In this article, we talk about money laundering – its three stages and what each means. We try to comprehend the detrimental effects it poses to businesses and the economy at large and grasp the methodologies that corporations can implement to safeguard themselves against such illicit activities.
The act of money laundering (ML) inflicts significant harm upon businesses, the investment climate, and the broader economic landscape. It significantly promotes crime and corruption and triggers a considerable decline in the effectiveness of the real sector of the economy. As a result, this criminal activity manifests many other consequential outcomes.
The magnitude of this unlawful conduct on a global scale is staggering. The United Nations Office on Drugs and Crime (UNODC) reports that each year, between 2 to 5% of the world’s gross domestic product (GDP) is subjected to money laundering, amounting to an estimated sum of between $754 billion to $2 trillion.
In most countries’ jurisdictions, the act of money laundering constitutes a grave offence, punishable by imprisonment and/or substantial fines. For instance, in the United States of America, the severity of the penalty for complicity in money laundering may escalate to $250,000 and extend to a maximum imprisonment term of five years.
Numerous enterprises may remain oblivious to the reality of being utilised for money laundering. Even though not all commercial entities may be held accountable for the illicit activities carried out through them, entities obligated to comply with Anti-Money Laundering (AML) regulations, including banks, are held to a different standard. The consequences can be colossal if the illicit conduct is discovered during an audit process. As an illustration, Danske Bank was recently subject to a €470 million ($495 million) fine owing to its involvement in an international money laundering scandal.
To safeguard your business from criminals and the imposition of regulatory fines, it is imperative to delve into the intricacies of money laundering, including the prevalent schemes that are commonly employed and the measures that can be taken to prevent this.
What is money laundering (ML) and why it matters
In its most basic definition, the act of money laundering is characterised by the intentional concealment or distortion of the source of proceeds that have been illicitly obtained to create the impression that the funds were derived from lawful sources. Money laundering (ML) entails a course of action whereby funds originating from unlawful activities such as drug trafficking, bribery, or fraud are obscured from their source.
Actions to combat money laundering (ML) are frequently associated with the battle against terrorism financing (TF), as both ML and TF entail the rechanneling of funds.
As per the Financial Action Task Force (FATF) findings, a staggering amount of $1.6 trillion is laundered annually from countries with lower-income levels, with the proceeds typically emanating from political corruption. In such areas, corruption exacerbates poverty, exacerbating environmental destruction and causing economic stagnation. Due to the intricate connection between money laundering and corruption, any initiatives aimed at curbing the proliferation of illicit funds also assume a crucial role in reducing corruption on a global scale.
Activities such as illegal arms sales, smuggling, and organised crime, including drug trafficking and prostitution rings, can produce significant sums of money. Similarly, embezzlement, insider trading, bribery, and computer fraud schemes can generate substantial profits and create the incentive to “legitimise” the unlawfully obtained gains through money laundering.
When a criminal endeavour results in sizeable profits, the involved parties must find a way to maintain control of the funds without drawing attention to the underlying activity or the individuals implicated. Criminals do so by disguising the source of the funds, altering their form, or relocating the funds to a location where they are less likely to attract scrutiny.
In light of growing apprehension regarding money laundering, the Financial Action Task Force on money laundering (FATF) was established by the G-7 Summit in Paris in 1989 to formulate a cohesive international response. One of the FATF’s primary objectives was to develop a set of 40 Recommendations, which outlined the measures that national governments should adopt to implement effective anti-money laundering programs.
How much money is laundered per year?
By its very nature, money laundering is an illicit activity perpetrated by criminals that operate outside the standard range of economic and financial data. In conjunction with other facets of subterranean economic activity, approximations have been posited to offer a glimpse into the scale of the issue at hand.
The United Nations Office on Drugs and Crime (UNODC) conducted a comprehensive analysis to ascertain the extent of illegitimate funds generated by drug trafficking and organised crimes and the degree to which these funds are laundered. The UNODC report approximates that in 2009, criminal profits constituted 3.6% of the global gross domestic product (GDP), with 2.7% (equivalent to USD 1.6 trillion) of those proceeds being laundered.
This falls within the ambit of the widely cited estimate by the International Monetary Fund (IMF), which stated in 1998 that the overall scope of money laundering across the world could be situated between two and five percent of the world’s GDP. Using the statistics of 1998, these percentages would suggest that the phenomenon of money laundering ranged between USD 590 billion and USD 1.5 trillion. At that juncture, the lower figure was roughly commensurate with the total output value of an economy comparable in size to that of Spain.
However, it is imperative to exercise caution while considering the above estimates. They are merely meant to approximate the magnitude of money laundering. Due to the clandestine nature of the transactions involved, precise statistical data is unavailable, making it impossible to produce a definitive estimate of the global amount of money laundered each year. Therefore, the Financial Action Task Force (FATF) abstains from publishing any figures in this regard.
The three main stages of money laundering
The placement stage
Illicit funds can be integrated into the financial system either directly or indirectly. In the placement stage, the most common technique used is the fragmentation of large sums of money into smaller, less conspicuous amounts, which can be deposited into one or multiple bank accounts using the ‘smurfing’ technique. Money service businesses are often utilised to execute smurfing.
Other placement methods include:
- False invoicing involves creating invoices for non-existing goods or services to overcharge or charge for services that were never provided. The difference between the actual cost of goods or services and the overcharged amount is then transferred as laundered money.
- Blending illegal money with legitimate money – involves depositing cash obtained through illegal activities into bank accounts with legitimately earned funds, making it difficult for law enforcement agencies to trace the illegal funds.
- Buying foreign currency – involves converting large amounts of illegal money into a different currency, which can then be deposited into foreign bank accounts or used to purchase assets in other countries.
- Purchasing securities or insurance using cash – involves buying stocks, bonds, or insurance policies with cash, which can later be sold for clean money.
- Gambling and betting on sports events – can be used to launder money by placing bets with cash obtained through illegal activities and then collecting the winnings as clean money.
The layering stage
The process known as “layering” denotes the complex set of actions aimed at severing the illicit origin of money and further masking its source by creating multiple “layers” of transactions to obfuscate the trail of an audit. This sophisticated practice serves the purpose of concealing the provenance of illegally gained assets by confounding their detection and tracking.
Undertaking the layering phase constitutes the most intricate stage of this fraudulent operation. It entails a series of elaborate financial transactions, which often cross national borders via international money transfers. To execute the layering strategy, the funds can be directed through purchasing and selling various types of investments or via a chain of accounts held in different financial institutions across multiple jurisdictions. Such illicitly obtained capital is frequently diverted to countries with permissive anti-money laundering (AML) regulations or those that do not cooperate with AML investigations.
The integration stage
Once the illicit money has been successfully placed and layered, the next stage for criminals is to reintegrate, or “return,” the money to themselves in a way that obscures its illegitimate origin, rendering it “clean.” Upon completing this stage, the funds become part of the legitimate financial system and can be utilised freely by the perpetrators.
The central goal of this stage is to integrate the money into the economy without raising suspicion or drawing the attention of law enforcement agencies. To accomplish this objective, criminals may acquire assets such as real estate, artwork, precious jewellery, or high-end vehicles, among other possibilities. These types of assets can serve to legitimise the previously illicitly obtained capital, as they can be perceived as having been acquired through lawful means.
How money laundering impacts businesses and the economy
Money laundering poses a significant threat to businesses, resulting in a host of adverse consequences such as revenue loss, damage to reputation, and regulatory penalties in the millions of dollars or suspension of licenses.
Furthermore, the socio-economic repercussions of ML are far-reaching and damaging, with global effects such as the perpetuation of corruption, an escalation in criminal activity, erosion of foreign investor confidence, widening income inequality, and a slowdown in economic growth. These effects are particularly concerning as they can compound and exacerbate pre-existing economic and social issues, creating further destabilisation and harm.
The perceived functioning of the banking and financial services marketplace within a framework of elevated legal, professional, and ethical standards is integral to preserving its integrity. A financial institution’s reputation for integrity is among its most valuable assets.
Suppose a particular institution is susceptible to processing funds generated by criminal activities, either due to the bribery of its employees or directors or by turning a blind eye to the illicit nature of such funds. In that case, it risks becoming actively complicit with criminals and thereby part of the criminal network itself. Any evidence of such complicity is bound to hurt the perceptions of other financial intermediaries and regulatory authorities, in addition to ordinary customers.
Unchecked money laundering also carries the potential for negative macroeconomic consequences, such as inexplicable changes in the demand for money, prudential risks to the soundness of banks, contamination effects on legitimate financial transactions, and increased volatility of international capital flows and exchange rates due to unforeseen cross-border asset transfers. Furthermore, successful money laundering rewards corruption and crime, damaging the integrity of society as a whole, undermining democracy, and compromising the rule of law.
Money launderers are constantly searching for new avenues to launder their ill-gotten gains. Economies with expanding or emerging financial centres, yet inadequate safeguards, are especially vulnerable, as countries with well-established financial centres implement extensive anti-money laundering protocols.
Launderers will exploit the differences in national anti-money laundering systems, relocating their networks to nations and financial systems with weak or ineffective countermeasures. Some may argue that developing economies cannot be too discriminating when it comes to attracting capital. However, postponing action is risky. The more action is delayed, the more entrenched organised crime can become.
Similar to the compromised integrity of a particular financial institution, the presence of organized crime controlling and influencing a country’s commercial and financial sectors hurts foreign direct investment.
Thus, combatting money laundering and terrorist financing is crucial in creating a business-friendly environment, which is a prerequisite for sustainable economic development.
The potential social and political repercussions of unaddressed or poorly managed money laundering are grave. Organised crime can penetrate financial institutions, seize control of significant portions of the economy through investment, or bribe public officials and even governments.
The economic and political sway of criminal organisations can erode the social fabric, shared ethical norms, and, ultimately, the democratic institutions of society. In nations transitioning to democratic systems, criminal influence can undermine the transition. At its core, money laundering is inextricably linked to the criminal activity that spawned it. By laundering funds, criminal activity is allowed to persist.
How to detect and prevent money laundering
To ensure the safety of businesses and prevent financial crime, a comprehensive Anti-Money Laundering (AML) compliance program must be implemented. Such a program should clearly define the procedures for detecting, assessing, and reporting suspicious financial activities. The following measures are key components of an effective AML program:
- Customer Due Diligence (CDD): Before a customer is allowed to use the services of a company, they must undergo a rigorous Customer Due Diligence check. This process involves obtaining and verifying customer information, such as their identification documents, and evaluating whether they pose any potential risk of being involved in criminal activities.
- Enhanced Due Diligence (EDD): In cases where there is a higher risk of money laundering, companies are required to implement Enhanced Due Diligence measures. One of the most critical elements of EDD is to scrutinise clients’ sources of funds to ensure they are not derived from illegal activities.
- Ongoing customer monitoring: This is an additional layer of risk management that involves continuously monitoring customer transactions and conducting periodic checks to identify and assess any suspicious activity.
- Independent AML audits: These audits allow businesses to identify and rectify any deficiencies and shortcomings in their AML compliance strategies before regulatory inspections to prevent penalties or fines.
- KYT or transaction monitoring: Transaction monitoring is a continuous security process that enables businesses to detect and prevent suspicious transactions. A reliable KYT software platform can identify unusual patterns, scrutinise dubious transfers, and monitor digital or fiat currency transactions. This helps to prevent and detect money laundering activities and other financial crimes.