Money Laundering and its Prevention

What is money laundering and what are its preventive methods? What are the challenges in the prevention of money laundering? Read here to learn more about this topic.

Money Laundering is a heinous crime that not only affects the social and economic fabric of the country but also tends to promote other serious offences like terrorism and drug trafficking etc.

It is a growing problem that needs to be addressed and the Prevention of Money Laundering Act was enacted in response to India’s global commitment to combat the menace of money laundering.

What is Money laundering?

Money laundering is the process of making large amounts of money generated by criminal activity – such as drug trafficking, terrorist funding, corruption, etc – appear to have come from a legitimate source.

The basic money laundering process has three steps:

1. Placement: At this point, the launderer deposits the dirty money into a legitimate financial institution. This is frequently in the form of cash as bank deposits. This is the most dangerous stage of the laundering process because large amounts of cash are visible, and banks must report high-value transactions.

2. Layering: This entails sending money through various financial transactions in order to alter its form and make it difficult to track. Layering can include several bank-to-bank transfers, wire transfers between different accounts in different names in different countries, making deposits and withdrawals to constantly vary the amount of money in the accounts, changing the currency of the money, and purchasing high-value items (boats, houses, cars, diamonds) to change the form of the money. This is the most complicated step in any laundering scheme, and it all revolves around making the original dirty money as difficult to trace as possible.

3. Integration: At the integration stage, the money appears to come from a legal transaction and re-enters the mainstream economy. A final bank transfer into the account of a local business in which the launderer is “investing” in exchange for a cut of the profits, the sale of a yacht purchased during the layering stage, or the purchase of a $10 million screwdriver from a company owned by the launderer are all examples of this. The criminal can now use the money without being caught. If there is no documentation from the previous stages, catching a launderer during the integration stage is extremely difficult.

Some of the common methods of money laundering are:

1. Smurfing: This method involves dividing large sums of money into smaller, less suspicious amounts. The money is then deposited into one or more bank accounts over time by multiple people (smurfs) or by a single person.
2. Overseas banks: Money launderers frequently transfer funds through various “offshore accounts” in countries with bank secrecy laws. Hundreds of bank transfers to and from offshore banks can be involved in a complex scheme. The Bahamas, Bahrain, the Cayman Islands, Hong Kong, Panama, and Singapore are among the “major offshore centres,” according to the International Monetary Fund.
3. Shell companies: These are fake companies that exist solely to launder money. They accept dirty money as “payment” for ostensible goods or services but provide none; they simply create the appearance of legitimate transactions through forged invoices and balance sheets.
4. Investing in legitimate businesses: Launderers will sometimes wash dirty money in otherwise legitimate businesses. They may use large businesses, such as brokerage firms, where the dirty money blends in easily, or they may use small, cash-intensive businesses, such as bars, car washes, strip clubs, or check-cashing stores. These companies could be “front companies” that provide a good or service but their true purpose is to clean the launderer’s money. This method typically works in one of two ways: the launderer can combine his dirty money with the company’s clean revenues, in which case the company reports higher revenues from its legitimate business than it earns; or the launderer can simply hide his dirty money in the company’s legitimate bank accounts in the hopes that authorities will not compare the bank balance to the company’s financial statements.
5. Hawala: A different or parallel remittance system is hawala. It exists and functions independently from or concurrently with “traditional” banking or financial channels. The majority of money laundering schemes use a combination of these techniques. This crime is challenging to eradicate due to the variety of tools available to money launderers.

Measures for prevention of Money laundering

There are various statutory frameworks to prevent money laundering such as PMLA, SAFEMA, NDPSA, FEMA, COFEPOSA etc. Everything will be discussed below.

Statutory framework

Before the Prevention of Money Laundering Act of 2002 (PMLA) was passed in India, the main statutes that included measures to address the issue of money laundering were:

1. The Income Tax Act, 1961
2. The Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974 (COFEPOSA)
3. The Smugglers and Foreign Exchange Manipulators Act, 1976 (SAFEMA)
4. The Narcotic Drugs and Psychotropic Substances Act, 1985 (NDPSA)
5. The Benami Transactions (Prohibition) Act, 1988
6. The Prevention of Illicit Traffic in Narcotic Drugs and Psychotropic Substances Act, 1988
7. The Foreign Exchange Management Act, 2000, (FEMA)

Prevention of Money Laundering Act (PMLA) 2002

The Prevention of Money Laundering Bill was introduced in 1998 and passed in 2002 in response to the urgent need for the adoption of comprehensive legislation for the prevention of money laundering and related activities, confiscation of proceeds of crime, the establishment of agencies and mechanisms for coordinating measures for combating money laundering, etc. Taking effect on July 1st, 2005, the Act was put into law.

The objective of the Act

• To prevent money laundering.
• To provide for confiscation of property derived from, or involved in, money laundering.
• For matters connected therewith or incidental thereto.
• It forms the core of the legal framework put in place by India to combat money laundering.

Its salient features include:

• Defines Money laundering.
• Expanded the reach of the Act by adding many more crimes under various legislations: It lists specific offenses that would fall under this Act’s purview under the IPC, the Narcotic Drugs and Psychotropic Substances Act, the Arms Act, the Wild Life (Protection) Act, the Immoral Traffic (Prevention) Act, and the Prevention of Corruption Act.
• In instances of cross-border money laundering, it enables the Central Government to implement the UN Convention against Corruption’s provisions by returning the confiscated property to the requesting nation.
• It aims to include certain financial institutions in the Act’s reporting requirements, including Full Fledged Money Changers, Money Transfer Services, and Master Card.

Enforcement apparatus

1. Adjudicating Authority: The Act gives the Central Government the authority to establish an adjudicating authority with a chairman and two other members and to specify the authority’s mandate and other terms of service. The Authority has been given independent authority to control its adjudicating process.
2. Administrator: The property laundered will be taken care of i.e. managed after confiscation by an Administrator who will act by the instructions of the Central Government.
3. Appellate Tribunal: An Appellate Tribunal established by the Central Government will hear all appeals from decisions made by the Adjudicating Authority. It will have two members, and the chairman will be in charge.

• Special Courts: An Appellate Tribunal established by the Central Government will hear all appeals from decisions made by the Adjudicating Authority. It will have two members, and the chairman will be in charge.
• Banking companies, financial institutions, and intermediaries are required by the PMLA and the rules thereunder to confirm the identity of their clients, keep records, and provide information to FIU-IND.

Institutional framework

• Enforcement Directorate: Investigation and prosecution of cases under the PMLA have been entrusted to Enforcement Directorate.
• Financial Intelligence Unit – India (FIU-IND): established in 2004 to serve as the primary national organization in charge of gathering, analyzing, and disseminating data about improbable financial transactions. As part of its mission to further the international fight against money laundering and related crimes, FIU-IND is also in charge of coordinating and bolstering the efforts of national and international intelligence, investigation, and enforcement agencies.

International Cooperation

• The Financial Action Task Force (FATF): The G7 summit in Paris in 1989 led to the creation of the FATF, an intergovernmental organization. The Financial Action Task Force (FATF) is a “policy-making body” that works to create the political will needed to bring about national legislative and regulatory reforms to combat money laundering, terrorist financing, and other related threats to the integrity of the global financial system.
• The Asia/Pacific Group on Money Laundering (APG) was a self-contained regional anti-money laundering organization. The APG’s mission is to facilitate the adoption, implementation, and enforcement of internationally accepted anti-money laundering and anti-terrorist financing standards outlined in the Financial Action Task Force’s recommendations (FATF).
• The Vienna Convention/ United Nations Convention against Illicit Trafficking in Drugs and Psychotropic Substances: In December 1988, it was the first major initiative in the prevention of money laundering. By requiring member states to criminalize the laundering of money from drug trafficking, this convention laid the groundwork for efforts to combat money laundering.
• The Council of Europe Convention: In 1990, this convention established a common policy on money laundering. It establishes a common definition of money laundering as well as common measures to combat it.
• Basel Committee Minimum Standards: The Basel Committee on Banking Regulations and Supervisory Practices is made up of representatives from the central banks and supervisory authorities of eleven major industrialized nations as well as Luxembourg. In 1998, the committee stated principles aimed at combating money laundering.

Effects of Money Laundering

1. Socio-cultural effects: Money laundering success encourages criminals to continue their illegal schemes—more fraud, more drugs on the streets, more drug-related crime, and so on.
2. Terrorism: Money laundering is a major source of terrorism financing. Terrorists have demonstrated adaptability and opportunism in meeting their funding needs.
3. Organized crime can infiltrate financial institutions, acquire control of large sectors of the economy through investment, or offer bribes to public officials and indeed governments.
4. Economic effects

• It’s estimated that money launderers scrub as much as $2 trillion (or 5 per cent of the world’s GDP) every year.
• Massive influxes of dirty cash into particular areas of the economy that are desirable to money launderers create false demand.
• Legitimate small businesses cannot compete with money-laundering front companies that can afford to sell a product at a lower price because their primary goal is to clean money rather than make a profit.

Challenges in the prevention of Money laundering

• Increased use of digital currency: The rise of cryptocurrency allows money launderers to conceal their illicit funds. Estimates suggest that criminals have used the hyper-connected cryptocurrency ecosystem to launder more than $2.5 billion in dirty Bitcoin since 2009.
• Preference for cash over digital payments for transactions: The use of cash will ease the process of “layering”.
• Lack of awareness about the seriousness of crimes of money laundering: Instead of going through lengthy paperwork transactions in banks, the poor and illiterate prefer the Hawala system, which has fewer formalities, little or no documentation, lower rates, and anonymity.
• Lenience from banks: Increasing competition in the financial market is forcing banks to lower their guards, allowing money launderers to use it illicitly in furtherance of their crime.
• Collusion by employees of financial institutions: Financial institutions are supposed to check the source of funds, monitor account activity, and track irregular transactions, but the involvement of financial institution employees makes laundering easier.
• Lack of comprehensive enforcement agencies: Money laundering is no longer limited to a single area of operation, but has broadened to include many different areas of operation. In India, there are separate wings of law enforcement dealing with money laundering, terrorist crimes, economic offenses, and so on, and they lack coordination.
• The widespread act of smuggling: There are a number of black market channels in India for the purpose of selling goods, with many imported consumers buying goods such as food, electronics, and so on. Black merchants conduct cash transactions and avoid customs duties, allowing them to offer lower prices than regular merchants.
• Tax Heaven Countries: Strict financial secrecy laws by tax heaven countries incentivize the creation of anonymous accounts in these countries by launderers.

Way forward

• Measures are needed to address the risk of cryptocurrency in money laundering.
• Tax heavens need to build a balance between financial confidentiality and this confidentiality turning to a money-laundering haven.
• Sensitize the masses about the ill effects of laundering.
• Prior to the launch of new products, business practices, or the use of new or developing technologies, financial institutions should conduct a risk assessment.

Implement FATF Recommendations which sets out a comprehensive and consistent framework. Some of them are:

1. Identify the risks; develop policies and domestic coordination to mitigate money laundering and terrorist financing risks.
2. Money laundering should be criminalized in accordance with the Vienna Convention and the Palermo Convention, which ensure that financial institution secrecy laws do not impede the implementation of the FATF Recommendations.
3. Apply the crime of money laundering to all serious offenses, with a view to including the widest range of predicate offenses.
4. Implement targeted financial sanctions regimes to comply with UN Security Council resolutions on the prevention, suppression, and financing of terrorism.
5. Examine the sufficiency of laws and regulations governing non-profit organizations, which the country has identified as vulnerable to terrorist financing abuse.
6. Apply preventive measures for the financial sector and other designated sectors.
7. Financial institutions should be required to keep all necessary records on domestic and international transactions for at least five years in order to respond quickly to information requests from competent authorities.
8. Establish authorities’ powers and responsibilities (e.g., investigative, law enforcement, and supervisory authorities), as well as other institutional measures.
9. Countries should have anti-money laundering policies and should designate an authority that is responsible for such policies.
10. Provide mutual legal assistance in the case of money laundering and effectively carry out extradition requests in the case of money laundering and terrorist financing.

Conclusion

The threat posed by this scheme necessitates advanced laws to prevent it from occurring, such as the use of AI and large intelligence databases at the government level.

This is not a threat that is limited to national borders but affects the entire world, so both national and international stakeholders must work together to tackle it.

Read:

• Extradition Treaties of India
• Benami law in India

Article Written by: Remya