Understanding money laundering

AFTER A lot of deliberations and debates at the parliamentary and ministerial levels, India has enacted the Prevention of Money Laundering Act and it came into force from June 2000 along with the Foreign Exchange Management Act. Most people do not know what is money laundering and many have no idea about this victimless crime. Many governments find it difficult to tackle this problem because it is an invisible crime that is always preceded by a predicate crime such as drug trafficking, robbery, etc., and hence the common man doesn't have knowledge about this major crime.

Money laundering is the process by which large amounts of illegally obtained money (from drug trafficking, terrorist activity or other serious crimes) is given the appearance of having originated from a legitimate source. If done successfully, it allows the criminals to maintain control over their proceeds and ultimately to provide a legitimate cover for their source of income. Money laundering helps the drug trafficker, the terrorist, the organised criminal, the insider dealer and many others who need to convert their illegal money into a legal one and escape from the legal consequences.

Incidentally, black money is different from illegal money. For black money, the source is a legal activity and if tax is paid, it becomes white money. But illegal money is earned from an illegal or criminal activities, punishable under the law. Illegal or dirty money is put through a cycle of transactions or washed, so that it comes out the other end as legal or clean money. Thus the source of illegally obtained funds is obscured through a succession of transfers and deals in order that those same funds can eventually be made to appear as legitimate income.

The original `sighting of' money laundering as an expression was in newspapers reporting the `Watergate scandal' in 1973 in the United States. The term has been widely accepted since then and is in popular usage throughout the world.

Money laundering was recognised as a crime only in the 1980s essentially within a drug trafficking context. Western governments were very much concerned at the massive drug abuse problem and the huge profits earned out of this illicit means that could corrupt entire society and the state.

Characteristics

According to a U.N. report, the basic characteristics of the laundering of the proceeds of crime, which to a large extent also mark the operations of organised and transactional crime, are its global nature, the flexibility and adaptability of its operations, the use of the latest technological means and professional assistance, the ingenuity of its operators and the vast resources at their disposal. It is a truly global phenomenon, helped by the international finance community, which is twentyfour hours a day business.

It is a group activity in that it is carried out often by more than one person; it is a criminal activity which is long-term and continuing and is carried out irrespective of national boundaries; it is large scale and generates proceeds which are often made available for licit use.

From the above characteristics we understand that money laundering is a very particular kind of criminal activity which is most developed, highly sophisticated and complex. The degree of organisation that is displayed in money laundering is therefore of much concern because of its scale, its capacity to exploit and influence the legitimate business world and its capacity for internationalisation. Hence the concerted efforts at the international level to combat this growing menace.

The `cleaning' process

There are several ways that people use to clean their ``dirty money.'' However the basic steps contain three stages: placement, layering and integration.

Placement: In the washing cycle this is the first stage. Money laundering is a cash-intensive business, generating vast amounts of cash from illegal activities in small denominations. The monies are placed into the financial system or retail economy or are smuggled out of the country. The aims of the launderer are to remove the cash from the location of acquisition to avoid detection from the authorities and then to transform it into other asset forms like travellers cheques, postal orders, etc.

Layering: The purpose of layering is to disassociate the illegal monies from the source of the crime by purposely creating a complex web of financial transactions aimed at concealing any audit trail as well as the source and ownership of funds. The layers are created typically by moving monies in and out of the offshore bank accounts through electronics funds' transfer. Since the number of wire transfers is very large, and the amount involved is huge (a rough estimate says that there are more than 5,00,000 wire transfers daily representing in excess of $1 trillion) and there is not enough information disclosed on any single wire transfer, it is very difficult to know how clean or dirty the money is. Therefore, it becomes an excellent way for launderers to move their dirty money in this channel. Other forms used by launderers are complex stock dealings, commodity dealings and futures brokers. Considering the volume of daily transactions and the high degree of anonymity available, the chances of locating the illegal transactions become insignificant.

Integration: This is the final stage in the process. Here the illegal money is integrated into the legitimate economic and financial system and is assimilated with all other assets in the system. By the end of this stage, it becomes exceedingly difficult to distinguish legal wealth from illegal wealth. This is accompanied either by establishing anonymous companies in countries where the right to secrecy is guaranteed or by sending off false export-import invoices overvaluing goods, from one company and country to another, with the invoices serving to verify the origin of the monies placed with financial institutions or by transferring the money via electronic mail transfer to a legitimate bank from the one owned by the launderers.

Underground banking, popularly known as parallel banking, tends to mirror more conventional banking practices, but is highly efficient and uses wholly unauthorised methods of transferring money around the world. The best known among them are the chop, hundi and hawala banking within various ethnic communities, which enable the avoidance of any conventional paper record of the financial transaction. Such methods do not require the actual payment of funds to another party in another country in local currency, drawn on the reserves of the overseas partner(s) of the hawala banker. The system is dependent on considerable trust and considerable simplicity - the money launderer places an amount with the underground bank, the identifying receipt for a transaction being something as innocuous as a playing card or post-card torn in half, half being held by the customer and half being forwarded to the overseas hawala banker. The launderer then presents his receipt in the target country to obtain his money, thus avoiding exporting cash out of the country and limiting the risk of detection.

International money transmitters, travel agents, persons who are dealing in `futures' market, finance houses, building societies, casinos, antique-dealers and jewellers are some of the parties who may involve themselves or help money laundering schemes using the anonymous nature of trading strategies.

The size of the problem

Money laundering, a magic trick of wealth creation, has escalated out of proportion and it is said that it is the third largest business in the world. Estimates of the size of the money laundering problem total more than $500 billions annually worldwide. This is a staggering amount and detrimental by any calculation to the financial systems involved.

SWIFT (Society for Worldwide International Financial Telecommunications), a cooperative society located in Belgium, is the principal international service for wire transfer message traffic that initiates funds transfers. SWIFT has more than 2,600 member institutions in 65 countries. Money launderers, with organised crime in control of banks, are able to launder huge sums of money not only for themselves but also for other criminal organisations.

Cyber payments is another system, which facilitate the transfer of financial value (i.e., digital currency, e-money). Such transactions via the Internet or through the use of smart cards, which unlike debt or credit cards, actually contain a microchip, which stores value on the card.

The common element is that these systems are designed to provide the transacting parties with immediate, convenient, secure and potentially anonymous means by which to transfer the financial value and this system has the potential to facilitate the international movement of illicit funds. The speed which makes the systems efficient and the anonymity that makes them secure are positive characteristics from the money launderer's perspective and it is this that makes it attractive to them.

Technology has offered, and it will continue to offer a more sophisticated and circuitous means to convert ill-gotten proceeds into legal tender and assets.

The largely unchecked growth of the Internet presents what has been described as the ``Armageddon scenario of banking on the Net - criminals could have money transferred without an audit trail.''

Preventive measures

Developed countries such as the U.K., Scotland and other European countries have passed a number of laws to detect and curb this mysterious but powerful crime. The Financial Action Task Force has identified three choke points, namely (1) the entry of cash in the financial system, (2) transfers to and from the financial system and (3) cross border flows of cash. The initial focus has to be on these areas, since in these areas the money launderers are most vulnerable to detection.

Nevertheless, whatever initiatives have been taken legally, unless there is a political will and international cooperation on information exchange and law enforcement, it may be difficult for the poor countries to combat this insidious crime. Measures are to be taken to increase public awareness of the threat from money laundering. Governments are to focus on new technologies and increase counter measures to fight their use for money laundering. It remains to be seen how India is going to fight this menace, especially in the wake of liberalisation and globalisation.

P. JAYASEELAPANDIAN

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