Money Laundering

Money laundering is the process of transforming the proceeds of crime and corruption into
ostensibly legitimate assets. In a number of legal and regulatory systems, however, the term
money laundering has become conflated with other forms of financial and business crime, and is
sometimes used more generally to include misuse of the financial system (involving things such
as securities, digital currencies, credit cards, and traditional currency), including terrorism
financing and evasion of international sanctions. Most anti-money laundering laws openly
conflate money laundering (which is concerned with source of funds) with terrorism financing
(which is concerned with destination of funds) when regulating the financial system.
Some countries define money laundering as obfuscating sources of money, either intentionally or
by merely using financial systems or services that do not identify or track sources or
destinations.Other countries define money laundering to include money from activity that would
have been a crime in that country, even if it was legal where the actual conduct occurred

Money Laundering- The Three Stage Process

The three stage of money laundering are:

Placement Stage
Layering Stage
Integration Stage

The Placement Stage

It represents the initial entry of the "dirty" cash or proceeds of crime into the financial system.
Generally, this stage serves two purposes:
(a) It relieves the criminal of holding and guarding large amounts of bulky of cash
(b) It places the money into the legitimate financial system. It is during the placement stage that
money launderers are the most vulnerable to being caught. This is due to the fact that placing
large amounts of money (cash) into the legitimate financial system may raise suspicions of
officials.

The placement of the proceeds of crime can be done in a number of ways. For example, cash
could be packed into a suitcase and smuggled to a country, or the launderer could use smurfs to
defeat reporting threshold laws and avoid suspicion. Some other common methods include: Loan
repayment, gambling, currency smuggling etc.
To combat this and other international impediments to effective money laundering investigations,
many like-minded countries have met to develop, coordinate, and share model legislation,
multilateral agreements, trends & intelligence, and other information. For example, such
international watchdogs as the Financial Action Task Force (FATF) evolved out of these
discussions.

The Layering Stage

After placement comes the layering stage (sometimes referred to as structuring). The layering
stage is the most complex and often entails the international movement of the funds. The primary
purpose of this stage is to separate the illigal money from its source. This is done by the
sophisticated layering of financial transactions that obscure the audit trail and sever the link with
the original crime.

During this stage, for example, the money launderers may begin by moving funds electronically
from one country to another, then divide them into investments placed in advanced financial
options or overseas markets; constantly moving them to elude detection; each time, exploiting
loopholes or discrepancies in legislation and taking advantage of delays in judicial or police
cooperation.

The Integration Stage

The final stage of the money laundering process is termed the integration stage. It is at the
integration stage where the money is returned to the criminal from what seem to be legitimate
sources. Having been placed initially as cash and layered through a number of financial
transactions, the criminal proceeds are now fully integrated into the financial system and can be
used for any purpose.

Money Laundering Methods

Structuring deposits
Also known as smurfing, this method entails breaking up large amounts of money into
smaller, less-suspicious amounts. In India, this smaller amount has to be below 50000
the amount at which Indian banks have to report the transaction to the government. The
money is then deposited into one or more bank accounts either by multiple people
(smurfs) or by a single person over an extended period of time.

Overseas banks
Money launderers often send money through various "offshore accounts" in countries
that have bank secrecy laws, meaning that for all intents and purposes, these countries
allow anonymous banking. A complex scheme can involve hundreds of bank transfers to
and from offshore banks. According to the International Monetary Fund, "major offshore
centers" include the Bahamas, Bahrain, the Cayman Islands, Hong Kong, Antilles,
Panama and Singapore.

Underground/alternative banking
Some countries in Asia have well-established, legal alternative banking systems that
allow for undocumented deposits, withdrawals and transfers. These are trust-based
systems often with ancient roots, that leave no paper trail and operate outside of
government control. This includes the hawala system in Pakistan and India and the fie
chen system in China.

Shell companies
These are fake companies that exist for no other reason than to launder money. They take
in dirty money as "payment" for supposed goods or services but actually provide no
goods or services; they simply create the appearance of legitimate transactions through
fake invoices and balance sheets.

Effects of Money Laundering

1. Effects on Financial Sector
The effect on financial sector is rather indirect. When money laundering takes place in a financial
institution, this most likely means that an employee is involved, either unknowingly or
knowingly, and the latter would mean that the affected financial institution is prone to corruption
from within, which damages the institution itself.

Once money laundering happens in a financial institution, and it becomes known to its
customers, customer trust is damaged as the perceived risk grows and the institution is now
viewed as corrupted. Once customer trust is gone, the financial institution becomes victim of its
own reputation and its whole purpose for existence is shaken because it becomes unable to
effectively collect and invest capital resources.

2. Effect on Real Sector

The Real sector deals with things other than those in financial sector. Things like real estate,
goods such as automobiles, arts and anything else that can be called goods fall into this sector
of the economy.
It is often the case when money is laundered through the real sector of the economy, and most of
the time the real estate channel is utilized. When real estate is purchased with laundered funds, it
creates artificial demand, which can falsely trigger supply and thus saturate the real estate
market. Further, real estate value suffers as a result of money laundering because its prices are
usually artificially determined and are below the fair market value.

3. Effect on External Sector

The External Sector holds in itself things like trade (imports and exports) and international
capital flows. These become affected when proceeds from an illegal activity are used to
purchase imported luxury goods with the intention to launder funds. When imports are
purchased with these funds, economy suffers because no fair economic activity is generated:
employment is not created and competition is not supported due to usually artificially set
prices for the purpose of laundering, etc. Such activities, therefore, can depress domestic
prices, damage natural competition between domestic and international companies, and
reduce profitability of domestic companies.

Role of the Government in Combating Money Laundering

A great deal can be done by the government to combat money laundering. The measures usually
aim to increase awareness of the phenomenon-both within the government and in the private
business sector-and then to provide the necessary legal or regulatory tools to the authorities
charged with combating the problem.
Some of these tools include:

Making the act of money laundering a crime

Giving investigative agencies the authority to trace

Seize and ultimately confiscate criminally derived assets

Building the necessary framework for permitting the agencies involved to exchange
information among themselves and with counterparts in other countries.

Money launderers have shown themselves to be extremely imaginative in creating new schemes
to disturb Government counter-measures. A national system must, therefore, be flexible enough
to detect and respond to new money laundering schemes. Anti-money laundering measures often
force the launderers to move to parts of the economy where tackling measures are weak or
ineffective. The national system to combat money laundering must, therefore, be flexible enough
to be able to extend counter-measures to new areas of its own economy. Finally, national
governments need to work with other jurisdictions to ensure that launders are not able to
continue to operate merely by moving to another location in which money laundering is
tolerated.

Laws to Check Money Laundering in India

The major statutes that incorporate certain measures which attempt to address the problem are
given below:
The Income Tax Act, 1961.
The Customs Act, 1962
The Code of Criminal Procedure, 1973
The Indian Penal Code, 1860
The Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974
(COFEPOSA).
The Smugglers and Foreign Exchange Manipulators (Forfeiture of Property) Act, 1976.
The Narcotic Drugs and Psychotropic Substances Act, 1985 (NDPSA)
The Benami Transactions (Prohibition) Act, 1988.
The Prevention of Illicit Traffic in Narcotic Drugs and Psychotropic Substances Act, 1988.
The Smugglers and Foreign Exchange Manipulators Act, 1976 (SAFEMA).

 The Foreign Exchange Management Act, 2000, (FEMA).

Prevention of Money Laundering Act , 2002 (PMLA).
Prevention of Terrorism Act, 2002 (POTA).

Conequences from Money Laundering To Banks

Banks also suffer serious consequences from money laundering, which include:
First, Reputation risk - Banks become vulnerable to reputation risk because they easily become
a vehicle for or a victim of illegal activities perpetuated by their customers. Once banks are
associated with such activities, their reputation in the market becomes tainted and they risk
losing customers
Second, Legal risk - Banks may become subject of lawsuits resulting from failure to observe
know your customer standards or from failure to practice due diligence in customer evaluation
and acceptance. As a result of this, banks can suffer from criminal liabilities, supervisory fines
and other penalties.
Third, Concentration risk - Banks are expected to have information systems to identify credit
concentrations and to set prudential limits to restrict exposures to single borrowers or groups of
related borrowers. The challenge for banks therefore is to adopt vigorous programs for the
detection of suspicious transactions, since failure to report such transactions under the new
money laundering legislation may subject the bank to criminal sanctions.
Fourth, lack of anti-money laundering practices in a bank may also affect its relationships with
correspondent banks because reputable international banks would not want to be associated with
banks that do not practice basic anti-money laundering techniques, and therefore be a threaten to
their own operations.
Fifth, money laundering compromises the corporate governance structure of banks. This is an
area of concern especially among the small banks when it comes to deposit mobilisation and
customer selection.

Role Of Banks In Preventing Money Laundering

1. The KYC procedures are expected to be applied even to the existing customers and the due
diligence practices should be in place. The working group set up by IBA has also come out
with detailed guidelines for the banks in India for strengthening the KYC norms with anti
money laundering focus and has also suggested formats for customer profiles account
opening procedures, establishing relationship with specific categories of customers as well
as illustrative list of suspicious activities.
2. However, as part of financial inclusion drive, in order to mitigate the constraints of small
depositors certain relaxation in KYC norms have been advised by RBI in August 2005. In
respect of those person who intend to keep balances not exceeding Rs. 50,000 in all their
accounts taken together and while the total credit in all accounts takes together is not
expected to exceed Rs.1 lakh, simplified documentation has been prescribed for account
opening, by way of introduction by another existing account holder of the bank, or any other
evidence.
3. The monitoring of cash transactions, the banks are required to keep a close watch of cash
withdrawals or deposits of Rs.10 lakh and above in deposit, cash credit or overdraft accounts
and keep record of the details of these large cash transactions in separate registers. These
records are to be kept for a period of 10 years. Banks are required to issue a travelers
cheque, demand draft money transfers, telegraph transfers for Rs. 50000 and above only by
debit to the customers account and not against cash.
4.

The requirements for furnishing PAN now stands uniformly to transactions of Rs. 50,000
and above. Branches of banks are required to report all cash deposits and withdrawal of
Rs.10 lakh and above as well as transactions of suspicious nature with full details in
fortnightly statements to the controlling office, who in turn will report to the FIU on a
monthly basis. Bank should have adequate internal control system or audit and inspection
mechanism in place as part of its risk management system and specifically adhere to the
Foreign Contribution Regulation Act

5. Each bank has to appoint an exclusive Principal Officer with a specific responsibility for
compliance of the KYC norms and undertake training of the staff members. Guidelines have
been issued specifically to be careful about the correspondent banks. Accounts of the
Politically Exposed Persons (PEP) residents outside India have to be carefully handle.

International initiatives/responses to money laundering

1. The Financial Action Task Force (FATF)
The FATF is a 26 member intergovernmental, policymaking body that was established in
1989 to guide the implementation of anti money laundering measures in the aftermath of
the 1988 UN Drugs Convention. Its membership includes the major financial centres of
Europe, North America and Asia. The FATF has come up with 40 recommendations
which member countries are expected to adopt. These are designed for universal
application and cover the criminal justice system and law enforcement, the financial
system; its regulation and international cooperation.
2. The Basel Committee of Banking Supervision.
The main thrust of regulatory response to money laundering has been to stop dirty
money from entering the banking system and to make sure that it is traceable when it
occurs. The Basel Committee, a grouping of the worlds leading bank supervisors has so
far come up with three guidelines for banks in combating money laundering, namely:
The Prevention of Criminal Use of the Banking System for the purpose of Money
Laundering (1988), the Core Principles of Effective Banking Supervision (1997), and
the Customer due diligence for banks (2001).
3. The Wolfsberg Principles.
The Wolfberg Principles came into force in 2000 and are an industry response to the
threat of money laundering. They are an agreement among eleven major international
private banks (which account for at least a third of the world private banking funds) to
guide the conduct of international private banking. Essentially, the Principles seek to
control money laundering by cutting across the multiplicity of jurisdictional issues and
addressing the serious reputation damage they were suffering in the media because of
money laundering.