The Effectiveness of Banking Regulations in Preventing Money Laundering and Ensuring Financial Stability

Abstract

The modern global financial environment faces a complex combination of requirements associated with ensuring systemic solvency while preventing the use of banks as conduits for illegal financial transactions. The current paper focuses on evaluating the capacity of modern regulatory standards for addressing these interconnected challenges. While modern legislation and regulatory approaches have reached a new level of sophistication and standardization, the dynamic nature of innovations in the field of decentralized finance integrate specific examples of Explainable AI (XAI) tools like SHAP values or Grad-CAM that regulators are currently using to improve transparency in decentralized finance. A qualitative-comparative methodology is employed for exploring the impact of strict enforcement of financial standards on the sustainability of the banking sector. Using case studies drawn from some of the world's largest economies, such as the EU, the US, and India, the study finds that despite the positive impact of regulations on the core of the global economy (e.g., through enhancing the financial cushioning of banks), there is evidence that the displacement effect has occurred, which means that risks and illegal activities continue to be relocated to the shadow economy. From the policy implications, a shift from a response-oriented and rule-based approach to one that is proactive and intelligence-based, emphasizing globalization and integration, becomes evident. For future regulation, there is a need for the coverage to be extended to non-bank financial institutions as well as dealing with the paradox of compliance whereby escalating costs have not yet translated into less global money laundering.