MONEY LAUNDERING

Published on 04 Feb 2025

According to INTERPOL, money laundering is concealing or disguising the identity of illegally obtained proceeds so that they appear to have originated from legitimate sources. According to the IMF, global Money Laundering is estimated between 2 to 5% of the World GDP.

Stages in Money Laundering 

• 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.

• Layering: Here it conceals the source of the money through a series of transactions and bookkeeping tricks.

• Integration: In the case of integration, the now-laundered money is withdrawn from the legitimate account to be used for criminal activities.

Methods of Money Laundering

• Structuring (Smurfing): This involves breaking down large sums of money into smaller, less suspicious amounts and then depositing them into various accounts to avoid suspicion.

• Example: A criminal organization may deposit $9,000 in cash into multiple bank accounts on different days to avoid triggering the mandatory reporting threshold for cash transactions.

• Shell Companies: Criminals set up fictitious companies (shell companies) to create a legitimate appearance for their illegal transactions.

• Example: A drug trafficker creates a fake company that supposedly sells medical supplies, and then uses the company to launder drug money by showing the funds as sales revenue.

• Trade-Based Laundering: Criminals manipulate trade transactions to move money across borders and obscure the true origin of the funds.

• Example: A criminal overvalues or undervalues goods on invoices to move money internationally while disguising the illicit source of funds.

• Real Estate Transactions: Criminals invest illicit funds in real estate to make the money appear legitimate.

• Example: A money launderer buys properties using illegal funds and then sells them, generating clean money as proceeds from the sale.

• Gambling: Criminals use casinos or online gambling sites to convert illicit funds into casino chips or gambling credits, and then cash out the winnings as clean money.

• Example: A drug trafficker uses drug money to gamble in a casino, wins some games, and then requests the casino to pay out the winnings in a check.

• Cryptocurrencies: Criminals use cryptocurrencies to transfer and convert illicit funds, taking advantage of the relative anonymity and global reach of these digital currencies.

• Example: A cybercriminal receives ransom payments in cryptocurrency, then transfers and exchanges the cryptocurrencies through various online platforms to conceal the source.

• Offshore Accounts: Criminals use foreign bank accounts in jurisdictions with lax regulations to hide and move their illegal funds.

• Example: A corrupt government official transfers embezzled funds to a secret offshore account, making it difficult to trace back to the original source.

• Layering: This involves creating complex financial transactions to obscure the paper trail and make it difficult for authorities to trace the source of the funds.

• Example: A money launderer may move funds between multiple bank accounts, conduct stock trades, and engage in various transactions to confuse investigators.

• Charitable Organizations: Criminals establish fake charitable organizations to donate illicit funds, giving the appearance of legitimate donations.

• Example: A criminal group sets up a charity and donates illegal funds to it, then uses the charity to transfer the money across borders under the guise of humanitarian aid.

• Cash Businesses: Criminals set up cash-intensive businesses, such as restaurants or laundromats, where they mix illegal funds with legitimate business revenue.

• Example: A criminal uses a cash-only restaurant to blend drug money with legitimate earnings from the restaurant's sales.

Reasons for the upsurge in money laundering

• External 

• Globalization and Cross-Border Transactions: As international trade and financial transactions have increased, so has the opportunity for criminals to move money across borders and exploit regulatory differences.

• Example: Criminal organizations might use trade-based money laundering to manipulate invoices and move funds undetected across multiple countries.

• Technological 

• Advancements in Technology: Digital advancements have facilitated the movement of funds through online platforms, cryptocurrencies, and electronic payment systems.

• Example: Cryptocurrencies like Bitcoin have been used to launder money due to their relatively anonymous nature and global accessibility.

• Cybercrime and Online Fraud: The rise of cybercrime has led to an increase in money laundering associated with online fraud, hacking, and ransomware attacks.

• Example: Cybercriminals might demand ransom payments in cryptocurrency, making it difficult to trace the flow of funds.

• Political 

• Regulatory Gaps and Weak Enforcement: Inconsistent and inadequate regulations across jurisdictions can create opportunities for money launderers to exploit gaps in enforcement.

• Example: Offshore jurisdictions with lax regulations might attract money launderers seeking to establish secret accounts.

• Corruption and Political Instability: In countries with corruption and political instability, money laundering can thrive due to weak governance and regulatory oversight.

• Example: Corrupt officials might embezzle funds from public coffers and then launder the money through offshore accounts.

• Economic 

• Complex Financial Systems: The complexity of financial systems can make it difficult to trace the origins of funds, especially when transactions involve multiple intermediaries and jurisdictions.

• Example: Criminals might use layered transactions involving multiple financial instruments to obfuscate the trail of illicit funds.

• High-Value Assets and Investments: Criminals may invest their illegal funds in high-value assets like real estate, art, and precious metals, making detection and tracking more challenging.

• Example: Criminals could use illicit funds to purchase luxury real estate, creating a seemingly legitimate source of wealth.

• Financial Secrecy and Offshore Accounts: Offshore accounts and financial secrecy can allow money launderers to hide the true ownership of assets and evade detection.

• Example: Individuals might set up shell companies in tax havens to move and hide illicit funds.

Role of Emerging technologies in money laundering 

Globalization of economies along with the ICT revolution is leading to increased financial cybercrimes resulting in Cyber laundering. Emerging technologies have provided both new opportunities and challenges for money launderers. These technologies can enable sophisticated methods to disguise the origins of illicit funds, conduct transactions anonymously, and exploit vulnerabilities in financial systems.

• Cryptocurrencies: Cryptocurrencies like Bitcoin offer a degree of anonymity and global accessibility, making them attractive for money laundering.

• Example: Criminals might use cryptocurrencies to transfer and convert illicit funds, using mixing services to obfuscate the transaction trail.

• Blockchain Anonymity: While blockchain technology provides transparency and security, certain privacy-focused cryptocurrencies and techniques can obscure transaction details.

• Example: Privacy coins like Monero use advanced cryptographic techniques to mask sender, recipient, and transaction amounts.

• Darknet Marketplaces: Online darknet marketplaces allow anonymous transactions for illegal goods and services, enabling criminals to launder money through purchases and sales.

• Example: Criminals might sell drugs on a darknet marketplace, receive cryptocurrency payments, and then convert the funds to clean money.

• Artificial Intelligence (AI) and Automation: AI and automation can facilitate the rapid movement of funds and enable criminals to manage large-scale money laundering operations.

• Example: Criminals might use AI-driven algorithms to automate transactions and move funds through a complex network of accounts.

• Online Payment Systems: Mobile wallets, peer-to-peer payment platforms, and online payment systems can be exploited for quick and anonymous money transfers.

• Example: Criminals could use mobile payment apps to send and receive funds without leaving a paper trail.

• E-commerce and Online Marketplaces: Criminals can use e-commerce platforms to disguise illicit transactions as legitimate sales, making it difficult to differentiate between legal and illegal activities.

• Example: Money launderers might set up fake online stores to conduct transactions using stolen credit card information.

• Virtual Reality (VR) and Augmented Reality (AR): Emerging VR and AR technologies could potentially be used to create immersive environments for money laundering activities, making tracking and monitoring more challenging.

• Example: Criminals might use VR environments to simulate real-world transactions and interactions, making detection harder.

• Ransomware and Cyber Extortion: Cybercriminals use ransomware attacks to demand payments in cryptocurrency, making it difficult to trace the flow of funds.

• Example: A cybercriminal might infect a company's systems with ransomware, demanding payment in cryptocurrency to release the encrypted data.

• Automated Trading Bots: Criminals might use automated trading bots to manipulate cryptocurrency markets and generate seemingly legitimate gains from trading activities.

• Example: A money launderer employs automated trading bots to conduct high-frequency trading and generate profits, which are then withdrawn as clean funds.

Linkage between Globalisation and Money Laundering

Globalization and money laundering are interconnected due to the increased movement of goods, services, capital, and people across borders. While globalization has brought many economic benefits, it has also created opportunities for criminals to exploit regulatory differences, evade law enforcement, and launder illicit funds on a global scale.

• Cross-Border Transactions: Globalization has led to a significant increase in cross-border trade and financial transactions, which criminals can exploit to move their illegal funds.

• Example: Criminal organizations might use trade-based money laundering, manipulating invoices to overvalue or undervalue goods, facilitating the movement of illicit funds across multiple countries.

• Offshore Financial Centres: The establishment of offshore financial centres in different jurisdictions has enabled money launderers to open secret bank accounts and shell companies to hide the true ownership of assets.

• Example: A corrupt official might funnel embezzled funds through an offshore account in a tax haven to evade detection by authorities in their home country.

• Digital Transactions and Cryptocurrencies: The digitization of financial transactions and the rise of cryptocurrencies have made it easier for money launderers to move funds globally with relative anonymity.

• Example: Criminals might use cryptocurrencies to conduct cross-border transactions, exploiting the pseudonymous nature of blockchain technology to hide the source and destination of funds.

• Complex Corporate Structures: Globalization has enabled criminals to set up complex corporate structures involving subsidiaries in multiple countries, making it challenging to trace the flow of funds.

• Example: Money launderers might establish a network of companies across different jurisdictions to disguise the movement of illicit funds as legitimate business transactions.

• International Real Estate Investments: Money launderers may invest their illicit funds in real estate across different countries, using the global property market to legitimize their wealth.

• Example: A criminal might use funds from illegal activities to purchase luxury properties in various countries, making it appear as though the wealth is from legitimate sources.

• E-commerce and Online Markets: Global e-commerce platforms provide opportunities for criminals to engage in cross-border transactions, making it difficult to track the origins of funds.

• Example: Criminals might use online marketplaces to launder money through fake transactions, using the global reach of these platforms to move funds between countries.

• Weakened Regulatory Oversight: Differences in regulations and enforcement across jurisdictions can be exploited by money launderers to avoid detection and prosecution.

• Example: Criminals might establish accounts in countries with weak anti-money laundering regulations, making it harder for authorities to identify suspicious transactions.

• International Charitable Organizations: Criminals might exploit global charitable organizations to move funds across borders under the guise of legitimate donations.

• Example: A criminal group might set up a fake charity and use it to transfer illicit funds internationally while appearing to engage in philanthropic activities.

Cryptocurrency and money laundering

Cryptocurrencies have gained attention in the context of money laundering due to their potential to facilitate anonymous and cross-border transactions. While cryptocurrencies offer benefits like decentralized transactions and financial inclusion, they can also be exploited by criminals for money laundering.

• Anonymity and Pseudonymity: Cryptocurrencies like Bitcoin offer a level of anonymity, as transactions are not directly linked to personal identities. Criminals can use this feature to hide the origin and destination of funds during money laundering.

• Mixing Services: Mixing services or tumblers are used to mix transactions from multiple users, making it difficult to trace the flow of funds. Criminals can use these services to "clean" their tainted cryptocurrencies.

• Example: Criminals use pump-and-dump schemes to artificially inflate the price of a cryptocurrency, attract investors, and then sell their holdings at the inflated price.

• Cross-Border Transactions: Cryptocurrencies enable seamless cross-border transactions without the need for intermediaries. Criminals can exploit this feature to move funds across borders quickly and anonymously.

• Example: Silk Road was an infamous darknet marketplace that operated from 2011 to 2013, primarily dealing in illegal drugs and other illicit goods.

• Layering: Criminals can use cryptocurrencies to create complex transactions involving multiple addresses and transactions, obfuscating the trail of funds.

• Example: Exit scams often involve transferring funds through various wallets and exchanges to obfuscate the money's path.

• Offshore Exchanges: Criminals might use cryptocurrency exchanges in countries with weak regulatory oversight to convert illicit funds into more widely accepted cryptocurrencies or fiat currencies.

• Darknet Markets: Cryptocurrencies are commonly used in illegal online marketplaces on the darknet, where transactions can be anonymous. Criminals can use these markets for drug trafficking and other illicit trade.

• Example: Ransomware attacks involve encrypting a victim's data and demanding a ransom payment, often in cryptocurrency, to provide the decryption key.

Impacts of money laundering

• Social Impact 

• Crime Proliferation: Money laundering supports criminal activities such as drug trafficking, human trafficking, and arms smuggling, contributing to increased crime rates.

• Example: Funds laundered from drug sales may indirectly lead to addiction-related problems and associated criminal activities.

• Undermining Governance and Institutions: Money laundering weakens governance structures by providing resources to corrupt officials and criminal networks.

• Example: Illicit funds laundered by corrupt politicians can erode public services and institutions, hindering development.

• Erosion of Social Trust: Money laundering erodes public trust in financial institutions, law enforcement agencies, and regulatory bodies.

• Example: If banks are involved in money laundering scandals, people may lose faith in the banking system, affecting their willingness to save and invest.

• Weakened Social Programs: Money laundering reduces tax revenue, limiting government funds available for social programs and public services.

• Example: Funds lost to money laundering could have been used to improve healthcare, education, and infrastructure.

• Negative Impact on Youth and Future Generations: Money laundering indirectly affects younger generations by perpetuating criminal cycles and undermining prospects for social development.

• Example: Money laundered through illicit businesses may contribute to the perpetuation of criminal lifestyles, leading to generational cycles of crime.

• Economic Impact

• Economic Distortion: Money laundering can inflate asset prices, distort competition, and undermine fair market practices.

• Example: A criminal invests illegal funds in real estate, driving up property prices and making housing less affordable for the general population.

• Erosion of Trust in Institutions: Money laundering erodes trust in financial institutions and regulatory systems, undermining confidence in the rule of law.

• Example: When financial institutions are involved in money laundering scandals, it damages their reputation and makes people question their integrity.

• Weakening of National Economies: Money laundering can siphon resources away from legitimate economic activities and productive investments, impacting economic growth.

• Example: Transparency International's Global Corruption Barometer indicates that money laundering, often linked to corruption, undermines public trust in institutions.

• Impaired Fiscal Policies: Money laundering can reduce tax revenue for governments as illicit funds escape taxation.

• Example: If a corrupt official embezzles funds and then launders them offshore, the government loses out on potential tax revenue.

• Financing Terrorism and Organized Crime: Money laundering facilitates the financing of terrorist activities, human trafficking, drug smuggling, and other criminal enterprises.

• Example: Illicit funds moved through cryptocurrency can support terrorist organizations that operate globally.

• Unfair Competition: Money laundering can give criminal enterprises an unfair competitive advantage, as they can access substantial resources.

• Example: Criminal organizations that launder money through legitimate businesses can undercut competitors and dominate markets.

• Increased Regulatory Burden: Governments and financial institutions must allocate resources to combat money laundering, diverting focus from productive activities.

• Example: Banks and financial entities need to invest in AML compliance measures, which can result in increased operational costs.

• Political Impacts 

• Corruption and Politicization: Money laundering can be used to legitimize the proceeds of corruption, giving corrupt officials a way to enjoy their ill-gotten gains.

• Example: The World Economic Forum's Global Agenda Council on Illicit Trade reported that money laundering has a direct impact on political stability and governance, undermining democratic institutions.

• Weakened Democratic Processes: Money laundering can distort political processes by enabling individuals with hidden financial interests to exert undue influence.

• Example: Money launderers may secretly support candidates or parties with their illicit funds, undermining the fairness of elections.

• Ineffective Governance: Money laundering undermines effective governance by diverting resources away from public services and infrastructure.

• Example: Funds lost to money laundering could have been used to improve public health, education, and infrastructure.

• Influence on Policy-Making: Money launderers with significant financial resources can influence policy decisions by supporting politicians and parties that align with their interests.

• Example: The International Consortium of Investigative Journalists (ICIJ) released the "Panama Papers" and "Paradise Papers," revealing how money laundering can shape political dynamics and undermine democratic principles.

Steps Taken by the Government of India to Prevent Money Laundering

• Legislative measures 

• Criminal Law Amendment Ordinance (XXXVIII of 1944): It covers proceeds of only certain crimes such as corruption, breach of trust and cheating and not all the crimes under the Indian Penal Code.

• The Smugglers and Foreign Exchange Manipulators (Forfeiture of Property) Act, 1976: It covers the penalty for illegally acquired properties of smugglers and foreign exchange manipulators and for matters connected therewith and incidental thereto.

• Narcotic Drugs and Psychotropic Substances Act, 1985: It provides for the penalty of property derived from, or used in illegal traffic in narcotic drugs.

• Prevention of Money-Laundering Act, 2002 (PMLA): It forms the core of the legal framework put in place by India to combat Money Laundering.

• Institutional measures

• Financial Intelligence Unit-IND: It is an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the Finance Minister.

• Enforcement Directorate (ED): It can take actions like confiscation of property if the same is determined to be proceeds of crime derived from a Scheduled Offence under PMLA, and to prosecute the persons involved in the offence of money laundering.

• Policy measures 

• Regulatory mechanism: The KYC requirements and RBI regulations are periodically updated to reflect changing money laundering threats and techniques.

• Bilateral Agreements: India has entered into an information-sharing agreement with the USA under the Foreign Account Tax Compliance Act of the USA.

• Global efforts to combat Money Laundering

• The Vienna Convention: It creates an obligation for signatory states to criminalize the laundering of money from drug trafficking.

• The 1990 Council of Europe Convention: It establishes a common criminal policy on Money Laundering.

• G-10’s Basel Committee statement of principles: It issued a “statement of principles” with which the international banks of member states are expected to comply.

• The International Organization of Securities Commissions (IOSCO): It encourages its members to take necessary steps to combat Money Laundering in securities and futures markets.

• FATF: FATF is responsible for setting global standards on anti-money laundering and combating financing of terrorism. Blacklisting of countries by FATF.

Challenges in Preventing Money Laundering

• Technological 

• Cryptocurrency Exploitation: Criminals exploit the anonymity and global reach of cryptocurrencies for money laundering.

• Example: The case of the "BTC-e" exchange, accused of laundering over $4 billion in Bitcoin, demonstrated how cryptocurrency exchanges can be used for large-scale money laundering.

• Growth of Technology: The enforcement agencies are not able to match up with the speed of growing technologies.

• Example: Identity theft through hacking of credit card information etc. Is used to layer illegitimate money under untraceable identities.

• Political

• Resource Constraints: Law enforcement agencies and financial institutions often face resource constraints in terms of personnel, technology, and expertise needed to combat money laundering effectively.

• Example: Limited resources may result in delayed responses to emerging money laundering trends and threats.

• Complex Corporate Structures: Money launderers use complex corporate structures to disguise the origin and movement of illicit funds.

• Example: The "1MDB" scandal involved layers of shell companies and financial instruments to launder money embezzled from a Malaysian state fund.

• Widespread act of smuggling: there are several black-market channels in India for the purpose of selling goods offering many imported consumer goods such as food items, electronics etc. which are routinely sold.

• Example: Black merchants conduct cash transactions and avoid customs duties, allowing them to offer lower prices than regular merchants.

• Lack of comprehensive enforcement agencies: Separate wings of law enforcement agencies dealing with money laundering, cyber-crimes, terrorist crimes, economic offences etc lack convergence among themselves

• Economic 

• Financial Innovation: Financial innovation can introduce new ways for money launderers to exploit vulnerabilities in payment systems and investment vehicles.

• Example: Criminals might use peer-to-peer lending platforms or digital payment apps to move and launder funds without raising suspicion.

• Non-fulfilment of KYC Norms: Increasing competition in the market is forcing the Banks to lower their guards and thus facilitating the money launderers to make illicit use of it in furtherance of their crime.

• Example: KYC norms do not cease or abstain from the problem of Hawala transactions as RBI cannot regulate them.

• Tax Heaven Countries: They have long been associated with money laundering because their financial secrecy laws allow the creation of anonymous accounts while prohibiting the disclosure of financial information.

• Example: Tax haven countries like Cayman Island, Panama etc. have structured their economies around assistance in tax evasion.

Way forward

• Policy Measures 

• Comprehensive Legislation Framework: Enact comprehensive anti-money laundering legislation that outlines legal definitions, reporting requirements, and penalties for non-compliance.

• Example: RBI needs to constantly upgrade both paper-based (watermark) and print-based (optical variable ink, see-through effect) security features.

• Data Sharing and Collaboration: Facilitate data sharing between law enforcement agencies, regulatory bodies, and financial institutions to enhance the effectiveness of AML efforts.

• Example: Digital Payment and e-KYC help reduce the risk of cash-based money laundering and improve financial transparency.

• Using Technology: This can involve the use of sophisticated software and algorithms to detect suspicious transactions and to create a transparent and tamper-proof ledger of financial transactions.

• Example: Big Data and AI are two examples of equally cutting-edge anti-money laundering tools that can be used to combat money laundering.  

• Coordination and Cooperation

• Enlist common predicate offences: To solve the problem internationally particularly keeping in mind the trans-national character of the offence of money laundering.

• Example: FATF sets standards and promotes effective implementation of legal, regulatory and operational measures against money laundering; and terror financing.

• Improving International Cooperation: The government can improve cooperation with other countries to investigate and prosecute cases of money laundering.

• Awareness and education: To infuse a sense of watchfulness towards the instances of money laundering which would also help in better law enforcement as it would be subject to public examination

• Institutional measures 

• Regulatory Oversight and Enforcement: Strengthen regulatory oversight of financial institutions to ensure effective enforcement mechanisms.

• Example: India established a Joint Task Force to tackle the misuse of corporate structures and shell companies for money laundering and tax evasion.

• Special cell dealing with money laundering activities: It should be created on the lines of the Economic Intelligence Council (EIC) exclusively dealing with research and development of anti-money laundering. 

• Example: Special Cell should have a link with INTERPOL and other international organizations dealing with money laundering. All key stakeholders, like, RBI, SEBI etc. should be a part of this.

• Laws in line with conventions: Countries should criminalise money laundering based on the United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances, 1988 (the Vienna Convention) and the United Nations Convention against Transnational Organized Crime, 2000.

Money Laundering is a global menace that requires a global effort to curb it. Mutual cooperation among Nations, and financial institutions along with the use of technological counter-measures such as big data and artificial intelligence is required to curb the menace of money laundering. 

Tags:
Security

Keywords:
Internal security Organized crimes Money laundering prevention of money laundering

Syllabus:
General Studies Paper 3

Topics:
Internal Security