Money Laundering Explained : Methods, Risks, and How to Prevent It

The illegal process of converting money earned from illegal activities into “clean” money.

What Is Money Laundering?

Money laundering is an illegal activity. It makes large amounts of money that’s generated by criminal activity such as drug trafficking or terrorist funding appear to have come from a legitimate source. The money from the criminal activity is considered dirty and the process “launders” it to make it appear clean.

Need to Launder Money

• A major business problem of large, organized criminal enterprises such as drug smuggling operations is that they need to conceal in order to avoid attracting investigations by legal authorities. The recipients of such large amounts of cash also do not want to have to acknowledge it as income, thereby incurring massive income tax liabilities.
• To deal with the problem of having millions of dollars in cash obtained from illegal activities, criminal enterprises create ways of “laundering” the money to obscure the illegal nature of how it is obtained. In short, money laundering aims to disguise money made illegally by working it into a legitimate financial system, such as a bank or business.

How Money Laundering Works :

Money laundering typically occurs in three phases

1. Placement : The first stage of the money laundering process is where the ill-gotten gains are initially introduced into the legitimate financial system, carved up into portions which do not raise alarms amongst authorities. Some common methods of placement to subvert reporting mechanisms include loan repayment schemes, gambling through casinos or betting agencies, smuggling, currency exchanges, and blending funds. 

2. Layering : The second stage of the money laundering process is when successive layers of legitimacy are added to the initially placed funds, until the source of the gains is sufficiently disguised from authorities to be unrecognizable as ever having been illegal. Some common methods of this stage include, but are not limited to, electronic transfers between countries, using shell companies, and moving funds between multiple banks or between multiple accounts within an institution. 

3. Final Integration : The third and final stage of the money laundering process, this is when the criminal retrieves their illicit funds, which by now are so shrouded in layers of legitimacy that the source is all but untraceable. Some common methods of the integration stage of money laundering include making legitimate investments in legal financial streams, and the sale or purchase of high-value items. 

The Involvement of Banks in Money Laundering

Major financial institutions, such as banks, are frequently used for money laundering. All that is necessary is for the bank to be a little lax in its reporting procedures. The lack of regulation enforcement enables criminals to deposit large sums of cash without triggering the deposits being reported to central bank authorities or government regulatory agencies.

Layering Transactions : It is second stage of money laundering, criminals can use banks to move money through multiple transactions, often involving international transfers and shell companies, to obscure the source of the funds. 

Placement : It is first stage of money laundering, banks can be used to deposit illicit cash or transfer funds through various accounts, making it, difficult to trace the origin of the money. 

Common Ways Criminals Launder Money

Criminals most often launder money through:

• Banks : Many banks must report large transactions. Money launders get around through a process called smurfing or structuring. They divide their total sum into smaller amounts that they deposit into separate bank accounts.
• Trade-based laundering : Criminals can also misreport the value of legitimate transactions to conceal dirty money, including by over -or under-invoicing for goods or services or falsifying the amount of product in a shipment.
• Real estate : Money launders can channel their dirty money into real estate, buying property with illegitimate funds and then selling it to recoup clean cash.
• Professional services : Criminals could use lawyers, accountants or financial advisors to help move or disguise illicit funds. These professionals might create complex financial structures, set up trusts, or help transfer assets, making the original source difficult to trace.
• Virtual currencies : A bad actor can also use digit currencies like Bitcoin to transfer money anonymously across borders. Criminals may also use crypto wallets or peer-topeer exchanges to obscure the origin and ownership of illegal funds.

Example of Money Laundering

A person earns money by selling illegal drugs. The money is in cash and cannot be shown directly in the bank otherwise, police will get suspicious.

• He opens a restaurant (which is a cash heavy business).
• He starts showing fake daily sales -for example, instead of Rs.10,000 real sales, he shows Rs.1,00,000.
• Now, he slowly adds his illegal drug money into the restaurant cash and deposits it in the bank.
• It looks like legal income from restaurant customers.

 (This process hides the illegal source of money and makes it look “clean.”)

How to Prevent Money Laundering

 

To effectively and sustainably prevent money laundering, businesses must take a risk-based approach to identifying and transacting with customers of all backgrounds. That requires: 

• Identifying your day-to-day business activities : Before you can create an AML (Anti-Money Laundering) program, you must understand the activities that the program will govern. Whether it’s creating bank accounts, making secure payments or issuing insurance policies, that’s what your AML policies should emphasize.
• Analyze your risk exposure : To prevent money laundering, the program you build should mitigate the most extreme risks, whether customers, employees, board members or potential other bad actors. 
• Conduct ongoing and independent reviews: Your compliance officer should regularly review your AML program, but you should also recruit an independent auditor to do the same. The auditor will offer an unbiased view of the efficacy of your problem with feedback you can use to improve.
• Cultivate a culture of compliance : For your anti-money laundering program to be successful, your employees must buy into its importance. Offer thorough and ongoing training to help employees understand money laundering risks and recruit them to help stop it. Be sure to thoroughly explain all AML (Anti-Money Laundering) policies and procedures. 

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