Why ‘laundering’?

Money laundering can easily be included in the list of world’s oldest crimes. In simpler terms, money laundering essentially means turning illegally gotten money into legal money, or money which can be safely used inside a financial system.

The origin of term ‘laundering’ is an interesting anecdote.

We all know about prohibition and the rise of organized crime in the US. During this time, infamous gangster Al Capone used laundromats to funnel the money as the incoming flow of money was hard to keep track of. Hence the term ‘laundering’.

A not-so-glorious history

While the term may have originated in the 20th century, the crime is one of the oldest ones. Historians have been able to track it as far back as 2000 years, when Chinese merchants used complex means to protect their money from government bureaucrats. However, the crime has now evolved from simple tax dodging via creative accounting to sinister ends like money obtained via crimes like drug trafficking, extortion, illegal trading, and financing terror. Suffice to say, the methods to process the money have also grown more sophisticated.

A deeper dive

Money-laundering remains a cause of concern for various reasons listed above. To curb the menace, governments and financial institutions across the world have put in several policies, regulations, and technologies to curb this menace. Collectively, these measures are  called Anti Money Laundering or AML.
But how is money laundered in the first place? Let us see…

Like any crime, money can be laundered via various techniques. Some of these techniques are

  • Routing money via shell companies and trusts: A shell company is a company which exists only on paper, but can hold bank accounts, depending upon the regulations. While such companies are also used during acquisitions to acquire intellectual property without any liabilities of the former company, this provision has also been abused for tax evasion and money laundering. It is very easy to conceal ownership in such companies due to relaxed norms in tax havens. This also enables the launderers to mask the source of the money.
  • Stuffing or smurfing: In this technique, the money to be laundered is broken down into smaller amounts which are lower than the statutory limits set by the governments. This allows the money to escape the financial institutions’ watchdogs without a report of the transaction to the government.
  • Round-tripping: Here is another area where shell companies come into play. The money to be laundered is clandestinely shipped to a shell company in a tax haven country. The sum is then routed back as a Foreign Direct Investment (FDI) into the original entity.
  • Capturing of institutions: This is a technique avid crime that movie buffs will be well aware of. The individual or organization wishing to whitewash its money buys a bank or a casino. The money is then moved through without raising any red flags.
  • Investing in stocks: This is a method which has been used very successfully. The entity holding the money buys backdated stocks, and then artificially drives up the stock prices by using dummy clients. Then sells the stock to show the concerned authorities that the money came from the market.

However, the bread can be sliced by multiple ways. There are many more methods to launder ill-gotten cash.

The role of AML

To combat this ever-evolving problem, various types of controls have been introduced. Here are some of them:

  • KYC: The Know Your Customer or KYC process is mandatory now for most financial institutions. The process also includes thorough understanding of risks the client brings on board. It further empowers the institution to keep an eye on the client’s activities and raise an alarm if any suspicious activities or transactions take place.
  • Integration with AI and ML: Software can be paired with AI and ML to better understand client transactions, classify and monitor data and deny transactions if they are in violation of norms.
  • Compliance and regulatory reporting: Yes, money laundering has been criminalized the world over. But the severity of regulation varies. Hence the rise of the so-called tax-havens. The UN has also issued guidelines to help countries prosecute the launderers.
  • In addition, AML can also help with the following processes: Data integration, transaction monitoring, real-time risk scoring, alert and case management, and analytics and visualization.

Of course, these measures do not and will not completely stop the practice of money laundering. Greed is a main driver fueling the growth of any crime. It applies here also. Recently, banks across the world were caught laundering money. They include international giants like HSBC and Standard Chartered have been caught and fined for laundering money. Here, the transactions were flagged, but no action was taken. All the technology in the world cannot help against human weaknesses. But we can fight, and fight hard.