Sri Lanka Faces High-Stakes FATF Evaluation Amid Persistent Money Laundering Risks

Money laundering continues to represent one of the most corrosive threats to both financial stability and national governance. For countries under the watch of global standard setters, the consequences of weak enforcement stretch far beyond local policy frameworks. Sri Lanka, which has already undergone two mutual evaluations, is now preparing for its third assessment by the Financial Action Task Force (FATF) in 2026. Unlike previous reviews, this round will place sharper emphasis on enforcement outcomes, moving past the existence of legal frameworks to demand evidence of effective prevention, detection, and prosecution of laundering activity. The process will test not only Sri Lanka’s legal foundations but also its institutional strength in confronting entrenched criminal networks and aligning with international compliance benchmarks.

The case offers a lens into the way national anti-money-laundering efforts intersect with systemic weaknesses and global scrutiny. It is at once an opportunity to measure progress and a reminder of how persistent gaps allow laundering schemes to flourish despite legislative change.

At the heart of Sri Lanka’s fight against illicit finance is the Prevention of Money Laundering Act (PMLA) of 2006, which criminalizes the acquisition, possession, or transfer of property derived from criminal activity when an individual knows or has reason to suspect its unlawful origins. Subsequent amendments granted authorities broader powers to freeze assets, pursue forfeiture, and engage in international cooperation, with the explicit aim of harmonizing the country’s framework with the FATF’s 40 Recommendations. The law was designed to capture all three laundering stages—placement, layering, and integration—and stipulates severe penalties, including prison terms of five to twenty years and fines up to three times the value of the laundered assets. It even shifts the burden of proof to defendants, compelling them to demonstrate the lawful origin of their wealth, signaling a tough approach to unexplained enrichment.

Still, enforcement has frequently lagged behind ambition. Gaps such as the absence of conspiracy provisions have limited prosecutors’ ability to pursue networks working in coordination. Meanwhile, predicate crimes including narcotics trafficking, corruption, and trade-based manipulation continue to generate illicit proceeds, with authorities often struggling to trace and tie them directly to offenders.

Past FATF reviews highlighted what were described as “strategic deficiencies” in Sri Lanka’s AML/CFT system, ultimately placing the country on the grey list in 2017, followed by blacklisting by the European Union. Removal required sweeping reforms by the Financial Intelligence Unit (FIU) and the Central Bank. Now, with the FATF’s revised methodology prioritizing effectiveness, the upcoming 2026 evaluation will focus squarely on measurable results such as convictions, confiscations, and inter-agency coordination. Whether Sri Lanka has progressed from paper compliance to operational success remains to be seen.

Money laundering in Sri Lanka often follows familiar global patterns but with distinctly local characteristics. The largest sources of illicit funds stem from narcotics, corruption, trade fraud, and public-sector embezzlement. These proceeds are initially placed into circulation through casinos, currency exchange houses, and front companies. Weak controls in these sectors, particularly casinos, have long been flagged as a vulnerability in the placement stage.

Layering then disguises origins through offshore transfers, shell companies, and false trade invoices. Investigations have uncovered funds wired to overseas firms under the guise of consultancy or procurement, as well as real estate purchases in the names of relatives to conceal true ownership. Until very recently, the lack of a public beneficial ownership registry made such schemes remarkably effective.

Integration closes the loop by reintroducing laundered money into the legitimate economy via property acquisitions, luxury cars, or shareholdings. The layering process frequently exploits multiple financial institutions, both domestic and regional. Notable cases have included alleged laundering through aviation contracts, with illicit payments disguised as aircraft procurement fees, and bond market transactions where insiders allegedly recycled profits through investment vehicles. The use of politically exposed persons (PEPs) to hide behind intermediaries and relatives has added another dimension of opacity, compounded by weak PEP monitoring and limited verification of asset declarations.

Although the FIU has expanded its capabilities, a consistent challenge has been synchronizing financial investigations with prosecutions of underlying crimes. Without this linkage, deterrence remains weak and offenders often retain access to illicit wealth.

Institutional weaknesses continue to dog the AML framework. High staff turnover in compliance and investigative units has undermined continuity, while some agencies still treat AML requirements as administrative exercises rather than national security imperatives. The lack of a fully functional beneficial ownership register remains a glaring deficiency despite FATF’s Recommendation 24, which requires authorities to hold timely, accurate ownership data. Legal reforms to the Companies Act introduced such obligations, but implementation has lagged.

Virtual assets present another blind spot. FATF Recommendation 15 mandates regulation of virtual asset service providers, yet Sri Lanka has only partially met this standard. Cryptocurrencies have become a new vehicle for layering and cross-border concealment, but national regulation has not kept pace with these technologies.

Coordination across enforcement agencies is another weak link. Predicate crimes are often investigated in isolation, with no corresponding financial probe to trace and seize illicit assets. In successful jurisdictions, criminal and financial investigations advance in tandem, cutting off both liberty and profit from offenders. Judicial capacity is also limited. Many judges and prosecutors lack the technical training needed to unravel complex laundering transactions, slowing trials and resulting in low conviction rates. While the number of convictions has risen—from one in 2015 to more than a dozen in recent years—the figure is still modest compared to the scale of illicit finance flowing through the system.

The economic fallout of weak AML enforcement is severe. Being grey listed increases transaction costs, subjects correspondent banking to stricter oversight, and reduces foreign investment. The Central Bank itself has admitted that maintaining correspondent banking ties is conditional on FATF compliance. The Proceeds of Crime Act, passed in 2024, gave regulators new powers to freeze and manage confiscated assets, signaling progress. However, execution will demand transparent governance, proper valuation processes, and strong inter-agency collaboration—areas that will receive close scrutiny in the 2026 assessment.

The stakes could not be higher. A poor showing in the evaluation risks renewed grey listing, which would constrict access to international markets and drive up borrowing costs. For Sri Lanka, effective AML enforcement is not simply a matter of regulatory compliance but an existential economic requirement. As long as the proceeds of corruption and organized crime remain untouched, the incentive structure for financial crime remains intact, undermining both governance and market trust.

Investor confidence also depends on robust AML protections. Foreign investors need assurance that their capital will not be exposed to co-mingling with illicit flows. Transparency and accountability therefore become competitive advantages, especially for emerging economies like Sri Lanka. The country’s strategic geographic position at major shipping crossroads makes its financial integrity even more critical, as transnational networks often exploit weak systems to move funds across borders.

The FATF’s latest methodology measures outcomes across eleven criteria, with a premium placed on real-world results rather than formal compliance. Whether Sri Lanka can demonstrate operational effectiveness—through confiscations, prosecutions, and sustained inter-agency cooperation—will decide if it consolidates recent progress or slips back into reputational risk.

Ultimately, the Sri Lanka AML case highlights that legislation alone is insufficient. True resilience requires synchronized enforcement, modernized technology, and institutional culture change. Compliance cannot be reduced to a bureaucratic box-ticking exercise; it must become a core element of governance. Recent reforms, including the beneficial ownership register and the Proceeds of Crime Act, represent steps forward, but their credibility hinges on outcomes. Transparent prosecutions, cross-border information sharing, and specialized judicial expertise remain indispensable.

As regulators and financial institutions brace for the 2026 review, the lesson is clear: “effectiveness, not formalism, defines resilience.” Sri Lanka’s ability to prove that its reforms are delivering tangible results will determine whether it has finally bridged the gap between legislative ambition and operational reality—or remains locked in a cycle of partial compliance and global mistrust.

By fLEXI tEAM