Coming Clean on Money Laundering

by Charumati Haran

Recently, the Hong Kong and Shanghai Banking Corporation (better known as HSBC), Britain’s biggest bank, was caught in a money laundering scandal. It was forced to pay a record $1.9 billion as fine. The allegation was that HSBC allowed drug lords and potential terrorists to launder millions of dollars through their bank. The penalty also includes a five-year agreement with the US Department of Justice under which the bank will appoint an independent monitor to assess internal controls. Various executives also have to forgo their bonuses. The bank itself has apologized for letting it happen and spent a great deal on reforms.

According to the Financial Action Task Force (FATF):

Money laundering is the practice of disguising the origins of illegally-obtained money. Ultimately, it is the process by which the proceeds of crime are made to appear legitimate. The money involved can be generated by any number of criminal acts, including drug dealing, corruption, accounting fraud and other types of fraud and tax evasion.

Hundreds of billions of dollars are laundered every year. Criminals take recourse to it specifically so that they can use the money safely instead of leaving a monetary trail of their activities. There is a huge variety of methods by which money may be laundered and there are many famous scandals like the Black Market Colombian Peso Exchange. Some common fronts for money laundering include:

• Shell companies: This refers to moving money in or out of what is essentially a fake company – made only for the purpose of the money laundering scheme.
• Casinos: This is often used as a cover for money laundering as criminals can transact money and pretend that it was from gambling.
• Real estate: This is an excellent front for money laundering. A person can purchase or sell property to move around his money.

Often, money laundering also takes the form of depositing money with illegal origins in one country and then having it transferred to any other country for use. This is similar to what HSBC is accused of, for allowing such movement of money. What happens is that money is transferred several times to make its real origin more difficult to trace. In many cases, money launderers try to pass the money through the accounts of their friends and family members. However, all money laundering scams have the following 3 steps in common:

1. Placement: This is the first entry point of illegal money into the financial system. This is usually done in a set of small transactions to avoid raising suspicion. If done successfully, this helps the money be ‘distanced’ from their source. If this is done in small packs in a systematized way, it is called ‘smurfing.’ It is done to make sure lump sums and large transactions do not alert officials.
2. Layering: This refers to moving the money through the system in various ways to hide their origin. It could involve currency changes, wire transfers and mixing the ‘dirty money’ with money of legal origin. Hence, it is called ‘cleaning’ or ‘washing’ as dirty money becomes legit. Money launderers could try to move funds across borders where the volume of transactions is very high, so as not to arouse suspicion.
3. Integration: This means regaining access to the ‘dirty money’ in such a way as to make it seem legitimate. Some techniques involve the purchase of assets like land, precious stones, etc. or making legitimate investments in the market. If successful, the criminals can now use the ‘laundered’ money safely without fear of being caught.

Today, every country has its own anti-money-laundering laws, though the strength varies from country to country. In India, we have the Prevention of Money Laundering Act, 2002. It places the responsibility on the accused to prove his innocence by verifying that his assets are lawful. This act provides for punishment in jail terms or fines, along with confiscation of the property derived from money laundering. It also describes how an adjudicating authority is appointed by the Central Government in these cases, which take place in a special court, called the PMLA court. There are also various international bodies working to counter money laundering, such as the FATF.

Financial institutions play an active role in identifying possible cases of money laundering. This is the reason that banks take so many personal details before creating bank accounts. This also explains why they closely watch large and significant transactions. Maintenance of bank records is an important policy. In fact, if bank officials note any suspicious transactions, they must inform law enforcement officials. Money laundering may be carried out not only by terrorists and drug lords, but by corrupt government and corporate executives.

One thing that sometimes causes a problem in detecting international money laundering is bank secrecy laws, which protect an account and the account holder’s details. This is the reason that ‘offshore banks’ (banks with accounts in a country other than the country of the depositor) are very popular for money laundering, along with the bank accounts in countries like Switzerland, and Singapore.

Countries with weak legislation (legislation having loopholes or lacking proper enforcement) make it easy for money launderers to move funds undetected. We sometimes even find donations, charities and trusts being accused of being fronts for money laundering, but it is difficult to analyze all of their transactions. In fact, in certain countries there even exist trust-based systems that allow financial transaction without leaving a paper trail. The most important example is the ‘hawala’ system which has been in place in India and Pakistan for hundreds of years and is used for both legitimate and illegitimate activities.

Money laundering hurts the integrity and stability of the international financial system. It distorts flow of capital throughout the global economy. If money laundering is done through imports and exports, it can even lead to inflation as it distorts prices. It has a major effect on investor sentiment as potential investors are scared of fraud, which reduces level of investment in an economy. This problem is particularly acute in developing countries, where the financial sector may not be as strict or safe. Another reason it is a serious concern for governments is because it creates what is called a ‘black economy’ or ‘underground economy’ worth billions of dollars. It helps in funding crime, corruption and terrorism. This way, money laundering hurts the economic development of all nations.

References

"Money Laundering." Wikipedia. Wikimedia Foundation, 01 Dec. 2013. Web. 14 Jan. 2013. <http://en.wikipedia.org/wiki/Money_laundering#Notable_cases>.

"How Money Laundering Works." HowStuffWorks. N.p., n.d. Web. 14 Jan. 2013.<http://money.howstuffworks.com/money-laundering.htm>.

"Bank Secrecy." Wikipedia. Wikimedia Foundation, 12 Sept. 2012. Web. 14 Jan. 2013.<http://en.wikipedia.org/wiki/Bank_secrecy>.

“Prevention of Money Laundering Act, 2002”, Wikipedia, Wikimedia Foundation, 18 Dec. 2012, Web. 15 Jan. 2013. <http://en.wikipedia.org/wiki/Prevention_of_Money_Laundering_Act>.