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Hemorrhage of Illicit Financial Flows in Africa


May 29th 2013

For over 30 years (1980-2009), close to US $1.4 trillion were drained out of Africa. Most of those capital flights were illegal in nature and were due to corruption, kickbacks, tax evasion, criminal activities, transactions of certain contraband goods, and other illicit business activities across borders. The geographical distribution of the “unrecorded capital flows” or illicit capital flight was uneven, with West and Central Africa surpassing the other regions at US $494 billion (37%), followed by North Africa (US $415.6 billion or 31%) and Southern Africa (US $370 billion or 27%). The top five countries with the highest illicit financial outflows during 2000-2009 were Nigeria, South Africa, Egypt, Algeria and Libya.

The “recorded capital outflows” (i.e. financial and non-financial transactions recorded in the balance of payments) were approximately US $30.4 million during the period 2000 to 2009; and such outflows originated primarily from the North Africa region (83%). The net recorded transfers were also considerable in West and Central Africa and were mainly driven by outflows related to repayment of loans and trade credits.

While the root causes of illicit financial flows (ranging from weak financial management systems, to political and macroeconomic instability, lack of financial liberalization, and search for higher returns on investment) have been widely researched, their impact on economic development in Africa cannot be underestimated. The direct and indirect consequences of those illicit financial flows (i.e. reduced investment and revenues for health, education, employment, income etc.) are major constraints for Africa’s transformation. The high corruption coupled with the risk and uncertainty of the domestic economy weakens the economic and social measures put in place, henceforth limiting the prospect for more inclusive growth. The incentives for illicit financial transactions are closely related to the high rates of savings and investments, particularly the private sector.

The estimated resources leaving the African continent in the form of illicit financial transfers is significant, and such resources could be mobilized and invested into Africa’s transformation plan. Our report, Illicit Financial Flows and the Problem of Net Resource Transfers from Africa: 1980-2009, jointly prepared with the Global Financial Integrity, provides key policy measures to address the issue of illicit financial flows. To stem the absorption of illicit financial flows from Africa and to better curtail such outflows, the following policy initiatives are recommended:

  • Promoting transparency in the financial system: Banks and offshore financial centers (OFCs) should be required to regularly report to the Bank for International Settlements (BIS) detailed deposit data by sector, maturity, and country of residence of deposit holders. Moreover, the BIS must be permitted to publicly disseminate the cross-border banking data for specific source and destination countries. Further, the obscurity of information on the beneficial ownership of companies, trusts, and other legal entities must be addressed. Domestic laws governing financial institutions should be strengthened to make it illegal to open accounts without knowledge of the natural person(s) owning the accounts (i.e., its beneficial owners).
  • Entering into automatic exchange of tax information agreements: Tax evasion is at the heart of the world’s shadow financial system and constitutes a significant component of illicit financial flows. One way to address the problem of tax evasion is for African countries to enter into automatic exchange of information (AEI) agreements with the destination countries where the proceeds of tax evasion are lodged. AEI agreements should be accompanied by double tax avoidance agreements, which set clear rules for countries’ ability to assess taxes and monitor compliance according to international norms, making it more difficult for individuals and entities to shift income between countries.

With respect to policies aimed at curtailing illicit financial outflows from Africa, policy initiatives are geared to resource-rich and resource-poor countries and include the following:

  • In resource-rich countries, the natural resource sector is usually the main source of illicit financial flows. These countries generally lack the good governance structures that would enable citizens to monitor the amount and use of revenues from the natural resource sector. These countries should promote transparency and accountability through the strengthening of civil society organizations and the implementation of open and transparent budgeting processes such as the Open Budget Initiative, the Collaborative Africa Budget Reform Initiative (CABRI), and the Extractive Industries Transparency Initiative (EITI). Countries will also need to look beyond the EITI to ensure that policies are in place to facilitate greater transparency and accountability over the entire resource value chain. Further, multinational companies operating in African countries should be required to publish annual financial reports that explicitly include their activities in Africa.
  • In resource-poor countries, illicit financial flows largely arise from the mispricing of trade by companies of all sizes. This activity is a form of money laundering and tax evasion. These countries should focus on strengthening legal institutions and anti-corruption laws and empowering regulatory agencies to exercise adequate oversight. Specifically:
  1. Undertaking tax reform to widen the tax base. Tax reform applicable to a broad group of taxpayers is not only fair but will ensure greater tax compliance than a proliferation of indirect taxes that are unwieldy to manage, costly to administer, and have large built-in incentives for evasion.
  2. Creating a national authority for the regulation and management of public procurement to ensure greater transparency and accountability in the contracting process. The procedures and rules for bidding on government contracts should be transparent, as should be information regarding the contracts awarded. African countries should follow international best practices in the area of government contracting so as to maximize public benefit.
  3. Reforming customs service procedures to curtail trade mispricing. This involves the removal of ad hoc exemptions from customs duties, streamlining clearance and document control procedures, and efficient computerization of payment and collection procedures in order to make procedures less cumbersome and more efficient. Additionally, capacity-building and training are needed to detect and investigate under- and over-invoicing of goods entering and leaving the country.
  4. Strengthening anti-money-laundering initiatives and enforcement. During the last decade, many African countries have set up anti-money-laundering programs under which financial institutions are required to report suspicious transactions to the relevant authorities. However, there is a need to strengthen the capacity of the relevant authorities to initiate appropriate legal actions on the basis of these reports. Policies to boost net recorded transfers by improving the business climate generally involve measures that range from improving a country’s political and economic stability to specific business-friendly measures to improve infrastructure, rationalize corporate taxation, and strengthen governance.

Comments

Catherine Phiri - Zambia 15/02/2014 07:41
The National Prosecution Authority in Zambia will from 2nd to 6th March host the 3rd IAP Africa and Indian Ocean Regional Conference in Livingstone Zambia whose theme revolves around the issues of financial crimes and will inevitably discuss the problem of illicit financial flows. This article and recommendations therein will definitely be relevant to the discussion.
Donald Deya - Tanzania 27/06/2013 15:16
This is very useful information. The Pan African Lawyers Union (PALU) will hold a Conference on "Illicit Financial Flows from Africa - Sealing the leaks, management and repatriation of frozen assets", in Nairobi, Kenya in mid-September 2013. So the recommendations here will assist us to formulate tangible, SMART action points for African lawyers and lawyers' associations. - Don Deya, CEO, PALU

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Mthuli Ncube

Professor Mthuli Ncube is the Chief Economist and Vice President of the African Development Bank, and holds a PhD in Mathematical Finance from Cambridge University, UK, on “Pricing Options under Stochastic Volatility”.

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