The recent inclusion of Nepal in the Financial Action Task Force (FATF) 'gray list' presents both immediate challenges and opportunities for systemic reform for Nepal.

The FATF Plenary that concluded in Paris on Friday decided to include Nepal and Laos on the list. This follows the Asia Pacific Group's mutual evaluation report which identified significant deficiencies in Nepal's anti-money laundering framework.

“In February 2023, Nepal made a high-level political commitment to work with the FATF and Asia Pacific Group (APG) to strengthen the effectiveness of its anti-money laundering and combating the financing of terrorism (AML/CFT) regime,” the FATF said. “Since the adoption of its mutual evaluation report in August 2023, Nepal has made progress on some of the actions recommended in the report, including streamlining mutual legal assistance (MLA) requests and increasing the capabilities of the Financial Information Unit (FIU).”

The APG's third mutual evaluation report of 2023 had highlighted various weaknesses in Nepal's anti-money laundering and counter-terrorism financing controls. FATF has been evaluating the status of any country in controlling money laundering and terrorism financing based on 11 effectiveness indicators and 40 technical indicators. FATF has concluded that Nepal has not been able to demonstrate full effectiveness in any of the 11 prescribed effectiveness standards. According to APG's latest report, Nepal has not been able to achieve full or substantial progress in any of these 11 indicators.

The gray-listing could have far-reaching implications for Nepal's economy. International financial institutions now onwards are likely to implement enhanced due diligence measures for transactions involving Nepali entities. This can affect trade financing and remittance flows which are  very crucial components of Nepal's economy. Likewise, the country might face increased transaction costs and delayed processing times for international transfers. More importantly, this could deter foreign investment at a time when the country is seeking to attract international capital for its development projects. The increased perception of risk could lead to higher borrowing costs and more stringent lending conditions in international markets.

The FATF, however, has provided Nepal with a clear, albeit challenging, pathway to exit the gray list by January 2027. The seven-point action plan encompasses comprehensive reforms, from enhancing public awareness about money laundering risks to strengthening technical compliance in preventing terrorism financing, improving risk-based supervision of commercial banks, higher risk cooperatives, casinos, dealers in precious metals and stones and the real estate sector, and demonstrating identification and sanctioning of hundi operators.

Suman Dahal, the director general of the Department of Money Laundering Investigation, says Nepal has already begun addressing these challenges. “Instead of getting entangled in many small financial crimes, we will now focus on major crimes. We will work by setting thresholds for this purpose," he added. 

The focus appears to be on three critical areas: improving investigative capacity, increasing prosecutions of financial crimes and enhancing asset seizure mechanisms. One noteworthy intervention is the preparation to implement new technological solutions, including KYC software and integrated data management systems. These technological upgrades, if successfully implemented, could significantly improve Nepal's ability to monitor and prevent financial crimes.

The success of Nepal's efforts will largely depend on its ability to translate plans into action. The country's previous experience with the gray list (2010-2014) should provide valuable lessons for implementing sustainable reforms rather than quick fixes.

 

The real measure of success will not merely be exiting the grey list but establishing a robust, transparent financial system that can effectively prevent and combat financial crimes. This could position Nepal as a more attractive destination for international investment and trade in the long term.