Money Laundering and Terrorist Financing Overview

We talk about Money Laundering and Terrorist Financing but actually are they affecting the economy at all?

Financial sector plays a crucial role in the overall development of a country. Bank as reporting agency play a vital role for preventing money laundering and terrorist financing.

Money Laundering and Terrorist Financing have become very vital issue in recent years. Money laundering is employed by launderers worldwide to conceal the illicit money flow earned by unlawful activities.

It may happen in almost every country in the world and the scheme typically involves transferring money through several countries in order to opaque its illicit origins.

The upswing of international financial markets creates money laundering easier than the daydreams, making it potential to anonymously deposit "illicit" money in one country and then have it moved to any other country for use.

Money Laundering and Terrorist Financing Overview

What is money laundering and why is it illegal?

Money laundering can be defined in a numeral of ways. But the fundamental concept of Money Laundering refers to the techniques criminals use to disguise money constructing from crime or illegitimate source.

If it is successful, then the identity of money can be disguised and ultimately appears to legitimate. The term “laundering” is used when criminals turn their "illicit" criminal money into ‘clean’ funds without arousing suspicion.

Receiving it into the financial system means that it becomes harder to trace and confiscate. Drug traffickers, terrorists, armed robbers, burglars and fraudsters all tend to launder the proceeds of their crimes through banking channels.

Illegal arms sales, smuggling and the activities of organized crime, drug trafficking and prostitution can generate huge funds. Misappropriation, insider trading & market manipulation, bribery and computer fraud schemes can also produce large profits and create the motivation to "legitimize" the ill-gotten achievements through money laundering.

At the time of generating substantial profits through a criminal activity, the individual or group involvement must find a way to control the funds without attracting attention to the underlying activity or the persons involved.

Criminals do this by disguising the sources, changing the form, or moving the funds to a place where its trail can be disguised. In summary, the money launderer wants to:-

• Place his/her money in the financial system, without arising suspicion; 
• Transfer the money everywhere, often in a sequence of complex transactions crossing multiple jurisdictions, so it becomes tough to identify its original source; and 
• Then transformation the money back into the economic and business system, so that it seems as legitimate funds or assets.

Most countries subscribe to the following definition which was adopted by the Vienna Convention (1988) and the Palermo Convention (2000):

• The conversion or transfer of property, knowing that such property is derived from any offence, e.g. drug trafficking, or offences or from an act of participation in such offence or offences, for the purpose of concealing or disguising the illicit origin of the property or of assisting any person who is involved in the commission of such an offence or offences to evade the legal consequences of his/her actions.
• The concealing or disguising the true nature, source, location, disposition, movement, rights with respect to, or ownership of property, knowing that such property is derived from an offence or offences or from an act of participation in such an offence or offences, and;
• The acquisition, possession or use of property, knowing at the time of receipt that such property was derived from an offence or offences or from an act of participation in such offence or offences.

The Financial Action Task Force (FATF), which is recognized as the international standard setter for Anti Money Laundering (AML) efforts, defines the term "money laundering" succinctly as "the processing of criminal proceeds to disguise their illegal origin" in order to "legitimize" the ill-gotten gains of crime.

"Money laundering" is a term that was originally conceived when Italian gangster named Al Capone purchased 'Laundromats' to combine illegal revenues earned from unlicensed liquor sales and prostitution with other legitimate business ventures from the 'Laundromats' to cover up his unlawful operation.

Al Capone (Al "Scarface" Capone) is baptized as the Father/Priest of the Money Laundering. Alphonso Caponi was born on January 17, 1899, in Brooklyn, New York. Capone’s father was originally from Naples and his mother was from Salerno, Italy.

His father was a barber. Capone performed school through the sixth grade, at that label he beat up his teacher one day and was himself beaten by the school's principal afterward.

Al "Scarface" Capone was an American gangster who influenced during the Prohibition era (1920–33) at the time of the United States banned the production and sale of liquor. His malicious career demonstrated the power and influence of organized crime in the United States.

Following is a video that highlights events of Al Capone's rise as a racketeer and bootlegger extraordinaire.

Stages of Money Laundering: There is no single method of laundering money. Methods can assortment from the purchase and resale of a luxury item (e.g. a house, car or jewelry) to transient money through a multifarious international web of legitimate trades and ‘shell’ companies (i.e. those companies that primarily exist only as named legal entities without any trading or business activities).

There are a number of crimes where the initial proceeds usually take the form of cash that needs to enter the financial system by some means. Drug trafficking, bribery, extortion, robbery, fraud forgery and smuggling are almost always made with cash.

These proceeds of crime have to enter the financial system by various ways so that it can be adapted into a form which can be more easily transformed, concealed. The procedures of achieving this are limited only by the inventiveness of the launderer and these systems have become gradually sophisticated.

Though the concept of money laundering is not something to elaborate in a few words, the video given below can give you a summarized idea of it.

Despite the multiplicity of methods employed, money laundering is not a solitary act but a process proficient in 3 basic stages which are as follows:

1) Placement – Materially depositing “cash” into financial systems such as currency exchanges; transforming “cash” into other financial instruments such as by purchasing monetary instruments (travelers’ checks, payment orders); or using “cash” to purchase luxurious items that can be resold. Launderers frequently pursue to deposit cash into Banks and then transfer these funds to Banks in regulated environments as “legitimate”. 

Smurfing – a type of placement where the launderer creates many small cash deposits in place of a large one to loophole local regulatory reporting requirements pertinent to cash transactions. Launderers anticipate to escape the threshold of Cash Transaction for dodging the reporting to Regulatory authority.

2) Layering– Splitting the proceeds of criminal activity from their source through the use of layers of financial transactions (numerous transfers of funds among financial institutions, early surrender of an annuity without concern of penalties, cash collateralized loans, false invoices/bills of lading in case of letter of credit etc.) to disguise the origin of the funds, disrupt any audit trail, and provide anonymity.

Launderers desire to handover funds everywhere, altering both the form of the funds and their place in order to make it tougher for law enforcement authorities to identify “dirty” money.  

3)  Integration– Insertion the laundered proceeds back into the economy in such a mode that they re-enter the financial system as ostensibly legitimate moneys.

The three basic stages may happen as isolated and distinct phases. They may also occur instantaneously or, more frequently, may overlap. How the basic steps are used depends on the accessible laundering tools and the necessities of the criminal associations.

The Economic and Social Consequences of Money Laundering

Money laundering has significant economic and social consequences, especially for developing countries and emerging markets. The easy passage of funds from one institution, or relatively facile systems that allows money to be placed without raising any questions, is fertile territory for money launderers.

The upholding of legal, professional and ethical standards is critical to the integrity of financial markets. The potential macroeconomic consequences of unchecked money laundering include:

➣ Increased Exposure to Organized Crime and Corruption:

Successful money laundering enhances the profitable aspects of criminal activity. When a state is realized as a harbor for money laundering, it will invite publics who commit crime.

If money laundering is prevalent, there is more likely to be corruption. In countries with weaker laws and enforcement, it is corruption that triggers money laundering.

A comprehensive AML, CFT & CPF framework on the other hand helps curb criminal activities, eliminates profits from such activities, discourages criminals from operating in a country especially where law is enforced fully and proceeds from crime are confiscated.

➣ Undermining the Legitimate Private Sector:

One of the most serious microeconomic effects of money laundering is felt in the private sector.

Money launderers are recognized to use anterior companies trades that seem legitimate and involve in legitimate business but are in fact well-ordered by criminals who commingle the earnings of illicit activity with legitimate funds to hide the illegal profits.

By using front companies and other investments in legitimate companies, money laundering proceeds can be used to control whole industries or sectors of the economy of certain countries.

This rises the prospective for financial and cost-effective volatility due to the misallocation of resources from artificial distortions in asset and commodity prices. It also provides a vehicle for evading taxes, thus depriving the country of revenue.

➣ Weakening Financial Institutions:

ML, TF and PF can harm the soundness of a country’s financial sector. They can adversely affect the steadiness of individual, banks or other financial institutions, such as securities firms and insurance companies.

The establishment and maintenance of an effective AML, CFT & CPF program is usually part of a financial institution’s charter to operate; non-compliance can result not only in significant civil money penalties, but also in the loss of its charter. 

➣ Dampening Effect on Foreign Investments:

Although developing economies cannot afford to be too selective about the sources of capital they attract, there is a dampening effect on foreign direct investment when a country’s commercial and financial sectors are perceived to be compromised and subject to the influence of organized crime.To maintain a business-friendly environment these impedance have to be weeded out.

➣ Loss of Control of, or Mistakes in, Decisions Regarding Economic Policy:

Due to the large amounts of money involved in the money laundering process, in some emerging market countries these illicit proceeds may dwarf government budgets.

This can result in the loss of control of economic policy by governments or in policy mistakes due to measurement errors in macroeconomic statistics.

ML can destructively affect currencies and interest rates as launderers reinvest funds where their schemes are disguised instead of getting higher rates of return. ML can increase the threat of monetary instability due to the misallocation of resources from artificial distortions in asset and commodity prices. 

➣ Economic Distortion and Instability:

Money launderers are not primarily interested in profit generation from their investments, but rather, in protecting their proceeds and hiding the illegal origin of the funds.

Thus, they “capitalize” their funds in events that are not necessarily economically beneficial to the country where the moneys are located. Moreover, money laundering and financial crime redirect funds from sound investments to low-quality investments that disguise their source, economic development may suffer.

➣ Loss of Tax Revenue:

ML diminishes government tax revenue and, therefore, indirectly harms honest taxpayers. It also makes government tax collection more difficult. This loss of income usually means greater tax rates than would generally be the case.

A government revenue deficit is at the focus of monetary complications in many countries, and correcting it is the primary emphasis of most economic stabilization programs. 

➣ Risks to Privatization Efforts:

ML threatens the efforts of many states trying to introduce reforms into their economies through the privatization of state-owned properties such as land, resources, or enterprises.

Sometimes linked with corruption or inside deals, a government may award a state privatization tender to a criminal organization potentially at an economic loss to the public. Moreover, while privatization initiatives are often economically beneficial, they can also serve as a vehicle to launder funds.

➣ Reputation Risk for the Country:

A reputation as a ML, TF & PF haven can harm development and economic growth in a country. It weakens legitimate international opportunities because foreign financial institutions find the additional scrutiny involved in working with institutions in money laundering havens is too costly.

When a country’s economic status is spoiled, revitalizing it is very tough and requires momentous resources to cure a problem that could have been prevented with appropriate anti money laundering controls. Other effects include specific counter-measures that can be taken by international organizations and other countries, and reduced eligibility for governmental assistance.

➣ Risk of International Sanctions:

In order to protect the financial system from ML, TF and PF the United States, the United Nations, the European Union, and other governing bodies may impose sanctions against foreign countries, entities or individuals, terrorists and terrorist groups, drug traffickers, and other security threats.

FATF also maintains a list of jurisdictions identified as high-risk and non-cooperative, whose AML, CFT & CPF regimes have strategic deficiencies and are not at international standards.

As a result, FATF calls on its members to implement counter-measures against the jurisdiction such as financial institutions applying enhanced due diligence to business relationships and transactions with natural and legal persons from the identified jurisdiction in an attempt to persuade the jurisdiction to improve its AML, CFT & CPF regime.

➣ Social Costs:

Substantial societal expenses and risks are accompanying with money laundering. It also allows human traffickers, smugglers, drug traffickers and other offenders to enlarge their procedures.

This efforts up the price of government expenditures and budgets due to the need for enlarged law enforcement and other costs (for example, increased healthcare expenses for treating drug addicts) to fight the severe consequences that result.

Financial institutions that rely on the earnings of crime face countless contests in effectively managing their assets, liabilities and operations, charming legitimate clients.

What is Terrorist Financing?

Terrorist financing may be simply defined as monetary support, in any form, of terrorism or of those who encourage, plan, or involve in terrorism.

Financing of terrorism usually refers to carrying out transactions comprising funds that may or may not be owned by terrorist, or that have been, or are intended to be, used to support the commission of terrorism. Financing of Terrorism includes:

• providing or accumulating property for carrying out an act of terrorism;
• providing facilities for terrorism purposes;
• organizing for retention or control of terrorist property; or
• dealing with terrorist  property.

The International Convention for the Suppression of the Financing of Terrorism (1999) under the United Nations defines TF in the following manner:

1) 'If any person commits an offense by any means, directly or indirectly, unlawfully and willingly, provides or collects funds with the intention that they should be used or in the knowledge that they are to be used, in full or in part, in order to carry out :

a) An act which constitutes an offence within the scope of and as defined in one of the treaties listed in the link given below; or

b) Any other act intended to cause death or serious bodily injury to a civilian, or to any other person not taking any active part in the hostilities in a situation of armed conflict, when the purpose of such act, by its nature or context, is to intimidate a population, or to compel a government or an international organization to do or to abstain from doing an act.

2) For an act to constitute an offense set forth in the preceding paragraph 1, it shall not be necessary that the funds were actually used to carry out an offense referred to in said paragraph 1, subparagraph (a) or (b).’

The Link between Money Laundering and Terrorist Financing

The methods used to launder money are fundamentally the similar as those used to conceal the sources and uses for terrorist financing. But funds used to help terrorism may create from legitimate sources, criminal activities, or both.

However, disguising the source of terrorist financing, regardless of whether the source is of legitimate or of illicit origin, is important. If the source can be hidden, it remains accessible for future terrorist financing to take place. Similarly, it is important for terrorists to conceal the use of the funds so that the financing activity can go undetected.

As mentioned above, a major difference between money laundering and terrorist financing is that the funds involved may originate from legitimate sources as well as unlawful activities. List of legitimate sources may include donations or gifts of cash or other assets to organizations i.e. foundations or charities are utilized to support terrorist activities or terrorist organizations.

Why We Must Combat Money Laundering and Terrorist Financing?

According to Mr. Min Zhu, former Deputy Managing Director of the IMF:

“Effective AML and CFT regimes are essential to protect the integrity of markets and of the global financial framework as they help mitigate the factors that facilitate financial abuse.”

Actions taken by Bank to prevent money laundering are not only a regulatory requirement but also an act of self-interest. A financial institution tainted by money laundering accusations from regulators, law enforcement agencies may loss their good market reputation and damage the reputation of the country.

It is very challenging and requires momentous resources to cure a problem that could be prevented with accurate program. ML &TF also affects individual financial institution. If a money launderer uses a financial institution for creating his/her money legitimate, the business of that financial institution may thwart.

If the money launderer withdraws his/her deposited money from an FI before maturity, the FI will face liquidity crisis if the amount is big enough. Moreover, if it is found that an FI was used for ML, TF & PF activities, and it did not take proper action against that ML, TF & PF as per the laws of the country, the FI will have to face legal threat.

Finally, the reputation of an FI can also be heavily affected through its involvement with ML, TF & PF activities. It is generally recognized that effective efforts to combat ML, TF & PF cannot be carried out without the co-operation of financial institutions, their supervisory authorities and the law enforcement agencies.

How Financial Institutions can Combat Money Laundering?

The prevention of laundering the earnings of crime has become a main priority for all jurisdictions from which financial events are carried out. One of the best methods of combating and deterring money laundering is a sound knowledge of a customer’s business and pattern of financial transactions and commitments.

The adoption of procedures by which Banks and other Financial Institution’s KYC is not only a principle of good business but is also a crucial tool to avoid involvement in ML. 

The efforts to combat money laundering mainly focus on those points in the manner where the launderer's activities are more susceptible to recognition and on the deposit taking procedures of banks i.e. the placement stage.

Institutions and intermediaries must keep transaction records for establishing an audit trail. Such records can also provide suitable information on the people and organizations involved in laundering schemes.

Having a sound knowledge of a customer's business and pattern of financial transactions and commitments is one of the best methods by which financial institutions and their officials will recognize attempts at money laundering.