What is Money Laundering?

What is Money Laundering? 

Money laundering is the process of making large amounts of money generated by criminal activity, such as drug trafficking or terrorist funding, appear to have come from a legitimate source. Money from criminal activity is considered ‘dirty,’ and the process ‘launders’ it to make it look ‘clean’. The purpose of money laundering is to make dirty money indistinguishable from legitimately-earned money, and thus to make it bankable.   

Money laundering is a serious criminal offence, and various laws and regulations are in place to prevent, detect, and deter it. Financial institutions are required to report any suspicious activities and conduct rigorous client due diligence to prevent money laundering. Setting up a framework to monitor and regulate this will be conducted by the in-house Compliance and Risk department. This is the internal team responsible for making maximum efforts to avoid any money laundering taking place at the firm. 

How Money Laundering Works  

The activities that make money dirty may or may not be crimes.  Collectively, these crimes and illegitimate activities are known as ‘predicate offences’. Examples include counterfeiting, illicit drugs, environmental crimes, human trafficking, and weapons trafficking. 

Money laundering typically involves three key stages: 

1. Placement 

This is the initial stage where the ‘dirty’ money generated from criminal activities is introduced into the financial system. This will often involve buying assets that can be acquired for cash, such as used cars, real estate (in some countries), life insurance policies (where the buyer pays an upfront premium in cash) or gaming chips. By turning the dirty money into something else, the process of distancing it from its source has begun. 

2. Layering 

In this stage, the money is moved through various financial transactions to obscure its origins. This could involve transferring money between different accounts, changing its form through investments, or making complex financial transactions that are difficult to trace. The layers are numerous transactions without any commercial purpose, for example ‘wash trades’, where a trade simultaneously buys and sells the same security. The real purpose of layering transactions is to create a smoke screen, obscuring the source of funds as much as possible.   

3. Integration 

The final stage is where the laundered money is integrated back into the economy as ‘clean’ money. This could be through the purchase of property, investment in legitimate businesses, or other means that make it appear as if the money has been earned legitimately. 

Mules 

Money laundering doesn’t always have to involve all three steps. Most often there are three, but an alternative method could be to recruit a ‘mule’. This is typically someone who needs some extra income and has time to spare, such as a retiree or a student. The mule must agree to bank the cash in their account and remit it to third-party accounts in exchange for a commission or fee. Mules may, or may not, know that by helping dirty money wash through their bank accounts but they are also money launderers. 

Types of Transactions  

There are various types of transactions that can be used in the money laundering process. Anyone working in finance should be trained to be aware of these types of transactions and alert the appropriate compliance officer within the firm if they have any suspicion that this may be taking place. Here are some examples: 

• Cash Transactions: Clients attempting large cash deposits or withdrawals that are inconsistent with the customer’s profile or business activities 

• Wire Transfers: Creating (or trying to create) rapid movement of funds, especially to or from jurisdictions with lax anti-money laundering regulations 

• Third-Party Payments: Creating payments made by or to individuals or entities not directly involved in the transaction 

• Trade-Based Transactions: Deliberately over or under-invoicing goods and services to facilitate moving money illicitly 

• Shell Company Transactions: Creating or using companies that exist only on paper to disguise the movement of money 

• Real Estate Transactions: Buying and selling property to integrate illicit funds into the legitimate economy 

These are just a few examples, and money launderers often use complex layers of these and other transaction types to obscure the trail of illicit funds. It’s important for financial institutions to monitor for unusual or suspicious transactions that could indicate money laundering activities. 

Money Laundering Case Studies 

SEB Bank 

In 2020, SEB, a Swedish bank, received a penalty of $170 million due to failure in its Anti-Money Laundering compliance process within its Baltic operations. Johan Torgeby, the CEO of the bank, challenged the effectiveness of these regulatory measures, noting that despite banks spending over $20 billion on compliance, they are successful in intercepting only about 1% of criminal funds estimated in the trillions of dollars. 

Commerzbank 

In June of 2020, German-based Commerzbank faced a $50 million fine. This was a result of its failure to employ ‘Know-Your-Customer’ (KYC) regulations for thousands of the bank’s customers and ignoring multiple warnings from the regulator beforehand. 

Credit Suisse 

In 2022, Credit Suisse was found guilty in a money laundering case, marking the first time a Swiss bank has been subject to such criminal prosecution. Switzerland’s criminal court found that the bank failed to do enough to prevent members of a crime syndicate from profiting from trafficking drugs into Europe. Credit Suisse was fined £1.7 million and ordered to pay £15 million to the Swiss government. 

Read about 10 Money Laundering Case Studies in the free download section. 

What are Signs of Money Laundering? 

The signs of money laundering can be quite subtle, but there are certain warning signals that financial institutions and individuals can look out for: 

• Funding Inconsistencies: If the funding is not commensurate with the customer’s age or experience, it could be a red flag 

• Lack of Documentation: When a customer’s explanations for the source of wealth do not make sense and no supporting documents are available, it should raise suspicion 

• Unusual Account Activity: An account with ample liquidity where the customer sells both winners and losers shortly after buying them could indicate layering 

• Indifference to Losses: A customer who appears unfazed by stock losses may be using the account for money laundering rather than investment purposes 

• Negative Media: If media checks identify negative news surrounding the customer, it could be a sign of involvement in illegal activities 

• Third-Party Transactions: Using the account to remit money to a third party whose account-opening request was denied can also be a warning sign 

These are just a few examples of the warning signals that might suggest money laundering activities. It’s very important for businesses and financial institutions to have robust systems in place to detect and report such activities to prevent the integration of illicit funds into the economy. If you’re looking for more detailed information or have specific concerns, it’s always best to consult with a financial crime expert or legal advisor. 

What is an Example of Money Laundering? 

Imagine that a criminal gang has earned $200 million from manufacturing and selling illicit drugs. Now the gang members are looking for a way to launder this money and hit upon the following plan:  

• Firstly, they plan to invest the dirty money in a plot of land in the Philippines, that they will purchase using cash. The gang plan to sell the land to a developer several months later who has agreed to pay them using a cashier’s order.   

• The cashier’s order will then be used to open and fund a new brokerage account that will be opened in Hong Kong. Using this brokerage account, the criminal gang can actively buy and sell stocks. They will be unconcerned with whether they make a profit or a loss, until they eventually close the account and ask the broker to wire the remaining cash to a bank.  

• Finally, they plan on opening a new bank account online in five minutes with a virtual bank. The account will receive the incoming transfer from the broker, and the gang can then begin using the ‘clean’ money. 

Would it Work?  

The effectiveness of money laundering depends how thorough and patient the gang is with everything they do to legitimize themselves and the money through the process. It is also dependent on how thorough the other parties are in determining who they are dealing with and the source of their funds. This applies particularly in our example to the broker and the virtual bank; both are financial institutions who should be robust in knowing their clients and being aware of signs of potential money laundering. 

What are the Warning Signs? 

If you were an employee of the brokerage or the virtual bank, what warning signals could alert you to the possibility that the customer’s money is dirty? These are just some of the potential warning signals, and broadly there are two types: 

Things that Don’t Make Sense or Don’t Add Up  

• When funding is not commensurate with the customer’s age or experience – if the customer is twenty years old, but has apparently made hundreds of millions from property deals in the Philippines we should be asking where his starting capital came from 

• When the customer’s explanations for source of wealth do not make sense and no supporting documents are available 

• If the customer is unfazed by stock losses and unconcerned with the profitability or costs of transactions 

Internal Automated Checks 

• If a customer’s bank account is being used to pay and receive money on behalf of a third party that is not allowed to bank at the institution 

• If the brokerage account has ample liquidity, but the customer sells both winners and losers shortly after buying them 

• If media checks identify negative news on the customer 

How to Prevent Money Laundering – Know Your Client 

Preventing money laundering is a multi-faceted process that involves several key steps and practices. Here are some important measures to ensure banks know exactly who their clients are: 

Customer Identification Program (CIP) 

Financial institutions are obliged to verify that all potential new customers are legally who they say they are. This requires collecting the applicant’s name, address, date of birth and social security (or national identification number) and checking they correspond with records. Names should also be checked against national and international databases to detect any persons who are wanted in relation to any ongoing investigations or sanctions lists. (This also applies to new company applications and verifying the management and persons involved.) 

Customer Due Diligence (CDD) 

Perform thorough due diligence on customers to verify their identity and understand their financial activities and motives. This is standard for low and medium-risk clients. 

Enhanced Due Diligence (EDD) 

For high-risk customers, such as Politically Exposed Persons (PEPs), charities, and money changers, financial institutions must conduct more in-depth checks to understand the source of funds and the nature of transactions. 

Identify Ultimate Beneficial Owners (UBO) 

Banks and financial institutions must make full efforts to determine who ultimately controls or benefits from a company, especially when dealing with complex corporate structures or listed companies. 

Additionally, ongoing due diligence and periodic reviews are necessary to keep customer information up-to-date and reassess risk levels. Trigger events, such as negative news reports, should prompt a thorough review of a customer’s risk profile. 

For high-risk clients, reviews should be conducted at least annually, while medium-risk clients can be reviewed every three years, and low-risk clients every five years. 

Conclusion 

Money laundering is a critical issue that can potentially undermine the integrity of financial systems and support criminal activities. It is essential to understand its mechanisms and stages to effectively combat it. Strengthening legal frameworks, enhancing international cooperation, and promoting awareness are vital steps in the ongoing fight against this illicit practice.