational damage. ### **3.2.3.3 Sales through Online and Digital Forums** Sales through Online and Digital Forums refers to the promotion and sale of insurance products through digital platforms such as company websites, mobile applications, social media, and other online channels. This strategy lets consumers to obtain insurance without having to engage with agents or brokers in person. Money laundering (ML) and terrorist financing (TF) risk factors linked with sales through online and digital forums include the vulnerabilities associated with marketing and selling insurance products via digital platforms. These dangers emerge from the distinct characteristics of online transactions and the possibility for exploitation by criminal actors. **Risk Factors** 1. ***Customer Verification Challenges*** *Risk:* Online and digital forums can make it more challenging to verify the identity and background of customers. *Impact:* Insufficient verification can lead to fraudulent applications or the onboarding of individuals involved in illicit activities. 2. ***High Transaction Volume*** *Risk:* Digital sales platforms can handle a large volume of transactions due to their broad reach and convenience. *Impact:* High transaction volumes can overwhelm monitoring systems, making it harder to detect and investigate suspicious activities. 3. **Fraudulent and Synthetic Identities** *Risk:* Online platforms are susceptible to the use of fraudulent or synthetic identities (identities created using a mix of real and fake information). *Impact:* These identities can be used to purchase insurance products with illicit funds or for other illegal purposes. 4. ***Cybersecurity Threats*** *Risk:* Digital forums are vulnerable to cybersecurity threats, including data breaches, hacking, and phishing attacks. *Impact:* Cybersecurity incidents can lead to unauthorized access to sensitive customer data, which can be exploited for financial crimes. 5. ***Inadequate Due Diligence*** *Risk:* The automated nature of online sales may lead to insufficient due diligence processes compared to traditional methods. *Impact:* Reduced due diligence can result in inadequate risk assessment and increased vulnerability to money laundering and terrorist financing. 6. ***Misuse of Digital Channels*** *Risk:* Criminals may exploit online platforms to conceal the true origin of funds or conduct illicit activities. *Impact:* Misuse of digital channels can complicate the tracking and investigation of suspicious activities. 7. ***Regulatory Compliance Challenges*** *Risk:* Different jurisdictions may have varying AML/CFT regulations, and ensuring compliance across multiple regions can be complex. *Impact:* Non-compliance with regional regulations can result in legal and financial penalties. 8. ***Automated Processes and Errors*** *Risk:* Automated processes used in digital forums may be prone to errors or may not fully capture all risk factors. *Impact:* Errors in automated systems can lead to incorrect assessments of risk or inadequate controls. 9. ***Limited Personal Interaction*** *Risk:* Online sales lack face-to-face interactions, which can provide additional context and insights into a customer's background and intentions. *Impact:* The absence of personal interaction can lead to missed signs of suspicious behavior or potential risks. 10. ***Data Privacy Issues*** *Risk:* Handling large amounts of personal and financial data online increases the risk of data privacy violations. *Impact:* Breaches of data privacy can lead to misuse of sensitive information and undermine AML/CFT efforts. **3.2.4 Geographic Risk Factors** --------------------------------- These are special risks connected with the geographic locations of clients, insurance companies, and the markets in which they do business. Geographic considerations such as a region\'s political stability, the existence of high-risk jurisdictions, and the regulatory environment can all have an impact on the possibility of money laundering and terrorism financing. #### **Risk Factors Inside Nepal** 1. ***Regional Variability in Risk Levels*** 2. ***Informal Economy and Cash Transactions*** 3. ***Geographic Accessibility and Monitoring Challenges*** 4. ***Border Areas and Cross-Border Trade*** 5. ***Political and Social Instability*** 6. ***Local Crime Trends*** 7. ***Regulatory and Compliance Differences*** 8. ***Economic Disparities*** 9. 10. ***Cultural and Social Factors*** #### **Risk factors abroad** ##### *High-Risk Jurisdictions Subject to FATF Call for Action* These are countries or territories that the Financial Action Task Force (FATF) has identified as having significant deficiencies in their AML/CFT systems. The FATF calls for action against these jurisdictions due to their failure to address these deficiencies effectively. When dealing with international AML/CFT (Anti-Money Laundering/Countering the Financing of Terrorism) risks, it is essential to understand the different categories of high-risk jurisdictions and their implications. Here's an overview of the risk factors associated with these jurisdictions: **Risk Factors:** 1. *Weak regulatory frameworks*: refer to jurisdictions that lack proper rules and regulations to address ML/TF. Insurance businesses operating in or with clients from these areas may be more vulnerable to being used for illegal financial operations due to a lack of effective oversight. 2. *High levels of corruption:* It affect government and financial organizations. Corruption can facilitate ML/TF activities since officials may be involved in permitting illegal transactions to take place without inspection. 3. *The presence of organized crime:* It refers to areas where syndicates operate and engage in unlawful operations such as drug trafficking and human trafficking. Insurance products may be used to launder money obtained through these illicit operations, raising the risk for insurers. 4. *Political instability:* It is defined as countries undergoing conflict, civil unrest, or major political upheaval. Political instability can lead to increased fraud and corruption, making insurance transactions in these areas more vulnerable to money laundering and terrorist financing. 5. *Inadequate Customer Due Diligence (CDD):* It refers to insufficient processes for verifying client identities and assessing risk profiles. Insurance companies may fail to adopt effective CDD procedures for clients in high-risk regions, increasing the possibility of dealing with people involved in ML/TF. 6. *Use of Cash transaction:* It is commonly used in impoverished countries with little banking infrastructure. Cash transactions are difficult to trace, making it easier for criminals to launder money through insurance products. **Case Studies** Iran: Similar to the DPRK, Iran is classed as a high-risk jurisdiction due to significant gaps in countering money laundering and terrorism financing. The FATF has regularly recommended its members to take strong steps when conducting financial transactions with Iran, emphasizing the need for increased vigilance and due diligence. Myanmar, which is on the FATF\'s \"black list,\" confronts major problems in its AML/CFT framework due to persistent political instability and violence. The FATF recommends that nations implement efforts to limit the risks associated with transactions involving Myanmar. The Democratic People\'s Republic of Korea (DPRK) is on the FATF\'s \"black list\" due to significant shortcomings in AML/CFT procedures. The country has been linked to a variety of criminal activities, including the financing of nuclear proliferation. The FATF urges all member nations to use heightened due diligence and countermeasures when dealing with the DPRK in order to protect the international financial system from risks posed by this jurisdiction. ##### *Jurisdictions Under Increased Monitoring (FATF Grey List)* These are countries that the FATF has identified as having strategic AML/CFT deficiencies but are working with the FATF to address these issues. They are often on the FATF Grey List, which signifies that they are under increased monitoring. **Risk Factors** - *Ongoing Reforms:* These jurisdictions are making efforts to improve their AML/CFT systems, but they may still have significant weaknesses. - *Higher Risk of Financial Crime:* Increased monitoring implies that these jurisdictions are considered higher risk compared to others that are compliant with international standards. - *Enhanced Due Diligence (EDD) Required:* Financial institutions must apply enhanced due diligence measures when dealing with transactions involving these jurisdictions. - *Regulatory Uncertainty:* The regulatory environment in these jurisdictions may be subject to change as they work towards compliance, creating uncertainty. **Examples:** Countries like Pakistan and Myanmar have been under increased monitoring due to ongoing issues in their AML/CFT frameworks ##### *Other Internationally Known Non-Complaint Jurisdictions* Jurisdictions that fall short of established international standards for financial regulation, especially in areas like tax transparency, AML, and CFT (countering the financing of terrorism), are referred to as internationally non-compliant jurisdictions. Assessments conducted by groups such as the Financial Action Task Force (FATF) and the Organization for Economic Co-operation and Development (OECD) frequently lead to this designation. These regions may encourage illegal financial activity and have insufficient regulatory monitoring, which puts businesses, including those in the insurance industry at serious danger. These countries\' insufficient efforts to stop money laundering and the funding of terrorism make them threats to the international financial system. Money laundering and terrorist funding operations are more likely to occur in nations with lax AML/CFT legislation or significant levels of corruption. Insurance firms are required to evaluate the risk involved in the nations in which they operate, particularly those that have been classified as high-risk or non-compliant by bodies such as the EU and the FATF. **Risk Factors:** - *Corruption and Mismanagement:* Inadequate governance or high levels of corruption may be factors in the failure of AML/CFT initiatives. - *Weak Financial Systems:* Weak financial infrastructure and lack of oversight can make these jurisdictions attractive for illicit financial activities. - *Increased Compliance Costs:* Dealing with these jurisdictions often requires additional compliance efforts and costs, including more thorough due diligence and monitoring. *Reputational Damage:* Associating with high-risk jurisdictions can lead to reputational risks and negative perceptions among clients, regulators, and partners. ::: {.section.footnotes} ------------------------------------------------------------------------ 1. ::: {#fn1} Bulgaria, Burkina Faso, Cameroon, Croatia, Democratic Republic of the Congo, Haiti, Kenya, Mali, Monaco, Mozambique, Namibia, Nigeria, Philippines, Senegal, South Africa, South Sudan, Syria, Tanzania, Venezuela, Vietnam, Yemen  as increased monitoring and Iran, Democratic Republic of Korea and Myanmar as call for action[↩](#fnref1){.footnote-back} ::: :::