AML Basics: Sources, Steps and Methods of MONEY LAUNDERING

Sources, Methods and Steps in MONEY LAUNDERING: 

The money laundering process is a complex and diverse process. Criminals follows many methods of money laundering process using the loop holes in the financial system. As a banker we would have came across many of those methods, especially during the demonetisation period. We have already discussed about money laundering in detail here. Now we will look into the methods of money laundering.

Sources of Illegal Money:

The common sources of illegal money or black money are

  • Trafficking of  drug, arms, human beings.
  • Terrorism.
  • Tax evasion.
  • Organised Crime like kidnapping, contract killing, gambling, prostitution, bank frauds, money paid to gangsters/ criminals for safety of business (protection money), Money earned through adulterated products, corruption.
  • Slush funds or Black funds – Secret reserve of money by Corporates for bribery to politicians  or donation to political parties.
  • Capitation fee – illegal fees sought by educational institutions.
  • Money lenders who charge extremely high interest also called as loan sharks.

Steps and Methods of Money Laundering:

The illegal money generated from the above criminal activities are made to look as legal money in the economy by using many methods of money laundering techniques. The money laundering process is often complex and virtually infinite procedures followed by criminals. A Bank or other financial institution is used at any point of those laundering procedures for conversion of Black money into White.

In general the money laundering process involves three steps:

  1. Placement,
  2. Layering, and
  3. Integration

Steps of Money Laundering

Step 1: Placement – Illegal money is deposited into the Financial Institutions using different methods. The main aim in this step is to remove the proceeds of crime (illegal money) from the criminal place to avoid detection from legal authorities. This is the tough phase for the launders due to strict restrictive provisions. Yet, they invent new techniques every day to pump the black money into the system.

Methods or techniques involved in this phase with Financial Institution:

  • Structuring / Smurfing technique: Depositing the large amount of illegal money into small amounts of cash in the accounts of unconnected depositors below the reporting threshold limit. The person who involved in the technique is called smurf.
  • Using connected accounts: accounts of relatives, benamis, associates such as shell companies (Fake Companies).
  • Multiple legitimate Account of same person in different banks and misuse of accounts of Educational Institutions, Non Profit Organisations and Charity trusts.

Step 2: Layering – Separating the illicit (criminal) origin of the illegal money through complex web of financial transactions. The main objective of this phase is to make the source of fund and its ownership untraceable, through multiple layering of complex transactions. This is a complex step in any money laundering activities.

  • Shell Companies or Fake Companies and Front Companies:

They are just a paper companies. They may or may not physically exist but they won’t do any productive activities like manufacturing or trading. For example: Mr.X is a money-lender, he lends money with heavy interest rate. But he registered his company as M/s.XYZ with sales tax registration and paying sales tax for selling of a commodity. He also files income tax for the net profit in the name of M/s.XYZ as trader. This is a money laundering process since he is actually a loan shark earning income from the lending interest.  But he used this fake company and changed the source of revenue as earned from a trading activity (legal).

Front Companies : A company which is used to shield another company from liability and scrutiny or to launder  illegal proceeds. Mostly the business of these companies are involved in huge cash transaction example: casinos, brokerage firms, Chit funds and in some countries banks. 

Front Groups or Front Organisation: A non-profit organisation or Trust used by another company to shield from scrutiny sometimes by terrorist organisation also. 

  • Offshore Banking:

The layering process is usually done by using the offshore banking services of different centres. In certain countries rules & regulation for Banking is liberal and secrecy of account holders are also protected makes them a favourable place for launders. The major centres are Hong Kong, Singapore, Bahrain, Switzerland etc,.

  • Hawala System:

In India and South Asia, Hawala System is a familiar type of money laundering technique. Hawala System is nothing, but a parallel non legal banking system. Let say Mr.Kumar wants to transfer money in Euro to his son Sanjay who is studying in UK. Mr.Kumar contacts a “Hawaladar A” in India and pays the amount in INR with commission to him. Now “Hawaladar A” calls and informs “Hawaladar B” who is in UK to pay the amount in Euro to Mr.Sanjay. The Hawaladar A and Hawaladar B then settle each other by manipulating the invoice through International Trade or another method.

  • International Trade:

Now Mr. Hawaladar A has to pay to Hawaladar B, he simply purchases a worthless product from B for the pending amount. Or we can say Hawaladar B has manipulated the invoice to A. This is also a major form of money laundering. These type of laundering technique is mainly used in Gold and Diamond market.

Gold: Gold has intrinsic value and constant market. Country like India are exporting more golds than its production so many chances for laundering activities using gold. Example: Drug trafficking agent pays in the form of gold and then this gold is imported with false invoice.

Diamond: The illegal trade of diamonds is an important source for launders and terrorists. Unlike gold which is homogeneous metal (if we cut gold into half, the price also divided equally) the diamond is a non homogeneous. The value of diamond is very complex even if both the diamonds are same colour, weight and clarity still they are not same; Because one might be twice the value of other and spotting the value of diamond requires lots of skill. This nature of diamonds helps the launders to easily manipulate the value of diamonds in the invoice. Also terrorist use illegal trade of diamonds as their source of funds transaction.

Methods or techniques involved in layering phase with Financial Institution:

  • Remittance Services like Foreign Telegraphic Transfers,
  • Bank drafts/money orders,
  • Loans to Shell companies and Front Companies.

Integration of laundered money

Step 3: Integration – Giving a legitimate image for illegal money. This is the last stage of the laundering process. During this stage it is very difficult to find the illicit origin of the money. After using the above methods of laundering, the illegal money is now circulated into the economy by way of investments, purchase of lands, expenditure or savings.

Effects of Money Laundering into the Economy:

Money laundering is a serious issue to economy; If laundering can be easily done then crime and criminal activities will started to grow which disrupts the order in the society. The legitimate companies, business owners or persons cannot compete with Front companies. Due to huge revenue loss for Government there will be increase in inflation. Since there will be sudden transfer of funds across countries which causes volatility (means sudden increase or decrease) in inflation rate, interest rate and exchange rate. If money laundering is not curtailed it may even lead to instability in the financial system and leads to downfall of Banks & other non Banking Financial Institutions.


Comments (3)

  1. Ramsha Mughal

    Thank you so much for precise and accurate information. It helped me alot in examination.

    1. Guru Bakyesvara Pandiyan (Post author)

      Happy you are benefited.!!👍

  2. Zahra

    This was a helpful article thank you so much


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