Money Laundering Definition – Money Laundering is the process used to disguise the source of funds or money derived from criminal activities such as smuggling, drug trafficking, extortion, corruption, terrorist activities etc in order to make them appear as derived from a legitimate source. In other words, it is simply process of converting dirty money into clean money. The funds or money obtain from illicit activities is considered as dirty and money laundering is the process used to make it look clean.
Three Basic Stages or Methods of Money Laundering Cycle
There are a number of ways or methods used for money laundering however the money laundering cycle can be broken down into three basic stages which are as follows –
Placement is the initial stage in money laundering process in which dirty money enters into the financial system. It is carried out by placing it into circulation through financial institutions, casinos, shops, bureau de change and other businesses. During this stage, money launderers are the most vulnerable to being caught as transactions are high amount cash based.
Placement serve the purpose of relieving the criminal of holding and guarding large amounts of cash and placing it into legitimate financial system.
Placement can be carried out through various processes and technique. Some of them as discussed as below –
- Currency Smuggling / Smurfing – Cash can be packed into a suitcase and smuggled to another country. Launderer may also use smurfing in which transaction amount is kept under threshold limit of AML reporting to avoid suspicions of officials.
- Loan / Credit Card Repayment – Repayment of loan proceeds or credit card bill.
- Currency Exchange – Foreign Exchange Markets also provide rooms for currency movements to another country. It can be used to purchase foreign currency with illegal proceeds.
- Blending Funds – Another way to launder money is by blending illegal money with legitimate sale receipts through a cash based business own by a criminal organization. These types of businesses are known as ‘fronts’.
- False invoicing
Layering is second stage in money laundering cycle. The primary purpose of layering is to separate the illegal proceeds from their origin and to make it difficult to detect and uncover laundering activity. It is done by layering of complex multiple financial transactions, international movement of funds, converting cash into monetary instruments, purchase of assets, loan back arrangements etc.
The primary objective is to make the audit trail difficult for the law enforcement agencies and keep the distance as much as possible from the source of illegal proceeds.
The final stage in money laundering cycle is ‘INTEGRATION’. In this stage, money comes back to owner or criminal from the sources appearing to be legitimate and is integrated into the financial system. The money appears to be from normal business or trade earnings.
The main purpose of this stage is to integrate the money in financial system in such a way that it appears to be earned from legitimate sources. For example – stocks, commodities, real estate, gold, jewellery etc are the common ways to integrate the money with financial system and enjoy illegal benefits from illicit activities. At this stage, money laundering cycle is completed and objective of launderer is accomplished without drawing attention of law enforcement agencies.
Effects or consequences of Money Laundering
Money Laundering has serious economic and social consequences.
- Loss of Revenue for the Government due to unanticipated cross border asset transfer.
- Reputational Risk for financial institutions.
- It adversely affect currencies and interest rates due to increased volatility of international capital flows.
- An economy affected by money laundering will not attract foreign as well as domestic investment
- Organized crime can infiltrate financial institutions, acquire control of large sectors of the economy through investments or by offering bribes to public officials and governments.
- The economic and political influence of criminal organizations can weaken the social fabric, collective ethical standards and the democratic institutions of society.
Here is an example of money laundering cycle which will help you to have better understanding of its three stages.
Placement – Mr. John, a drug trafficker, deposit funds with the licensed remitter in a shell company’s accounts in an island nation with liberal bank secrecy laws.
Layering – Subsequently, the shell company transfer the funds to its account in the US which in turn is transferred to a shell company accounts in Austria.
Integration – Placing funds in ‘term account’ of the trafficker completes the scheme.
Look at another example,
Placement – A drug dealer will deposit the illegal money in smaller amounts, likely below the AML reporting requirement.
Layering – The money may be moved around by wire transfer to different countries, be converted into certificates of Deposit and used as collateral for a loan.
Integration – The loan proceeds could then be transferred to the drug trafficker without a direct connection.