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Illicit Financial Flows

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Illicit Financial Flows

Introduction

Illicit financial flows (IFFs) refer to the circulation of money or capital illegally from one

country to another. Amounts of money used for these international transfers are obtained

from illegal markets, tax evasion and bribery. Illicit Financial Flows refers to capital taken

abroad in a hidden form either because it is illegal, it goes against social norms, or it might be

an economical or political threat.1 The reasons why these financial flows are said to be illicit

can be explained in two ways. First, they become illicit because they prevent the development

and also are found to be unlawful considering the existing agreement about the

social good. Secondly, they are illicit because they are earned, transferred or used in a way

that contravenes the law.2 

Global financial integrity (GFI) states that this money movement is an illicit flow when

funds are earned by illegal means, transferred and used across an international border.3 Some

activities of illicit financial flows include a terrorist organizing money wiring from one

region to another; a drug cartel using money laundering techniques to mix illegal money with

legal money; a corrupt public official using an anonymous company to transfer funds to a

United States bank account, and an importer using wrong trade invoices to evade income

1
. Epstein, Gerald A., ed. Capital flight and capital controls in developing countries.

Edward Elgar Publishing, 2005, 78-110

2
. Blankenburg, S. and M. Khan, “Governance and Illicit Flows,” in P. Reuter (Ed.)

Draining development? Controlling flows of illicit funds from developing countries, The

World Bank (2012).

3
. Ibid
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taxes or customs duties among others. The concept of Illicit financial flows falls into three

main areas; the acts are illegal; funds are a result of illegal acts and funds are used for illegal

purposes.

In most developing countries, a lot of wealth is lost through illicit financial flows, and this

is a significant threat to their development by draining their tax revenue and capital. This

illicit movement of capital outside the country enables criminals, tax evaders, businesspeople

and corrupt officials to protect their funds better.4 These sums of money could otherwise have

been used for a country’s development in areas like infrastructure, education, health care,

among others. Reduction of the illicit financial flows helps the government to have more

public funds available for investments. Reducing the illicit financial flows can be done by

prosecuting the cartels as well as strengthening the law, which in turn increases trust among

citizens and thus contributing to stability.

The Global Financial Integrity estimates that the revenue lost by developing countries to

be 1.1 trillion U.S dollars in 2013 through illicit financial flows.5 Research shows that 45% of

these illicit flows end up in foreign financial centres while 55% in developed countries. In

2015, Latin America and Asia had a total tax revenue to GDP ratio of 22% and 15%

respectively, while African countries had 19%.6 Africa continent is faced by many problems

that are negatively affecting social and economic development. With tax being one of the

4
. Kar, D. and Freitas, S., 2012. Illicit Financial Flows from China and the Role of Trade

Misinvoicing. Global Financial Integrity, Washington, DC.

5
. Naheem, Mohammed Ahmad. "Illicit financial flows: HSBC case study." Journal of

Money Laundering Control (2018).

6
. Ibid
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primary revenue sources, researches show that illicit financial flows drag African

governments base due to capital outflows and lack of good governance.

Sources of Illicit Financial Flows

Corruption

Corruption is a significant source of illicit financial flows and enables money laundering,

which allows the corruption proceeds to be used and hidden. Therefore, this illicit movement

of capital makes corruption easier to carry out.7 As a result, the provision of public goods is

limited, thus affecting the public institutions in developing countries. Illicit funds from

corruption can be transferred to a foreign country secretly. Corrupt public officials can earn

bribes from several activities such as illegal contract awards, and charging for free rights. 

Tax evasion

The activities that provide tax funds are legal. However, the illegality comes in when there

is the evasion of tax payments. These tax evaders can be private or public companies.8 In

every corrupt nation, evasion of taxes is a significant protected activity for which officials

obtain bribes. Taxes are paid to the governments where a value should be created. Therefore,

tax avoidance is an abusive tax as it goes against the laws.

Criminal Entrepreneurs

Drug trafficking, human smuggling and other illegal activities can generate large

revenues; contributing to a significant part of these flows. Most of these activities affect the

social, economic and environmental goals of a country.9 Illegal waste trafficking has

7
. Kar, Dev, and Joseph Spanjers. Illicit financial flows from developing countries: Global

Financial Integrity (2015): 1-10.

8
. Ibid., 7

9
. Ibid., 7
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significant consequences for human health and the environment, despite that there is little

knowledge about it as a source of illicit financial flows. 

Illegal Markets

These include local and international markets for trading illicit goods and services. Such

activities involve criminal actions to create profit.10 These may include illegal trafficking of

drugs, firearms, smuggling of migrants, among others. Such activities generate illicit

financial flows related to international trade of illegal goods and services.

Factors Influencing IFFs Generation

The first factor influencing a generation of illicit financial flows is the country’s political

stability. In many developing countries, most governments have been predatory whose

primary goal is to enrich the senior government officials. Corrupt officials will need to avoid

seizure of their assets by a successor government.11 Corrupt officials in a stable country may

reach in agreements that there will be no seizures of corrupt assets, but the agreement may

only be tactical. Secondly, there is the issue of currency controls. The stricter the currency

controls, the greater the incentive to violate them. Some restrictions put in place will make it

difficult to move assets and goods abroad and therefore, will encourage illegal methods

instead.

Hiding assets from the government is another factor that may result in illicit financial

flows. Funds held in a foreign nation are more difficult for the domestic government to track

and seizure.12 Factors like the transparency of domestic financial systems will affect the

10
. Ibid., 8

11
. Reuter, Peter. Illicit financial flows and governance: The importance of disaggregation.

World Bank, 2017.

12
. Ibid.
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extent to which corrupt public official will seek to hide their assets abroad. There is also the

issue of portfolio diversification, where the owner seeks to acquire assets in other countries

where economic fortunes are weak compared to those in his own country.

Effects of IFFs on Developing Countries

Developing countries lose a lot of wealth to tax evasion, corruption and money laundering.

These funds could be used for funding the country’s developmental activities such as health

care, infrastructure, education, among others. The consequences of illicit financial flows can

be destructive. For instance, it may help corrupt officials and economic elites to hide their

corruption deals.13 Again, reduction in tax collected due to tax evasion has a significant

adverse effect on the provision of public services and also on private and public investment.

This, in turn, leads to fewer jobs and infrastructure projects, as well as weaker social

protection for citizens, which offers tax burdens to honest businesses and poor citizens.

Illicit financial flows can also affect other developmental aspects. If elites can hide a lot of

wealth outside the country, they will have less support on the country’s development. IFFs

will therefore harm good governance.14 Again, Illicit financial flows harm social trust, both in

the government and the society as well. If the elites secretly hide their wealth and evade

taxes, they pose a significant impact on the citizen’s trust. People not only will lose trust but

also in the long term, it will add cost to the society. 

Measures to Counter Illicit Financial Flows

13
. Forstater, Maya. "Illicit financial flows, trade misinvoicing, and multinational tax

avoidance: the same or different?." CGD policy paper 123 (2018): 29.

14
. Ibid.
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Some of the measures to counter and control illicit financial flows include fiscal

transparency, institution-building strategies, information exchange and international

cooperation. The concerned development stakeholders need to understand that illicit financial

flows are a significant obstacle to the country’s development, and work towards the reduction

of such flows. Institutional building strategies mostly deal with corruption and taxation.15

Efforts to curb illicit financial flows related to corruption seek to prevent individuals from

enriching themselves illegally. Financial intelligence units identify and suspicious financial

transactions as a piece of evidence for their investigations. 

Cooperation and information exchange is another way to deal with illicit financial flows.

There needs to be a high level of understanding between cooperation authorities in different

countries to investigate money laundering and recover the laundered assets. Taxpayer

confidentiality rules prevent the sharing of taxpayer information to authorities of other

countries. Information exchange will enable authorities to investigate and determine the

incidences of illicit financial flows. 

Fiscal transparency requires public disclosure of financial information. One major issue is

the disclosure of private sector payments to the government that makes it possible to compare

the data and investigate the possibility of illicit financial flows.16 Fiscal transparency can also

be done by implementation of different financial action task force standards. This

transparency is making it possible to identify the bank account’s ownership and other assets,

which will help to verify if they have been used to hide crime proceeds. Disclosure of

15
. Blankenburg, Governance and Illicit Flows

16
. Kar, Illicit financial flows from developing countries.
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payments to governments helps address the issue of illicit flows. There is also the country-to-

country breakdown of financial reports.

Illicit financial flows drain billions of developmental funds in developing countries. These

large amounts of money illicitly flowing out of developing countries can be limited by

clamping down on criminal financial activities in developed countries. Developed countries

need to enforce laws to monitor, track and prevent illegal transactions.17 Loss of development

finance for developing countries can be stopped by sharing information, streamlining laws

and regulations, and improving investigation capacities and prosecution of criminals carrying

out these illegal activities in both developed and developing countries.

Conclusion

The interconnectedness of illicit financial flows from developing to developed countries

when most of the illegal assets are hidden raises the alarm as to why there is a global

predicament that requires global efforts and actions.18 Therefore, there is a need for a robust

international system to combat and eliminate the problem; which may include efforts to

bridge the gaps on the existing international system and other regional bodies; to fully be able

to counter the issue of illicit financial flows that affect domestic resources needed for the

country’s development agenda. Illicit financial flows are disastrous, especially for developing

countries which most of them are struggling from dictatorship, civil wars and poor

administration.

The issue of illicit financial flows remains one of the unknown subjects. These flows are

estimates of a hidden phenomenon. If correct and perfect data were available, these flows

17
. Naheem, Illicit financial flows.

18
. Reuter, Illicit financial flows and governance.
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would be trending at zero in the given country.19 Better methodologies for data estimations

can be used to deal with these flows. Two new measures will give precise data on these illicit

flows, that is, the annual flow of profit misalignment by multinational companies as well as

the annually recorded stock of undeclared offshore assets. Illicit financial flows in developing

countries should are one of the reasons why countries are lagging in terms of economic

developments because they are losing a lot of revenue as a result of these illegal financial

activities related to financial outflows.

Good governance and proper regulations promote best practices to fight illicit financial

flows in developing countries. Corruption should, therefore, be fought as it threatens

developmental initiatives. Local governments should work closely with local banks to track

and monitor any suspicious transactions.20 By this, more funds will be available through

domestic resources mobilizations. The fight against illicit financial flows is not a role for one

nation. It requires global cooperation between states and other international stakeholders to

come up with a standard solution. Many efforts are still needed despite the progress made by

nations to establish regulation initiatives. These efforts need to be accompanied by political

willingness. National leaderships, global partnership and development assistance, are the

main ingredients that help to combat these problems. 

19
. Ibid.
20
. Epstein, Gerald A., ed. Capital flight and capital controls in developing countries.

Edward Elgar Publishing, 2005.

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Bibliography

Epstein, Gerald A., ed. Capital flight and capital controls in developing countries. Edward

Elgar Publishing, 2005.

Blankenburg, S. and M. Khan (2012) “Governance and Illicit Flows,” in P. Reuter (Ed.)

Draining development? Controlling flows of illicit funds from developing countries, The

World Bank.

Kar, D. and Freitas, S., 2012. Illicit Financial Flows from China and the Role of Trade

Misinvoicing. Global Financial Integrity, Washington, DC.

Kar, Dev, and Joseph Spanjers. "Illicit financial flows from developing countries: 2004-

2013." Global Financial Integrity (2015): 1-10.

Naheem, Mohammed Ahmad. "Illicit financial flows: HSBC case study." Journal of Money

Laundering Control (2018).

Reuter, Peter. Illicit financial flows and governance: The importance of disaggregation.

World Bank, 2017.

Forstater, Maya. "Illicit financial flows, trade misinvoicing, and multinational tax avoidance:

the same or different?." CGD policy paper 123 (2018): 29.