Anti Money Laundering – Strategy and Way Forward

Money Laundering is an international issue since from the beginning of its evolution. This is a threat to the world economy, because of the fact that the black money is being used for the terrorist financing and several other illegal activities by various sources of money laundering activities. Such activities are not only impairing the world financial health, but also a threat to the human kind. In order to curb the money laundering, the steps taken by Bharat and the principles adopted by United States should be acknowledged by the world to combat money laundering and terrorist financing.

Index Terms- Financial intelligence & regulation, Money Laundering, Terrorist Financing

Key Findings

The world has now acknowledged that organized crime groups extended their umbrella of anti-social activities by expanding their portfolio through the help of drug cartels, human trafficking, counterfeit goods, supplying armed weapons, illegal migration and so on.

Technology is playing a pivotal role in drug trafficking an easier job than before. The cellular market has provided an extra weapon for the drug traffickers by creating an opportunity that they no more need to travel long distances or get involved personally. The work is simply getting done through a simple instant message. The street vendors go to the users and collect the cash and drug suppliers text the customers on the location of the drug, making the process simpler and easier than ever before. It has also come to light that customers can purchase drugs using cryptocurrency, example: bitcoin.

Around 30 per cent of drug proceeds are set to contribute towards illicit financial flows. A study with specific interviews with drug cartels in Italy in 2016 showed that drug proceeds are used towards money laundering across international borders.

It is also important to note that the illicit money makes the economy weak. It makes the country poor and forces the citizens to turn towards anti-social activities. The drug money used in the real estate business artificially increases the price of properties. It destroys the exports of the country, encourages unequal competition among the companies, and encourages corruption. In this process, genuine businesses find it difficult to survive in the market and no further investments are seen in the country.  The increase in the illicit money in the country’s economy increases the corruption and collapses the regulatory system, thus making the country fail and developing unrest.

Introduction

Money Laundering is one of the key elements which contribute its best in collapsing the world economy. Money Laundering has become an art and science in the modern world, which draws off billions of dollars from the world financial system each and every year, and then routes the illegal money to terror organizations globally. This becomes a serious challenge for both developed and developing countries.

The money that is routed through illegal activities is even used to manipulate politics in economically backward countries. It is also important to note that counterfeit currency is a major component of money laundering activity. The money is used for drug dealings, human trafficking and exploitation, buying and building weapons, terrorism and so on.

Developed countries are already cautious about money laundering and its impacts. They have formed an international joint operation to control and stop money laundering activities. The detailed steps and procedures adopted by Bharat and United states are two examples for the world to recognize and adopt for the eradication of money laundering.

It is not fair to conclude that other countries are not cognizant about the impact of money laundering and that they have not developed the tools and techniques to address it. But the focus in the current article is Bharat and United States, and how they both are working on eradicating money laundering.

Research Elaborations

Money Laundering Stages:

Money Laundering is done in several varieties of transactions that are almost impossible to identify and track down the illegitimate transactions, compared to the legitimate ones.

  1. Step One: Placement — getting the cash into the physical system.
  1. Step Two: Layering — Spin the money around the world, in and out of fake companies that can never be traced back to the original source. This step is followed by sending phony invoices between those companies for all kinds of goods and services that never existed. Their banks pay those invoices wiring money back and forth across borders. It’s often impossible to follow the money trail due to digitization of global markets. It’s easier to layer with the countries that are disconnected from the rest of the world in banking services.

Money Laundering

(Source: http://www.unodc.org/unodc/en/money-laundering/laundrycycle.html)

  1. Step Three: Integration — bringing the illicit money into real estate, legitimate investments, buying luxury assets etc. are the done in the final stage of Integration. It is highly impossible to determine the difference between legal and illegal assets due to the fact that the money once invested in these activities, transfers the hands, banks and finally integrates into the financial systems across the globe.

How big is the problem?

The world of transnational crime – The first official estimate was in 1998 by the International Monetary Fund, which estimated about 2% to 5% of global GDP, or $900 billion US dollars of black money is flowing across the world economy. The latest report was the United Nations Office on Drugs and Crime Report in 2011, which is consistent with the IMF numbers – 3.6% of the global GDP is illicit proceeds.

The ratios of socio-economic costs to the economy from $1 of illicit proceeds is a 2 to 1 ratio globally and for the United States it is 3 to 1. That means, for every $1 of illicit drug money it costs $2 or $3 for society to address all the issues associated with it.

Demonetization in Bharat- A lesson for the rest of the world

On November 8, 2016, Bharat announced the demonetization of Rs 500 and Rs 1000 currency notes and introduced new Rs 500 and Rs 2000 currency notes to curb the contraband currency notes. The impact of demonetization automatically helps in eradicating terrorism financing, funding to real estate projects through illegal money, financing to anti-social elements to create political unrest. Demonetization helped Bharat at large with the immediate effect of making billions of contraband currency into just a piece of paper, which stopped funding to the antisocial elements that used to create political unrest in some of the world-renowned tourist parts of the country like Jammu and Kashmir.

However, the immediate effect of demonetization to the general public was felt heavily during the first two months of the implementation as banks and ATMs ran out of the currency notes, creating panic among general public. Fuelling the anxiety of the general public, media played a key role in relatively negative propaganda on demonetization, supporting the opposition political parties.

The negative publicity slowly vanished and a confidence was developed in the public due to the RBI interference during the end of 2016 and steady introduction of the new Rs 500 and Rs 2000 currency notes though early 2017 helped the banks and post offices gain the public trust about the timely support of central govt. Public slowly understood the importance of demonetization and the banks, post offices and subsequently media’s support to the government’s move is a big plus point.

The impact of demonetization is seen on several sectors of the economy. The major impacted sector is the financial sector, which is highlighted below.

  • Retail Sector: The retail sector has seen a major decline in the growth due to lack of availability of currency notes in the general market, which forced the general public to limit their spending on retail sector.
  • Increase in retail savings: The impact of demonetization helped the banks in getting more retail savings, thus increasing the balance sheet of the banks.
  • Increase in the bank accounts: Demonetization helped in generating five crore new bank accounts under various government schemes within 1 year from the date of implementation.
  • An eye on unusual financial transactions:  An amount of around Rs Two trillion is estimated to have been deposited into the banks by various fraudulent modes.
  • Decrease in lending rates: The increase in savings and current account balances with the deposits of general public, banks received costless monies into their books, which helped in reducing the lending rates.
  • Increase in investments: A great amount of household savings are diverted towards mutual funds and insurance sector due to demonetization
  • More retail digital payments: Demonetization helped the economy in alternate payments mechanism. General public started using various means of card payment services, thus increasing digital payments.

Before the implementation of demonetization on Nov 8th, 2016, Bharat’s Government had introduced a new act to curb black money ‘THE BLACK MONEY (UNDISCLOSED FOREIGN INCOME AND ASSETS) AND IMPOSITION OF TAX ACT, 2015’ and reviewed the Older ‘Benami Transactions (Prohibition) Act, 1988’ and made various changes to it, keeping in mind the upcoming demonetization and released it as ‘Benami Transactions Act, 2016’.

The government has given an opportunity to the general public to disclose the undisclosed income, voluntarily through ‘Income Declaration Scheme (IDS)’ between June 2016 to September 2016; without exempting the tax deduction. Government started tracking on all large scale investments on various precious metal purchases and made it compulsory to provide Permanent Account Number (PAN) for all money dealings in excess of Rs 200,000.

The plan for demonetization on November 8th, 2016 is a perfect step with a lot of back ground work done by the Government of Bharat to curb the illegal and illicit money in the country.

The after effects of Demonetization

Within 12 months from the date of demonetization, nearly 99% of the demonetized currency was back into the banks through various sources of currency exchange options provided by Government of Bharat. With that said, the value of notes in circulation was reduced by 20.2% and the volume of currency in circulation has increased by 11.1%.

It is also visible that the digital transactions increased with the decrease of money in circulation.

Monthly digital transactions (Rs in Million)

October, 2016    870
November, 16  1020
December, 16  1490
January, 2017  1460
Febraury,17  1310
March,17  1560
April,17  1560
May,17  1430
June,17  1360
July,17  1380
August,17  1380
Total 14820

With the increase in digital transactions, an increase in the electronic frauds during the same period of demonetization has also been observed in Bharat. There were 13,083 fraud cases of electronic wallets and electronic payment reported for the FY 14-15 and the cases increased to 16,468 for the FY 15-16. In order to curb the electronic crimes, Government of Bharat has also created cyber forensic labs.

By the end of Nov 2017, approximately 85% of the debarred money has been deposited into the banks and started re-circulation into the market. That means the general public re-invented a safe mechanism to deal with the cash even though the limit for cash transactions is Rs 200,000 only.

Drawbacks

It was understood that demonetization was announced without printing sufficient new currency. The banks and ATMs were empty within a period of 2 weeks from the date of demonetization due to insufficient supply of smaller denominations in the place of old Rs 500 and Rs 1000 notes.

Prior issuance of ATM cards to all the customers of the banks and planned recalibration of ATMs to dispense the new notes would have helped in reducing the chaos of cash withdrawals inside the bank premises. It was also noted that there were enormous queues outside the banks for the withdrawal and deposit of currencies, causing several incidents of death.

General public started approaching money launders to get their existing Rs 500 and Rs 1000 notes exchanged, in lieu of the abnormal queues outside the banks for the exchange of demonetized currency. Money launderers started using the fictitious accounts to deposit the illicit money they collected through the chain and started exchanging the currency by bribing the bank officials.

It was also noted that gold and other related investments increased right after demonetization; due to the fact that gold merchants started accepting illicit money in exchange of gold and bringing back the debarred money into the system for re-circulation through illegal processes.

Result of demonetization in Bharat

  • Banks kept on monitoring all the bank accounts and it was observed that ~ 2 million illegal bank accounts were frozen during the period of demonetization. Also, 0.30 million directors were barred from the companies for suspect financial transactions.
  • The IT department of Bharat served warning letters and investigated the persons who made large deposits of demonetized currencies into their bank accounts.
  • It is also observed that demonetization has halted the political unrest and militancy in Jammu & Kashmir, due to the fact that there is no enough currency in circulation to be supplied to the political miscreants in the area. However, this is a temporary phenomenon in the area of Kashmir.
  • It is also noted that debarring Rs 500 and Rs 1000 notes helped the country fight against the terrorists within the country and also temporarily halted the activities from the neighboring countries who supply counterfeit currency into Bharat.
  • Businessmen started paying advance income tax and declare the demonetized currency by surrendering the excess money and converting it to white money.
  • There will be only positive outcomes over a period of 3-4 years from the date of demonetization, and the results will be positive for the Government of Bharat.

United States

As of November 2017, currency in circulation—i.e., U.S. coins and paper currency in the hands of the public—totalled about $1.6 trillion dollars. The amount of cash in circulation has risen rapidly in recent decades and much of the increase has been caused by demand from abroad. The Federal Reserve estimates that the majority of the cash in circulation today is outside the United States. The below chart depicts the actual Billions of Dollars in circulation from 04/01/1984 to 22/11/2017.

(Source: https://fred.stlouisfed.org/series/WCURCIR#0)

Dollars in circulation

This includes both notes and coins held in the hands of the public and in the safe rooms of the depository institutions. About 0.33% of the unfit for circulation currency notes are destroyed by Fed every year. For example, a $1 bill is the most circulated currency, stays in the market for a period of approx. 5.9 yrs ; $ 100 note for approx. 15 years.

Denomination of Bill

Life Expectancy
(Years)

$1

5.9

$5

4.9

$10

4.2

$20

7.7

$50

3.7

$100

15

(Source : https://www.newyorkfed.org)

The Fed requests for new currency from the (BEP) Bureau of Engraving and Printing, which manufactures the required currency and sends it directly to the Reserve Banks. Unlike the other countries, United States maintains only 6 small Denomination bills in circulation which helped the country to prevent hoarding of physical cash. However it is continuously striving to prevent money laundering.

There are many loopholes in law enforcement which allow illicit, counterfeit and contraband money to flow into US economy. However, Financial Action Task Force’s (FATF – an inter-government initiative of G7 countries to curb money laundering) relentless efforts in anti-money laundering, anti-terrorist financing etc. are highly effective. FATF has implemented innovative tools and techniques to monitor and control money laundering. The United States received failing scores for its efforts to prevent the laundering of criminal proceeds by shell companies, accountants and real estate agents, FATF  said in a report ( Source: Reuters)

FATF gave a low score to Washington due to the lack of monitoring of non-financial institutions involved in money laundering activities – mostly realtors and law firms.

In the United States, real estate agents are excluded from the scrutiny and disclosure of suspected money laundering activities by their customers who purchase properties through illicit money. FATF noticed and brought these activities into lime light, which raised concerns in Washington and its lack of monitoring.

New York State banking regulation body accused Standard Chartered Bank of assisting around $250 bn of money laundering between 2001-2007. Regulators charged the bank with numerous counts of charges of knowingly engaging in different fraudulent activities. It is also unclear about how much money went towards financing rogue nuclear programs and terrorist financing. The bank altered the reports of sources for wire transfers, and used a series of codes to wire transfer money into Iran, showing various sources of money.

More recently, HSBC, Bank of America and Wachovia (now Wells Fargo) have also been investigated and accused of helping Mexican drug traffickers, laundered their illicit funds through the American banking system.

The United States has some of the strictest anti-money laundering laws in the world plus a regulatory environment capable of investigating reported cases. However, it is very common to have some prominent contacts among the bankers for money laundering activities by paying huge bribes. US has become a safe path for the money launderers for passing the money through US banking systems and once the money moves out of US, it is declared as genuine money in most of the cases.

Regulators are more concerned on the most non-regulated financial systems in the world, from where the money laundering is done through a series of transactions showing it as a legitimate transaction. However it is very difficult for the regulators to monitor each and every financial transaction. Regulators are dependent on banks to notify on any suspicious activities. It depends on the banks to notify regulators on which is a suspicious transaction.

The process of close monitoring is not eradicating money laundering, however it is making the money laundering expensive with the involvement of more number of players in it. Tax evasion is added as an offence to the money laundering prosecution in 2012 as a global standard.

With this stated, US is expanding its Real Estate Data targeting Los Angeles, San Diego, SFO, Brexar county-Texas, New York City, Miami. There are triggers associated with each of these cities/regions, so that regulators start investigating more into real estate transactions.

In order to further strengthen the regulatory framework in the United States, FinCEN (Financial Crimes Enforcement Network) was introduced by order of the Secretary of the Treasury on April 25, 1990 to include regulatory responsibilities. FinCEN developed an information technology portal called FinCEN Portal and Query System, which migrated with 11 years of data into FinCEN Query. It is a search engine like Google and it is a “one stop shop” accessible via the FinCEN Portal allowing wide range of searches across more fields than before and resulting in more outputs. Since September 2012 FinCEN generates 4 new reports: Suspicious Activity Report (FinCEN SAR), Currency Transaction Report (FinCEN CTR), the Designation of Exempt Person (DOEP) and Registered Money Service Business (RMSB). These reports are used to track, identify and take further actions to curb money laundering and terrorist financing.

(Source: https://en.wikipedia.org/wiki/Financial_Crimes_Enforcement_Network)

CONCLUSION

The threat to the world economy through money laundering is immense. It is 2 to 3 times more expensive to prevent the society from the impact of these illicit activities through money laundering. Not only is it expensive, but it is also a major challenge to the regulatory authorities to identify the money laundering agencies and take action against them due to the political, local and international boundaries and restrictions.

Bilateral and multilateral agreements with countries which are more active towards the prevention and control of anti-money laundering should be entered into and worked upon for the global cause. It is also pertinent to state that money laundering is a global threat due to the fact that there are several countries who mainly survive with the money laundering, drug trafficking funds. The laws in those countries are weak. This in turn attracts the rest of the world to route the illicit money through them into the rest of the developing and developed countries, causing world unrest.

A strict legal action towards these countries and standard law will prevent the money launderers from gaining advantage of using different laws and jurisdictions. The financial institutions, law enforcement agencies, administrators and regulators need to come close and work together as a joint task force to combat the issue of money laundering and terrorist financing, so that there would not be another 9/11 in any other country.

Strategies that countries and territories can follow to combat money laundering:

  • Maintain coins, small denominations currency bills, adapt proper security measures which reduce printing of duplicate bills, demonetization of older bills in circulation and reissuing new currency bills with the same denomination with more security features.
  • Vigilant check on all the bank accounts with international money transfers on frequent basis and those accounts that pool the money from different sources.
  • Conduct due diligence on the customer, follow KYC norms and raise red alerts when a banker finds any suspicious activity in their customer accounts.
  • There should be more coordination between the regulatory authorities, Financial Institutions and enforcement department in addressing the issue of money laundering.
  • Strict punishment to those individuals or groups who are caught in money laundering – 1 year, 2 years or 5 years imprisonment and a small amount of financial penalty would not be sufficient. Punishment should be such that it creates a serious deterrence to future crime.
  • Create a Financial Intelligence Unit (FIU) in every country containing bankers, investigators, financial crime analysts, who can help and analyze the information from banking portals and red flag the money laundering activities to the regulatory authority for further investigation or criminal prosecution.
  • Take strict actions on those countries which encourage money laundering activities and terrorist financing. Monitor the banks and take stringent action against the banks which loosen the wire transfer regulations.
  • Bank secrecy laws should be reconsidered and any restriction on information sharing between the banks and regulatory authority should be reconsidered. Protection should be provided to the banks / bankers who provide support to the regulatory in providing the appropriate information on criminal activities of their customers.
  • Keep the records of the customers and their transactions for a period of at-least 5 years in case of physical documents and electronic documents should be stored in the data base for at-least 10- 20 years. This way regulatory authorities can go back and reference the physical and electronic documents of those suspected customers over a period of time to identify the criminal activities.
  • Banks and the staff should be given adequate training on modern techniques of identification of money laundering activities and the training should be mandated periodically for all the employees of the bank.
  • International coordination between countries should be implemented to enable the agencies working closely on money laundering activities.
  • Countries should implement stringent laws on money launderers and anti-social elements, whose properties should be seized and forfeited into Government books.

References:

http://www.indiacode.nic.in/acts-in-pdf/2015/201522.pdf

https://www.reuters.com/article/us-usa-banks-moneylaundering/u-s-failing-to-curb-money-laundering-by-shell-companies-task-force-report-idUSKBN13Q4R1

https://www.unl.edu/eskridge/cj394laundering.doc

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https://fred.stlouisfed.org/series/WCURCIR#0

https://www.hindupost.in/economy/bharats-demonetization-a-review/

http://www.businessinsider.com/r-us-failing-to-curb-money-laundering-by-shell-companies-task-force-report-2016-12

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Featured Image source: http://vinciworks.com/blog/one-week-till-the-fourth-directive-will-the-uk-get-its-money-laundering-act-together/


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About the Author

Arun Dharmapuri
I am a senior banker with 15+ yrs of Industry Experience. Studied MBA(Osmania University) and Post Graduate Diploma in Foreign Trade (Annamalai University). Working with Pfizer Treasury HQ - United States. Previously worked with ICICI, DCB, INDUSIND and State Bank of Mauritius in senior positions within Corporate Banking & Treasury.