How North Korea Evades Financial Sanctions
In response to North Korea’s third nuclear test in February 2013, the UN Security Council voted to tighten financial sanctions on North Korea to “prevent the provision of financial services” that could “contribute” to the North’s missile and nuclear programs. US financial sanctions dating back to September 2005 are more comprehensive than those authorized by the Security Council, targeting not just weapons-related and other trade that the UN sanctioned, but all transactions by North Korea with any bank in the world.
Denied access to international financial institutions, North Korea should have had a lot of trouble conducting trade. International trade usually requires a letter of credit issued by a bank to guarantee payment to a seller of goods by the issuer whether or not the buyer eventually pays, and often also to assure the quality of goods to the purchaser.
One myth widely accepted in policy circles is that the US financial sanctions imposed on the North in 2005 were creating severe problems for Pyongyang and that the new sanctions will have a similar effect. Yet, North Korean trade has grown substantially since 2005—not just with its main partner China, but also with countries throughout South and Southeast Asia, Africa and Europe. Even its trade with South Korea set a record high in 2012 despite the South’s reduced engagement with the North. The transactions are often opaque, making calculations imprecise, but EU data puts North Korea’s trade with the world at 5553 million euros in 2011, up 26.7 percent from 2007. Its trade with Europe in 2011 was 159 million euros, one-third higher than in 2007. Imports from India, much of it petroleum, reportedly topped 1 billion USD in 2010, a tenfold increase from mid-decade. Some evidence compiled by Marcus Noland and Stephan Haggard even suggests that for the first time in its history, the North may have enjoyed a current account surplus in 2011—“bad news” for those who want to believe that economic pressure will bring North Korea to heel.
So how has North Korean trade continued to grow despite sanctions intended to crimp it?
BDA and Beyond
The US Treasury first threatened to invoke Section 311 of the USA PATRIOT Act against the Banco Delta Asia (BDA) in Macao, which it accused of money-laundering for North Korea, in September 2005. So-called “Super 311” would bar BDA from correspondent relations with any US financial institutions. In short, BDA would be unable to transact business with US banks on behalf of its clients. The reputational risk to BDA of the mere threat to invoke Super 311was immediate: a run on the bank that prompted the authorities in Macao to shut it down.
From a broader perspective, the US Treasury’s action proved counterproductive. Interpreting the freezing of its accounts at BDA as a breach of the September 19, 2005 Six Party joint statement and a sign of US hostility, Pyongyang boycotted Six Party Talks until its funds were repatriated. In 2006, it test-launched seven missiles including the longer-range Taepodong 2, ending a seven-year moratorium on such launches first concluded with the Clinton administration. Pyongyang then conducted its first nuclear test. Within days of that test, the Bush administration began bilateral talks with Pyongyang to unfreeze its BDA accounts, but the US Treasury impeded resolution of the dispute for months.
This US Treasury action, euphemistically called “financial measures,” was ostensibly part of the Illicit Activities Initiative (IAI) initiated by the Bush administration. IAI was designed to crack down on North Korean counterfeiting of currency and cigarettes and manufacture of amphetamines.
Yet the US Treasury’s efforts extended far beyond BDA. It threatened to apply Section 311 to any bank in the world doing any business with North Korea.
In July 2009, Under Secretary for Terrorism and Financial Intelligence at the US Treasury, Stuart Levey, made public what he and other US officials had been telling banks in private for over three years—that the US Treasury was not only targeting the North’s illicit trade or its dealings with just one bank:
The bottom line is that because of this kind of deceptive conduct that North Korea engages in that obscures the nature of their transactions, it’s virtually impossible to distinguish between legitimate and illegitimate North Korean business. In the financial world, transparency is a fundamental value. … And North Korea acts in a way that is intended to be opaque. And so it’s for that reason that this has a powerful effect not only with governments, but with the private sector, and particularly banks around the world that have every incentive to protect themselves from this kind of illicit activity. They don’t want to get involved in illicit transactions, whether it’s a nuclear transaction, a missile transaction, whether it’s a transaction that involves the provision of luxury goods to North Korea, which is a violation of the Security Council resolutions. They don’t want to get involved in those transactions, both because they’re good corporate citizens, but also because they are very protective of their own reputations.
The next month, Philip Goldberg, Coordinator for Implementation of UN Security Council Resolution 1874 on North Korea at the State Department, told the UN sanctions committee, “Financial companies must use caution in dealing with not only companies listed on the U.N. blacklist subject to sanctions, but all North Korean companies and individuals.” Similarly, in 2010, Daniel Glaser, Deputy Assistant Secretary for Terrorist Financing, warned that banks that violate United Nations Security Council resolutions and help North Korea’s illicit trade “will be at the risk of falling on the wrong side of these measures and being targeted by these measures,” and added,
I think we’ve shown in the past that sanctions have been very effective in applying pressure on North Korea. I think we’ve shown in the past that we can take targeted measures with respect to North Korean entities involved in illicit activities and have those measures have a profound systemic effect on North Korea’s ability to engage with the international financial system.
The ultimate risk for such banks is that they would be denied access to SWIFT, or the Society for World Interbank Financial Telecommunications. SWIFT transmits orders for payment from one bank to another to facilitate secure and rapid international settlements. Any bank that is shut out of SWIFT would, in effect, be put out of business. Banks exercising due diligence are supposed to ascertain the identities of those with whom they conduct business.
Rather than unwittingly risk a failure to do due diligence and thereby jeopardize correspondent relations with US financial institutions, many reputable banks abroad simply refused to do business with any entities dealing with North Korea.
Why Try to Curb Legitimate Trade?
Washington understandably wants to curb Pyongyang’s money-laundering and other illicit activities, but it seems perverse to impede its legitimate trade when North Koreans are relying more on markets than the state to meet their everyday needs. When North Korea revalued its currency in 2009, so widespread were the protests to the confiscatory measure that it forced the regime to reverse course—evidence that weaning the populace from dependence on the state is transforming its political-economic system.
The flow of goods into North Korea’s markets from outside, especially from China, facilitates that transformation. Isolation, by contrast, would only tighten the regime’s grip.
End Runs by Banks
Yet the question remains, how has North Korea managed to circumvent financial sanctions to conduct trade? As with many aspects of North Korea, it is difficult to know with much confidence, but in this case, educated guesses are possible. Talking to American bankers with many years of experience in Asia reveals several intriguing possibilities.
One way to circumvent financial sanctions, these bankers say, is to disperse funds into small accounts in many banks and keep transactions from each account small enough to avoid triggering the bank’s due diligence. Due diligence requirements in Asia are not always as stringent as those in the United States. Yet even banks operating in good faith, the bankers say, will have trouble vetting documents for trade that is re-invoiced, run through transshipment centers or conducted through one or more intermediaries.
Moreover, some banks knowingly run the risk because they can charge more for transactions with suspect entities or those without extensive correspondent relations with US financial institutions. Shady banks in the Balkans, Russia, Cyprus, the Middle East and China are suspected of doing such transactions, the bankers say, for which they charge 10-20 percent commissions. So are some private banks in Singapore, Hong Kong, Switzerland, Lichtenstein, Luxembourg and Austria.
Regional banks in China are suspected of doing substantial business with North Korea, although most of its trade with China does not use the banking system there at all. John Park, who has long studied the subject, says, “North Korea is doing all its transaction in cash via trading companies inside China, so even BDA-style sanctions will not be able to harm them.”
China has signed on to UN Security Council sanctions curbing weapons-related financial transactions, but the US Treasury is reportedly now picking a fight with China over other transactions as well. As a US Treasury official put it recently,
Treasury has been using tools at its disposal to increase financial pressure on the North Korean regime by targeting individuals and entities responsible for facilitating payments connected to North Korea’s nuclear and ballistic missile program, as well as financial institutions such as the Foreign Trade Bank, which has served as a key node for the regime’s foreign exchange.
Such action would impede the North’s legitimate trade—a step China is unwilling to take. Yet, even if the authorities in Beijing want to curb bank transactions, they may not find it easy to do so. Regional banks in China operate with considerable autonomy, thanks to political protection from powerful local party officials or provincial authorities. Their autonomy was evident after China adopted the world’s largest fiscal stimulus in response to the global financial meltdown. Regional banks put much of the money to work building office and apartment complexes—far in excess of existing demand. When Beijing ordered the banks to redirect investment to more productive uses, it was ignored. Central bankers had to resort to raising reserve requirements for the regional banks in an effort to pop the resulting real estate bubble.
If Beijing cannot control its regional banks’ allocation of domestic investment, will it have more success curbing the banks’ lucrative dealings with murky North Korean entities? That may be especially problematic for banks in the poorer provinces bordering on North Korea whose growth has been spurred in recent years by dealings with the North.
Worshipping at the Temple of Money Changers
Another way around the financial system, the bankers say, is hawala, informal networks of brokers or middlemen who transfer money for clients in countries with large Muslim populations like Malaysia, Indonesia and the Philippines, as well as Syria, Lebanon, the Gulf States and Iran—even India. Hawala operates on the honor system, eliminating the need for a paper trail.
According to a financier with experience in Asia, similar networks of money brokers or middlemen operate in China to facilitate the transfer of funds by Chinese trying to evade taxes and seeking safe havens abroad for their wealth—for a hefty fee. “A lot of the money passes through Hong Kong and Singapore, where I worked,” he said. Macao’s casinos have also been known to launder Chinese money. If so, Beijing may have trouble trying to turn off this flow of funds for North Korea as it does for its own people. “If we’re serious about going after illicit transactions, how do we do that if a lot of it takes place through Chinese firms?” a US official acknowledged in 2010. “I don’t know.”
Another way around the banking system is to carry payment in the form of gemstones, specie or antiquities. North Korea has been known to sell gold for hard currency through shell companies and hire couriers or even use its diplomats to transport the bulk cash wherever it is needed. In 2006, the year after the US Treasury imposed financial sanctions, North Korean exports to Thailand shot up 82 percent to 163 million USD. The US embassy in Bangkok estimated that sales of gold accounted for some 30 million USD of that increase, up from nil the previous year.
UN Security Council Resolution 2094, enacted this March, extends sanctions to bulk cash couriers suspected of involvement in prohibited weapons technology transactions, including DPRK diplomats. Tracking and intercepting them could prove difficult, however.
And finally, the North can circumvent the banking system by barter—exchanging goods without the use of money.
What works for legitimate trade would also enable North Korea to finance illicit trade—including exports and imports of nuclear and missile technology.
In a world where money flows like water, trying to plug all the leaks is doomed to fail. Circumventing the international banking system may make transactions more costly for North Korea, but financial sanctions have not slowed legitimate trade—or stemmed the trade in weapons-related technology that is rightly the focus of those sanctions.
North Koreans may condemn the financial sanctions as evidence of US hostile intent, but they’re crying all the way around the banks.
 EU, North Korea: EU Bilateral Trade and Trade with World, November 29, 2012. The EU data excludes inter-Korean trade, which hit a record high in 2012, because South Korea treats it as internal, not international, trade.
 Megha Bahree, “Look Who’s Helping North Korea,” Forbes, August 9, 2010.
 Marcus Noland, “Hugely Important: North Korea Running a Current Account Surplus?” North Korea: Witness to Transformation, Peterson Institute for International Economics, March 18, 2013.
 US Department of State, Office of the Spokesman, Background Briefing on North Korea, July 15, 2009 (emphasis added).
 “U.S. Imposes More Economic Sanctions against Korea,” Dong-A Ilbo, August 1, 2009 (emphasis added).
 Robert J. Einhorn, Special Advisor for Nonproliferation and Arms Control, and Daniel Glaser, Deputy Assistant Secretary for Terrorist Financing, Department of Treasury,” Press Conference at US Embassy, Tokyo, August 4, 2010, US, Department of State transcript (emphasis added).
 Cho Jong-ik, “Little Power Left in BDA Route,” DailyNK, February 19, 2013.
 Chico Harlan, “U.S. Official Outlines Plan Targeting Firms, Banks That Help Fund North Korea,” Washington Post, August 3, 2010, p. A-6.
 BANGKOK 6702, Subject: Thailand’s Trade with North Korea, November 6, 2006.