Definition of Money Laundering
Money Laundering can be defined a process where illicit, ill-gotten gains, or profits of crime are disguised to make them appear as if such an income or profit was earned through legitimate sources.
Background of Money Laundering
Criminals, criminal syndicates or cartels, corrupt officials and politicians commit crimes or assist in the execution of crimes because of the motive to earn quick financial profits or gains. However, these financial gains earned due to criminal activities are often in the form of large amounts of cash, wire transfers in tax haven or regulatory haven countries, or in the form of virtual assets such as Bitcoin and Ethereum, to name a few. The concept of money laundering originated due to the requirement of evading detection by law enforcement agencies.
The catch situation these criminals face is that they cannot, like a straightforward law-abiding citizen earning genuine salary or business profits, go and deposit proceeds of crime into a bank account or transfer proceeds of crime from one criminal or syndicate to another by internet banking or wire-transfer services offered by banks and other financial institutions.
Any individuals or corporates wanting to use formal banking and financial institution services need to provide their details to fulfil regulatory compliances such as Know Your Customer (KYC) and Customer Due Diligence (CDD) requirements.
If criminals or criminal syndicates make use of formal banking and financial institution services, they would also end up being subjected to regulatory compliance requirements, which, if they truthfully provide, then they would end up being prosecuted as providing details of their own and their sources of income would establish their connection with crimes.
Criminals and criminal syndicates resort to money laundering to avoid such detection of earnings because of crime and prosecution by law enforcement agencies.
The word “launder” in the concept of money laundering refers to the act of washing away the traces of the criminal or illicit origin of funds acquired by various illicit activities such as extortion, drug dealing, human trafficking, and so on.
Process of Money Laundering
The process of money laundering enables criminals and criminal syndicates to separate the connection between them and the proceeds of crime acquired by them. Money laundering makes it possible to do so as the process of money laundering contains three steps:
- Placement: At this first stage, the proceeds of crime in cash form or other assets acquired as profits from criminal activity are introduced into the legitimate financial system. Examples include:
- Dividing large sums of money into smaller chunks and depositing the same in multiple bank accounts to avoid crossing the reporting threshold and triggering reporting requirements.
- Buying foreign exchange in cash with illicit cash.
- Purchasing gift cards with stored value in cash and using gift cards to transfer funds/carry cash.
- Layering: At this second stage of money laundering, the illegally acquired money is separated from its origin by the introduction of layers that help conceal or disguise the illicit origin and give fake legitimate proof of such gains. Examples include:
- Moving funds within the same group of shell companies by creating fake invoices.
- Converting deposited cash into financial instruments.
- Investing in real estate and high-value precious metals such as gold and silver.
- Integration: At this third and last stage of the money laundering process, legitimacy is given to the illicit income by facilitating the re-entry of layered funds into the mainstream economy. Examples include:
- Creating business relationships and contracts with legitimate businesses and investing funds in such businesses
- Investing or purchasing high-value assets such as yachts, artwork and high-priced limited-edition vehicles and watches.
In simple words, money laundering is a process that disguises illegal sources of gains or income and makes it appear as if the same was acquired legitimately. Criminals resort to money laundering techniques to avoid detection and prosecution by law enforcement authorities.
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Definition of Terrorist Financing
In order to understand the definition and concept of terrorism financing, it is essential to understand what terrorism means. Terrorism is the use of force, violence, and destruction of property and human life, with the intent to intimidate or force governments and people at large to support or comply with the objectives and demands of people carrying out terrorism, also known as terrorists. Examples of terrorism include mass killings through suicide bombers, hijacking and destruction of monuments.
Carrying out terrorist activities requires extensive funding for the purchase of weapons and explosives, training of individuals to further out terrorist activities, recruitment of terrorists, and related activities.
Process of Terrorism Financing
Terrorism Financing is a process through which terrorist organisations or individual terrorists acquire funds to further their terrorist activities. Terrorists can acquire funds for their motives through multiple means, including legal and illegal means. The process of terrorism financing is carried out in four stages:
- Raise: At this first stage, terrorists acquire funds by evading formal channels and collecting funds that help them in carrying out terrorist activities. Examples include:
- Seeking funds through donations under false pretexts, such as donations for surgery of underprivileged children.
- Collecting donations from supporters of similar fanatic ideologies.
- Store: At this second stage, terrorists, after raising funds, look to store the funds until it is safe to move these funds to prevent detection by authorities. Examples include:
- Purchasing cryptocurrencies or virtual assets.
- Purchase of high-value assets such as art and antiques.
- Depositing cash in several bank accounts.
- Move: At this stage, terrorists mobilise the funds. The movement of funds is carried out by various formal and informal ways of channelling funds. Examples include:
- Sale/Transfer of virtual assets.
- Bulk cash couriers.
- Use: At this stage, the goal of terrorism financing is within reach of terrorists. They utilise funds for:
- Purchase of weapons.
- Purchase of destructive materials.
- Recruitment of people for terrorist motives.
Importance of Understanding the Inter-Relationship between Money Laundering and Terrorist Financing
Effective implementation of ML/TF risk mitigation measures requires persons involved in their implementation to have basic training and an understanding of core concepts of AML compliance, such as what ML/TF is and the interrelationship between them.
The persons involved in the implementation of AML compliance measures are the customer-facing staff, the compliance team, including the AML compliance officer, and the senior management of the business, responsible for signing off the onboarding and continuation of business relationships with high-risk customers.
Knowledge of the inter-relationship between money laundering and terrorist financing also enables businesses such as DNFBPs and VASPs to implement the risk-based approach in curtailing ML/TF in a more effective manner, as both ML/TF have similar countermeasures and red flags where one helps identify and curb another at the same time.
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Similarities between ML/TF
When it comes to addressing similarities between ML/TF, following considerations need to be made:
1. The countermeasures in preventing the occurrence of money laundering and terrorism financing serve dual purposes, such as:
- Identification of suspicious activities and transactions by having suitable and adequate Know Your Customer (KYC) / Customer Due Diligence (CDD) practices in place.
- Regular monitoring of transactions.
- Compliance with AML/CFT laws and regulations.
2. ML/TF have similar channels of execution:
- Relying on cash couriers, exchange houses, and similar channels to “layer” or “move” funds for illicit purposes.
Difference between ML/TF
Money Laundering | Terrorism Financing |
Motive: Money laundering is conducted with the motive to wash away or disguise the illicit origin of funds to enable the launderer to use funds and separate the illegal origin of money from the money itself. | Motive: Terrorism financing is conducted with a singular goal to further religious ideologies and spread fear and destruction by conducting terror events such as bombings or hijackings. |
Source: The source of money laundering is always through an illegal activity, a predicate offence. | Source: The source of terrorism financing can be both legitimate or illegal; for example, terrorists may collect funds legally through crowdfunding or may collect funds illegally by utilising proceeds of crime earned by committing other crimes such as extortion or human trafficking racket. |
Methodology: The process of money laundering is circular in nature, meaning that the person acquiring illicit proceeds is the beneficiary or the ultimate user of laundered funds. | Methodology: The process of terrorism financing starts with collecting funds from various legal and illegal sources and ends up being used by terrorists in conducting terror events. Thus, the movement of funds is linear in nature. |
Inter-relationship of Money Laundering and Terrorist Financing
Money laundering and terrorism financing are closely interlinked concepts due to their inherent nature of facilitating the movement of illicit funds through multiple channels till they are ready for final use. Both ML/TF use and rely on similar channels of carrying out the “layering” or the “moving” of money, such as cash couriers, or exchange houses. Other than this, the red flags for ML or TF might indicate the presence of another and help curtail both.
1. Shell Companies
Both Money Laundering and Terrorist Financing involve Shell companies to hide the Ultimate Beneficial Owners.
2. Complex Transactions
Criminals resort to complex financial transactions to make it difficult for regulatory authorities to reach the ultimate source of their ill-gotten money. This holds true for both money laundering and terrorist financing.
3. Trade-Based Money Laundering (TBML)
Both Money Laundering and Terrorist Financing involve manipulation of trade transactions to disguise the movement of funds.
4. Shared Vulnerabilities
The word vulnerability refers to the openness to being attacked. In the context of ML/TF risk, businesses are vulnerable to being misused as a channel or instrument to further ML/TF activities by launderers or terrorists. This shared vulnerability exists due to the presence of similar structures or channels to conduct money laundering or terrorism financing. The infrastructure relied on by businesses to conduct cross-border transactions or international business transactions, or while dealing with virtual assets, is often targeted by money launderers and terrorism financing groups for exploitation and transferring proceeds for their illicit motives.
5. Overlap in Regulatory Obligations
The regulated entities have to craft AML/CFT policies and procedures, conduct KYC and CDD, perform transaction monitoring, maintain records, appoint independent auditors, submit regulatory reports like SAR/STR, and have a proper governance framework to counter ML/TF. These obligations are aimed at tackling money laundering and terrorist financing issues simultaneously.
6. International Cooperation
Given the cross-border nature of money laundering and terrorist financing, the countermeasures require international cooperation.
7. Socio-Economic Impact
The prevalence of money laundering and terrorist financing have a devastating socio-economic impact. They can affect economies adversely and undermine public trust in banks and financial institutions, and therefore, it is important to address both issues together.
8. Mutual Dependence Between Money Laundering and Terrorist Financing
As discussed earlier, terrorists always require large amounts of funding regularly to support their activities, such as the training and recruitment of new terrorists, purchase of weapons, ammunition, tracking and interception equipment, and so on. The primary motive of TF is to spread fear and destroy human lives in the name of ideologies, which is only possible through conducting terrorist activities supported by a supply of funding.
The funding for TF is supplied through legal and illegal means. Terrorists acquire funds legally through a collection of small donations from a substantial number of individuals supporting the ideology or may receive state-sponsored funds. Terrorists can also acquire funds illegally through a collection of funds in the name of donation under a false agenda or through other crimes such as drug dealing, human trafficking, drug trafficking, and other crimes.
Whenever the element of cross-border or international transfer of funds from one country to another comes into the picture, terrorists inevitably have to rely on money laundering processes such as layering as well as integration, where the ultimate user of illicit proceeds can access the funding across the globe, easily and without raising suspicion in the eyes of law enforcement agencies.
The sly and swift manner in which launderers transfer and disguise copious amounts of funds is what draws terrorist groups to rely on money laundering channels to move and store their funds, waiting for the right time to make use of such funds in a manner which avoids alerting law enforcement agencies.
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Challenges in Combatting Money Laundering and Terrorism Financing
The challenges in combatting ML and TF are multi-fold, arising due to a variety of factors, such as:
1. Emergence of New Typologies
With increasing regulations and compliance requirements in countries that strive to combat ML/TF effectively, the launderers and terrorists frequently manage to find loopholes to circumnavigate the regulatory checks and balances to curb ML/TF risks.
The conduct of finding loopholes and innovating ways to avoid detection and prosecution by law results in the emergence of new ML/TF typologies.
New ML/TF typologies are used by criminals on a daily basis across the globe, making it difficult for businesses implementing detection mechanisms to identify new typologies and the regulators investigating and deciding on Suspicious Activity Reports (SARs) and Suspicious Transaction Reports (STRs) submitted to them whether certain behaviour or transaction is actually a red-flag indicating ML/TF motive or false alert.
New typologies of ML/TF make it difficult for businesses to report them as they might not be aware of new means of conducting ML/TF used by criminals, leading to non-reporting of such activity or transaction and criminals passing through compliance filters without consequences.
2. Mismatch in Regulatory Controls
The degree and extent of effectiveness and stringency of ML/TF regulations vary from country to country. This results in launderers or terrorists resorting to funnel their illicit proceeds from one weak regulatory country to another with ease and decreased chances of detection.
This mismatch of stringency in regulatory controls results in enabling launderers and terrorists to mobilise and channel their illicit proceeds for ultimate use in laundering money and conducting terrorist events.
3. Non-Adherence to Global Standards
The Financial Action Task Force (FATF) is a global watchdog for ML/TF controls across the world. It sets out recommendations for countries and businesses operating within to combat ML/TF risks more effectively.
However, there are still countries that do not follow or come in alignment with FATF and other global standards, resulting in increased risk of ML/TF risks in those countries. This impact of increased risk flows from weak AML/CFT jurisdiction to countries that have their regulations in place.
4. Lack of trained AML Professionals
The lack of trained AML professionals contributes to the compliance deficit. Many countries face a lack of trained AML professionals who can be employed by regulated businesses in their country to look after AML/CFT compliances. This lack of appropriate talent results in difficulty for businesses in adhering to applicable ML/TF compliances in totality.
5. Lack of Awareness in Non-Financial Sector
Most medium and small–scale DNFBPs and VASPs are unaware of their AML/CFT regulatory compliance obligations. They usually go on conducting business until a fine/ penalty or inspection from the regulator takes place. This results in business being already used as a channel for laundering or terrorism financing before compliance measures are implemented.
Global Efforts in Fighting ML/TF
The FATF, United Nations, Wolfsberg Group, Egmont Group, and multiple FATF Styled Regional Bodies (FSRBs) are testament to global efforts in fighting ML/TF. They collect and disseminate information about potential ML/TF threats in the form of suspicious activity and transaction reports received by Financial Intelligence Units (FIUs) of various countries. They analyse and map trends of ML/TF typologies and threats. By doing so, they produce new methodologies and suggestions to curb ML/TF.
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About the Author
Pathik Shah
FCA, CAMS, CISA, CS, DISA (ICAI), FAFP (ICAI)
Pathik is a Chartered Accountant with more than 26 years of experience in governance, risk, and compliance. He helps companies with end-to-end AML compliance services, from conducting Enterprise- Wide Risk Assessments to implementing the robust AML Compliance framework. He has played a pivotal role as a functional expert in developing and implementing RegTech solutions for streamlined compliance.