Even before the Financial Action Task Force (FATF) Plenary in Paris, it was widely expected that Nepal would be placed back on the FATF 'Gray List'. High-ranking government officials, including central bank governor Maha Prasad Adhikari, had signaled that Nepal would remain under FATF’s watch. When FATF announced the outcomes of its Plenary on February 21, Nepal’s return to the gray list came as no surprise to many.

The FATF, a global body combating money laundering and terrorist financing, cited Nepal’s inadequate measures to prevent financial crimes as the reason for its reclassification. The country has been deemed high-risk for money laundering, largely due to political and administrative inaction in investigating and addressing suspicious financial transactions.

Announcing the outcomes of its Plenary, FATF outlined seven key areas where Nepal must improve and stressed the need for a comprehensive action plan.

Nepal was previously on the gray list from 2008 to 2014 but was removed after implementing reforms to strengthen its anti-money laundering framework. Its return to the list now places it under renewed international scrutiny.

Lack of Compliance and Enforcement

An assessment by the Asia Pacific Group (APG), a regional affiliate of FATF that monitors money laundering risks, had already indicated that Nepal was likely to be placed back on the gray list. Central bank officials say Nepal was formally notified of this decision during an APG meeting in Manila, the Philippines, a month ago. The move followed Nepal’s failure to implement recommendations from its mutual evaluation conducted a year and a half earlier.

Nepal's poor compliance was evident in two key areas: legal and structural measures, and their actual effectiveness in curbing money laundering. While Nepal has made efforts to establish a legal framework and supporting institutions, weak enforcement means the country still remains at high risk for money laundering.

A government official acknowledged the shortcomings, stating, “We have taken steps to establish structures and implement legal reforms to prevent money laundering. However, gaps in regulation and coordination have hindered effective enforcement.”

The FATF highlighted several critical concerns about Nepal’s anti-money laundering efforts, particularly in areas where the country continues to fall short. One of the most pressing issues is Nepal's failure to effectively monitor illicit financial flows. Sectors such as cooperatives and real estate, long suspected of facilitating illegal financial activities, lack proper mechanisms to detect and report suspicious transactions. The absence of robust reporting systems allows illicit financial activities to persist unchecked, undermining broader anti-money laundering efforts.

Although Nepal has enacted laws to combat money laundering, these laws have not fully been translated into effective preventive measures. In 2023, while the banking sector reported over 6,000 suspicious transactions, cooperatives, a high-risk sector, reported only two. This stark discrepancy highlights significant gaps in compliance, suggesting that many entities either lack awareness or deliberately neglect their regulatory obligations.

Another area of concern is the enforcement of legal frameworks. Although Nepal has enacted laws to combat financial crimes, the mechanisms to enforce them remain underdeveloped. Nepal’s asset forfeiture system is still in its infancy, and investigations into terrorism financing are progressing slowly. This sluggish pace, combined with a low percentage of cases being actively pursued, further hampers the country’s ability to effectively address money laundering.

The FATF also highlighted the lack of oversight in key sectors such as cooperatives and real estate. Despite being prime targets for money laundering, these sectors have not seen the introduction of necessary regulatory measures. There are still no licensing systems for real estate brokers or structured investigative processes for property transactions. This absence of controls leaves significant loopholes that allow illegal financial activities to flourish in these high-risk areas.

On a positive note, Nepal has made some progress in enhancing its anti-money laundering measures. Notably, the country has linked national identity cards to financial transactions, thereby improving personal identification systems. Additionally, the government is preparing its first anti-corruption action plan in nearly a decade.

However, efforts to regulate the cooperative sector have encountered significant opposition. In 2023, a proposal to cap savings in cooperatives at Rs 2.5 million was rejected by the House of Representatives due to resistance from cooperative leaders. The revised Cooperative Ordinance, passed in December, now permits a maximum savings limit of Rs 5 million, depending on the nature of operations.

Few Registered Cases

Despite a surge in money laundering complaints, the number of officially registered cases remains strikingly low. The Department of Money Laundering Investigation (DoMLI), responsible for probing and prosecuting such cases, admitted in its annual report that it has struggled to complete investigations and file charges for most complaints. Of the 4,083 complaints received to date, only 101 cases, or just 2.47% of the total, have been registered.

According to the report, money laundering complaints typically take two to three years to resolve, contributing to the low prosecution rate. The DoMLI recorded its lowest number of registered cases in 2009/10 and 2014/15, with just one case each, while the highest (14 cases) was in 2020/21.

As of 2023/24, preliminary investigation officers have been assigned to 3,368 complaints. The highest number of complaints investigated in a single fiscal year was 596, recorded in 2023/24.

DoMLI Spokesperson Atmaram Satyal attributes the low registration rate to the lengthy investigation process required before prosecution. However, stakeholders argue that frequent leadership changes within the department have further weakened its effectiveness. Since its establishment in 2011, the DoMLI has seen 17 directors general, with tenures ranging from just two months to a maximum of 2.5 years. Most director generals served for only a few months.

Consequences of Graylisting

The economic implications of FATF graylisting are significant. The country’s growing international reputation, particularly following its BB- rating by Fitch, has been overshadowed by its failure to address money laundering concerns. This designation could tarnish Nepal’s financial image and deter foreign investment.

Banking experts warn that graylisting will make international transactions more expensive for Nepali banks, leading to higher transaction costs that will affect both imports and exports. Additionally, the government may face difficulties in securing loans and financial aid from international institutions, while foreign lenders could raise interest rates for Nepali entities.

Being classified as high-risk will also subject Nepali nationals to increased scrutiny in financial dealings, making it more challenging to open bank accounts, obtain insurance or send remittances. If formal remittance channels become obstructed, informal methods like hundi could see a rise, further impacting the economy. Experts argue that Nepal’s ambition to attract foreign investment could suffer setbacks due to the economic consequences of being labeled high-risk for money laundering. Nepali businesses operating internationally are likely to face heightened scrutiny, while securing foreign loans and financial aid will become more difficult. Additionally, rising trade costs and concerns over reputational risks could make foreign investors hesitant to engage with Nepal.

Bankers are particularly concerned about the financial sector, as increased international scrutiny on Nepali transactions will make seamless cross-border operations more challenging. This could lead to higher costs and additional obstacles for businesses involved in international trade.

Nepal Rastra Bank (NRB) Governor Maha Prasad Adhikari acknowledged that the graylisting reflects Nepal’s effectiveness in combating money laundering. He warned of potential economic repercussions but stressed the importance of strengthening governance and regulatory enforcement. Speaking to New Business Age, Adhikari said, “We were placed on the gray list based on our compliance level and effectiveness. This listing will come with economic costs. However, the progress we’ve made over the years has laid a solid foundation for further improvement. We should see this as an opportunity to enhance our overall governance.”

The Road Ahead: Two-Year Window

Nepal has been given a two-year window to strengthen its anti-money laundering efforts. If it makes significant progress within this period, it could be removed from the gray list. However, failure to meet FATF’s recommendations could result in Nepal being blacklisted.

The FATF will provide Nepal with a detailed action plan outlining necessary reforms. Key areas of focus will include improving the management of assets acquired through criminal activities, enhancing the country’s anti-money laundering framework and ensuring effective enforcement. Nepal will be required to submit regular progress reports to demonstrate compliance.

Finance Minister Bishnu Poudel has expressed confidence that Nepal can implement the required reforms and exit the grey list ahead of schedule. He insisted that the groundwork for reform has already been established.

Nepal now faces a crucial period of reform to restore its financial credibility and prevent long-term economic repercussions. The government must act swiftly and decisively to strengthen anti-money laundering measures and reassure the international community that Nepal remains a safe destination for investment.

(This news report was originally published in   March 2025   issue of New Business Age Magazine.)