Money Laundering

What is Money Laundering?

Money laundering is the process of making the source of money legitimate, which, in reality, originates from an illegal activity like drug trafficking or smuggling. This term has been defined in the UN Vienna 1988 Convention Article 3.1.

Money laundering involves money and any economic good and is not limited to any specific country.

Money from criminal sources is regarded as “dirty,” and the process “launders” it to make it appear clean. The money is passed through a web of transfers, transactions, and businesses to make it appear legitimate.

The money can then be used without hiding it from the authorities. This process has become even more accessible these days with the use of online banking and cryptocurrencies.

Money laundering is a significant issue with a substantial impact on national economies, although precise estimates of the amount laundered annually vary.

Some banks have been implicated in money laundering operations, though it’s important to note that such activities are illegal, and most banks have measures in place to prevent them.

Criminal organizations often possess large amounts of illicit cash, which they seek to hide through money laundering to evade law enforcement detection rather than to avoid taxation.

So, to hide the illegitimate sources of vast amounts of cash, they launder the money by working it into the legitimate financial system.

It is fuel for criminal activities because it helps drug dealers, terrorists, arms dealers, corrupt officials, and members of criminal organizations such as the mafia, businesses, and private individuals to operate and expand.

How Money Laundering Works

Criminals must make their money appear to come from a legitimate source to transfer it to legitimate financial institutions, as dealing in large amounts of illegal cash is difficult and dangerous.

Typically, three stages are involved in this process:

1. Initial Entry or Placement: In this stage, the launderer introduces the “dirty money” into the legitimate financial system. This stage is usually done by breaking the massive amount of cash into smaller parts that are either directly deposited into a bank account or by purchasing cheques and money orders that are collected and then deposited into accounts at some other location.
2. Layering: In this stage, the launderer transfers the money through various transactions, such as purchases and sales of investment instruments, payments for goods or services, etc., to distance the money from its origin.
3. Integration: After passing through the first two stages, the money can be withdrawn and freely used without further hiding it. In real life, the process can differ, i.e., not all stages may be involved, or some stages could be combined or repeated several times. There are various ways to launder money, like using money mules, opening shell corporations, or running a legitimate cash-based business.

Money Laundering Example

Suppose a criminal or criminal organization owns a legitimate laundromat business and deposits small amounts of illegal money in the business’s bank account.

So, if the laundromat makes a sale of $500 in one day, then an additional $500 is recorded through illegitimate bookkeeping tricks, and it is deposited in its account as if it made cash sales of $1000 on that day.

The money now appears to have come from a legitimate business.

To avoid substantial tax liabilities, the money will then be passed through multiple transactions such as foreign currency exchange, investment in securities, or real estate, and ultimately be sent to an offshore bank account in a tax haven with fewer regulations.

The money can now be used for any legitimate business, which can be further utilized for laundering more cash or personal investments like high-end luxury goods such as jewelry, real estate, or automobiles without concealing it.

Variants of Money Laundering

There are various methods of laundering money. Some of them include:

1. Smurfing (also known as structuring)

In this method, vast amounts of cash are broken into smaller chunks and deposited into different bank accounts to avoid suspicion. Sometimes, the money is used to purchase bearer instruments, such as money orders, and then deposited into different accounts.

2. Bulk cash smuggling 

Cash smugglers transport large amounts of cash to other countries with fewer anti-money laundering regulations, like Afghanistan and Kenya, to evade detection.

3. Cash-intensive businesses 

The illicit money is transferred to the bank account of the legitimate business operated by the individual or criminal organization to launder money, as explained in the example above. This cash is shown as the business's revenue.

Usually, a service business is used as it has little to no variable cost, like car washes, casinos, laundromats, restaurants, strip clubs, bars, etc.

4. Trade-based laundering 

Invoices are overvalued or undervalued to mask the movement of money. For example, the exporter of goods can send an overvalued invoice to the importer to transfer a more significant amount than the value of shipped goods. 

5. Shell companies and trusts 

Trusts may provide some degree of anonymity for beneficiaries, but they are not designed to hide the identity of the valid owner of the money. Shell companies exist only on paper or are inactive. They claim to perform some services and receive cash in return from customers.

The launderer may deposit the money in the shell company’s account and employ various methods, including producing fake receipts, to obscure its origins.

The laundered money may then be returned to the initial criminal or routed through additional shell companies before returning to the criminal.

6. Round-tripping 

The company sells an asset to another company and, at the same time, agrees to buy the same or similar asset at about the same price. Though no economic value is produced, the company’s books show purchases and sales, which indicate growth to lure investors into investing in the company.

Another example is sending money to a tax haven with minimum regulations and shipping it back as Foreign Direct Investment (FDI), free from taxation.

7. Bank capture 

In this method, the launderer owns a controlling stake in a financial institution, preferably in a place with weak anti-money laundering regulations, and transfers the money freely.

8. Casinos 

The criminal goes into the casino with illicit cash and buys chips but plays for a minimal period. When the chips are returned, the casinos return the money either in the bank account or by cheque.

9. Black salaries 

A company with dirty money may have unregistered employees without written contracts and can use that money to pay them.

10. Electronic money laundering 

Cryptocurrencies like ZCash and Monero provide anonymity and can be used for illegal transactions. Online games like Second Life and World of Warcraft are sometimes exploited to convert money into virtual goods, services, or cash, facilitating potential money laundering activities.

“Mixers” and “Tumblers” are often used to send and receive cryptocurrency, which helps hide their illicit origin.

How to Prevent Money Laundering

Anti-money laundering describes the legal controls that require entities like financial institutions to prevent, detect, and report money laundering activities. These efforts have only been implemented in recent decades.

In 1989, the Financial Action Task Force (FATF) was formed by the Group of Seven (G-7) to fight this crime globally. In the early 2000s, its scope was expanded to combat the financing of terrorism.

Financial institutions worldwide are supposed to identify and report suspicious transactions to the authorities in their respective countries. They should complete the “Know Your Customer” (KYC) process to do this.

Financial institutions also use anti-money laundering software, which flags suspicious transactions and alerts the bank, which must report them to the government.

Under the Bank Secrecy Act 1970 in the United States, financial institutions must report certain transactions, such as cash transactions above $10,000 or any other transaction they believe to be suspicious, on a Suspicious Activity Report (SAR) to the Department of Treasury.

The Financial Crimes Enforcement Network (FinCEN) then uses that information and can share it with domestic criminal investigators, international bodies, or foreign financial intelligence units.

The Money Laundering Control Act of 1986 expanded and strengthened existing anti-money laundering laws in the United States, providing a statutory framework for prosecuting money laundering offenses. Before the enactment of this law, money laundering was illegal in the United States.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: