April 3, 2017 | Center for Strategic and International Studies

Severing China-North Korea Financial Links

Chinese companies and banks are complicit in Pyongyang’s efforts to evade financial sanctions. Washington should authorize the Treasury Department to impose fines against banks that aid North Korea’s sanctions evasion. Ultimately Chinese banks must be forced to choose: either stop aiding North Korea or lose access to the U.S. banking system.

Since 2006, China has supported multilateral United Nations sanctions targeted at curtailing North Korea’s illicit financial transactions. Since 2011, Beijing has also backed the Financial Action Task Force’s call for its members to impose countermeasures on Pyongyang for its lack of anti-money laundering and counter-terrorism finance controls. Last year the United States declared North Korea a jurisdiction of primary money laundering concern, a declaration which cut Pyongyang from the U.S. financial system and prohibited foreign banks from providing indirect access. A U.N. report released this month revealed North Korea’s aggressive efforts to evade financial sanctions over the last six years.

In September 2016, the Justice Department found that from 2009 to 2015, Chinese nationals had used 22 front companies to open accounts in Chinese banks to conduct dollar transactions through the U.S. financial system for sales to Pyongyang. In the December 2015 trial of Chinpo Shipping in Singapore, a Bank of China representative suggested transactions in dollars would be successful if the company removed references to North Korean vessels in wire transfers. Both Reuters and the U.N. report also detailed additional North Korean efforts to use front companies and banks in mainland China and Hong Kong.

Presidents Bush and Obama were unable to convince Beijing to rein in North Korea’s nuclear weapons and missile programs and comply with sanctions on the Kim regime. For its part, the Trump administration is conducting a policy review and is reportedly considering long-overdue sanctions against Chinese companies and banks that do business with North Korea. The new administration likely considered four options: maintaining the status quo, pursuing Treasury engagement, implementing fines on a Chinese bank, and sanctioning one.

Status Quo

North Korea has long been a contentious issue in the U.S.-China relationship. Beijing is interested in managing rather than solving the North Korea threat, an approach that successive U.S. administrations have begrudgingly accepted. The Obama administration policy included U.S. sanctions, but stopped short of sanctioning Chinese banks. This approach, however, is untenable, as Treasury has acknowledged by labeling North Korea’s financial activities “a threat to the integrity of the U.S. financial system” itself.

Treasury Engagement

The Iran sanctions regime serves as a useful template for changing the attitudes of China’s banks. Presidents Bush and Obama understood the gravity of Iran’s nuclear threat, and engaged in robust economic and financial warfare to address it. The Treasury Department forced businesses and banks to make a simple choice: access to the U.S. or a relationship with Iran. The new administration now needs to replicate that approach with North Korea.

Treasury officials should meet with Chinese government officials, key businesses, and banks and inform them of Washington’s new approach. The meetings should include detailed briefings on North Korea’s illicit activities, and Chinese companies and banks’ complicity in these efforts. This new approach will only work if the United States is serious about sanctioning those who refuse to stop working with Pyongyang. The Iran experience suggests banks will be the most willing to comply, and will force that compliance on businesses and, eventually, the government.

Fines on a Chinese Bank

Fines against banks that violate U.S. sanctions are an often-overlooked U.S. regulatory tool. From 2012-2015, the U.S. levied more than $12 billion in fines against large European banks for sanctions violations – efforts that were not popular with the banks’ home governments. In June 2014, for example, French President Francois Hollande lobbied U.S. President Barack Obama against penalizing BNP Paribas for violations of Sudan, Iran, and Cuba sanctions, which the Obama administration did later that month to the tune of nearly $9 billion. China will similarly object to any effort by the United States to sanction its banks.

The Justice Department’s September 2016 findings revealed a disturbing pattern amongst China’s banks. Those banks could have determined the relationship of the relevant Chinese company and North Korea with minimal research. From January 2011 to September 2015, the company imported 99 percent of its goods from North Korea. One Chinese bank, China Merchants Bank, processed dollar transactions through U.S.-based banks rather than its own New York branch – suspicious activity that suggests the Chinese bank may have known North Korea was involved.

While the U.S. could seek greater cooperation on North Korea from Chinese banks, it is not necessary. A large fine would send shockwaves through the Chinese financial system, causing other Chinese banks to evaluate their compliance procedures. For example, a Chinese company this month accepted a penalty of over $1 billion for violations of North Korea and Iran sanctions. This should be a model for addressing the activities of China’s banks.

Sanction a Chinese Bank

Designating a Chinese bank is a popular but risky option. The United States sanctioned China’s Bank of Kunlun in 2012 for providing services to Iranian banks. The move was important in curtailing Iran’s financial activities, but Iran and China likely developed workarounds and Washington was probably reluctant to designate additional Chinese banks.

Some of the Chinese banks assisting North Korea have access to the U.S. financial system, and sanctions would be a powerful tool. But there are also downsides. Designation of a medium-to-large Chinese bank would likely be met with stiff resistance from Beijing. Moreover, Washington would need to continue designating additional Chinese banks as North Korea evaded the sanctions, but multiple rounds of sanctions against Chinese banks are unlikely, as they could derail the U.S.-China relationship and have dire consequences for the U.S. economy.

The U.S. has expended significant effort to persuade Beijing to implement sanctions against North Korea, and that campaign has thus far failed completely. Washington cannot trust that Pyongyang’s financial transactions are legitimate and should block this access. Therefore, based on the options presented, and in line with Washington’s past efforts against Tehran, the U.S. should pursue significant fines against Chinese banks that are aiding North Korea’s financial transactions, coupled with senior-level Treasury engagement with counterparts in Beijing.

North Korea is developing a nuclear weapon that can reach the United States, and China’s actions warrant a harsher U.S. response for helping its ally get to that point. Beijing is critical to any effort to increase sanctions against Pyongyang, and Washington should not continue to let it stand in its way. Sanctions against both North Korea and China are the only peaceful means for coercing the Kim regime, and are for that reason indispensable.

Anthony Ruggiero, a Senior Fellow at Foundation for Defense of Democracies, was advisor to the U.S. delegation to the Six-Party Talks’ 2005 rounds and spent 17 years in the U.S. government, including at the Treasury Department. Follow him on Twitter @_ARuggiero.

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Issues:

North Korea