Nepal's FATF Gray Listing: The Impact of Hundi, Corruption, and Weak AML/CFT Frameworks on the Economy
Author
Nepsetrading
What Is the Gray List?
A "gray list" is a term commonly used by the Financial Action Task Force (FATF), an international organization focused on preventing money laundering and terrorist financing. It refers to a list of countries that have strategic weaknesses in their anti-money laundering (AML) and counter-terrorism financing (CFT) systems. Unlike the "black list," which includes nations deemed non-cooperative, gray-listed countries are actively working with the FATF to address these shortcomings. Being on the gray list can lead to increased monitoring, economic challenges, and reduced foreign investment, but it’s seen as a step below the harsher black list designation.
In Nepal, remittances (money sent from abroad) play a significant role in the economy, contributing 20-25% of the total GDP. However, a large portion of these remittances—around 40%—flows through illegal channels like hundi. This means that nearly half of the remittance income bypasses the formal banking system, which has several negative impacts.
Why do people use illegal channels (hundi)?
Lower Costs: Hundi allows users to avoid taxes and fees, making it a cheaper option for transferring money.
Faster Transactions: Transactions through hundi are much quicker compared to the formal banking system.
Lack of Access: Formal banking services are often unavailable or inaccessible in rural and remote areas.
Confidentiality: Hundi offers a level of privacy, which can be attractive for illegal activities.
These factors make hundi an appealing option for many, despite its illegality and the broader negative consequences for the economy.
1. Hundi Activity and Its Impact on Nepal's Economy
Hundi has become a major channel for illegal financial transactions in Nepal, undermining the formal banking system and contributing to the country's gray listing. The following are the key areas where Hundi activity has increased:
a. Import of Goods from China via Hong Kong
Hong Kong as a Hub: Nepal has seen a significant rise in Hundi transactions originating from Hong Kong, primarily for importing goods from China. Traders and businesses use Hundi to avoid taxes, customs duties, and regulatory scrutiny, making it a cheaper and faster alternative to formal banking channels.
Impact on Economy: This illegal activity deprives the government of legitimate revenue, distorts trade data, and creates an uneven playing field for businesses that comply with legal procedures.
b. Import of Gold and Electronic Goods from Dubai
Dubai as a Key Source: Dubai has emerged as a major source of Hundi transactions for importing gold and electronic goods into Nepal. The high demand for gold and electronics, coupled with weak regulatory oversight, has fueled this illegal trade.
Gold Smuggling: Gold smuggling via Hundi has become rampant, with significant quantities of gold entering Nepal without proper documentation or taxation. This has severe implications for the country's economy, including loss of revenue and distortion of the gold market.
c. Human Trafficking
Illegal Remittances: Hundi is widely used to facilitate payments related to human trafficking, particularly for Nepali migrant workers. Traffickers and agents use Hundi to transfer funds across borders without detection, making it difficult for authorities to track and combat this crime.
Exploitation of Migrant Workers: Many Nepali workers are forced to pay exorbitant fees to agents, which are often transferred via Hundi, further exacerbating their exploitation.
d. Capital Flight by NRNs and TRC Holders
Non-Resident Nepalis (NRNs) and Temporary Resident Certificate (TRC) holders have been actively involved in selling land and property in Nepal and transferring the proceeds abroad via Hundi. This capital flight deprives Nepal of much-needed foreign exchange and investment.
Destinations: The funds are often transferred to developed countries such as the USA, Australia, and others, where these individuals have settled or invested.
e. Bitcoin Trading and Digital Payment Platforms
Cryptocurrency Transactions: The trading of Bitcoin and other cryptocurrencies has gained traction in Nepal, with platforms like Esewa and Khalti indirectly supporting these activities. Since cryptocurrencies operate outside the formal banking system, they are often used for Hundi transactions.
Regulatory Gaps: The lack of clear regulations governing cryptocurrencies in Nepal has made it easier for individuals and businesses to use them for illegal financial activities.
2. Role of Corruption and Political Support
Corruption among government employees, coupled with political support, has been a major enabler of Hundi and other illegal financial activities in Nepal. Key issues include:
Bribery and Collusion: Government officials, including those in customs, immigration, and law enforcement, often collude with Hundi operators and other illegal actors in exchange for bribes.
Political Patronage: Many Hundi operators and illegal traders enjoy political protection, making it difficult for regulatory authorities to take action against them.
Parking Dirty Money Abroad: Corrupt officials and politicians are known to park illicit funds in foreign banks and invest in properties abroad, further exacerbating capital flight.
3. Capital Flight by the Marwadi Community
The Marwadi community, a prominent business community in Nepal, has been accused of engaging in capital flight to India. This is primarily done through Hundi, where funds are transferred to India for investment in businesses, real estate, and other assets. This not only weakens Nepal's economy but also raises concerns about the misuse of the financial system.
4. Role of Domestic and International Remittance Companies
Several domestic and international remittance companies have been actively involved in facilitating Hundi transactions. Key players include:
IME Group: One of the largest remittance companies in Nepal, IME has been accused of being involved in Hundi activities, particularly in facilitating illegal cross-border transactions.
Prabhu Money Transfer: Another major remittance service provider, Prabhu, has also been linked to Hundi operations, raising questions about its compliance with AML and CFT regulations.
These companies often operate in a gray area, exploiting regulatory loopholes to facilitate illegal transactions.
Impacts of Nepal Being on the FATF Gray List
Impact on Foreign Direct Investment (FDI):
Reduced FDI: International investors may see Nepal as a high-risk destination due to weak AML/CTF measures, leading to a decline in foreign investment.
Loss of Investor Confidence: Gray listing creates uncertainty, discouraging long-term investments in infrastructure, industries, and other sectors.
Difficulties in Foreign Trade:
Increased Scrutiny: Nepalese exporters and importers may face additional checks and delays in cross-border transactions.
Trade Barriers: Trading partners may impose stricter compliance requirements, making it harder for Nepal to access global markets.
Reduced Trade Opportunities: Businesses may avoid dealing with Nepalese entities due to perceived risks, shrinking trade volumes.
Increase in International Trade Costs:
Higher Transaction Costs: Banks and financial institutions may charge more for processing payments to and from Nepal due to enhanced due diligence requirements.
Longer Processing Times: Delays in trade financing and settlements can increase operational costs for businesses.
Difficulties in Securing International Loans:
Challenges with IMF and World Bank: Nepal may face hurdles in securing loans or grants from international financial institutions like the IMF and World Bank, as these organizations prioritize AML/CTF compliance.
Higher Borrowing Costs: If loans are approved, Nepal may face higher interest rates due to increased perceived risk.
Impact on Remittances:
Stricter Controls: Financial institutions may impose additional checks on remittances, making it harder and costlier for Nepalese workers abroad to send money home.
Reduced Inflows: Remittances, a key source of income for Nepal, could decline if processes become more cumbersome.
Reputational Damage:
Loss of Trust: Nepal’s global reputation may suffer, making it harder to attract investment, trade, and international cooperation.
Negative Perception: Being gray-listed signals weaknesses in governance and financial systems, deterring potential partners.
Strained Diplomatic Relations:
Pressure from Other Countries: Nepal may face diplomatic pressure to improve its AML/CTF frameworks, straining relationships with key allies.
Exclusion from International Forums: Nepal’s voice in global financial and economic discussions may be marginalized.
Increased Regulatory Burden:
Stricter Domestic Laws: The government may need to enforce tougher AML/CTF regulations, increasing compliance costs for businesses and financial institutions.
Enhanced Monitoring: Financial institutions will face more scrutiny, leading to higher operational costs.
Impact on Development Projects:
Reduced International Funding: Donors and development partners may hesitate to fund projects in Nepal due to perceived risks.
Delayed Projects: Stricter compliance requirements could slow down the implementation of critical infrastructure and development initiatives.
Social and Economic Inequality:
Impact on Vulnerable Groups: Reduced remittances and foreign aid could disproportionately affect low-income households and rural communities.
Public Distrust: Citizens may lose confidence in the government’s ability to manage the economy and financial systems.
Nepal’s History with the FATF Gray List
February 2008: Nepal First Listed
Nepal was added to the FATF gray list in February 2008 due to significant weaknesses in its anti-money laundering (AML) and counter-terrorist financing (CFT) frameworks, including inadequate laws and enforcement.October 24, 2014: Removed from Gray List
Following legislative reforms, such as amendments to the Anti-Money Laundering Act of 2008, Nepal exited the gray list on October 24, 2014, after the FATF plenary recognized its progress.December 5–16, 2022: Renewed Scrutiny
The Asia Pacific Group (APG) conducted a mutual evaluation from December 5 to December 16, 2022, identifying persistent AML/CFT deficiencies, including delays in legal updates and weak oversight in non-financial sectors.July 5, 2023: Narrow Escape
At the APG annual meeting in Canada on July 5, 2023, Nepal avoided re-listing but was given a deadline of October 2024 to address remaining gaps, with the FATF warning of potential gray list return.February 21, 2025: Back on Gray List
During the FATF Plenary in Paris (February 17–21, 2025), Nepal was re-added to the gray list on February 21, 2025, due to insufficient progress since the 2022 evaluation
