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How to Combat Money Laundering?

Oct 12, 2022

Money laundering costs the world nearly 5% of its GDP. The losses are estimated to be over $2 trillion per year.  

For starters, money laundering is not some harmless misdemeanor. It’s a serious financial crime with significant economic and social consequences. As 90% of money laundered is off the radar, criminals and terrorist financiers find it very easy to fund and monetize illegal activities. 

What is money laundering?

Money laundering is an illegal process that conceals the origin of ill-gotten funds and makes them appear as if they are from a legitimate source.  

Here’s an example.     

A could have gotten paid for organized criminal activities such as drug trafficking, corruption, embezzlement, or gambling. Now, to spend the gains without drawing attention, A uses shell corporations, high-cash businesses, and other naive financial companies to illegally clean the dirty money and let it out in circulation. 

Now money laundering doesn’t affect just a particular set of businesses. Its dystopian effect surpasses industries and nationalities. 

How does money laundering happen?

Money launderers traverse three stages to stealthily release illicit funds into the financial ecosystem. 

3 stages of money laundering

1 Placement 

Here the laundered funds are shifted from criminal associations to be placed and positioned as a legitimate source. Usual techniques to mask the identity include false invoices, moving money to heavy cash flow businesses, foreign bank accounts, and offshore companies.   

2 Layering

Otherwise called the ‘structuring phase,’ layering divides a large sum of money into small transactions to cover up money laundering. It blankets the international money movement, making it difficult for law enforcement to track down launderers. Ultimately, the laundered money circulates globally and is exchanged in foreign markets. 

3 Integration

Also called the ‘extraction phase,’ integration is the final stage of money laundering. In this phase, the laundered money returns to the criminals and integrates with the regular financial stream. Masked to be from a legitimate source, criminals can now legally recover their laundered money and use it for any purpose. 

Need to combat money laundering 

The impact of money laundering is severe. It decays financial health, income distribution, and tax revenues, in addition to promoting crime and slowing down economic growth.  

Institutions specializing in money movement, including banks, NBFCs, and other financial institutions, are more likely to be impacted by money laundering. Hence, they need to be highly vigilant.  

The September 11 attacks, popularly known as the 9/11 terrorist attack, had an intense effect on money laundering regulations, mainly focused on the banking sector. After this, the Patriot Act was introduced, which offered the US government power to fight against terrorism. It also directed the financial institutions to expand their Anti-Money Laundering (AML) programs and intensify due diligence on foreign bank accounts. Title III strengthened banking rules by improving communication between law enforcement and financial institutions. This resulted in the US enforcing a stricter AML regime, followed by other countries.  

In India, RBI imposes stringent anti-money laundering regulations. Banks must follow strict customer identification processes for account opening and transaction monitoring. Anything suspicious must be reported immediately to the appropriate authority.

Strong Anti-Money Laundering (AML) regulations and compliance are critical in today’s modern landscape, where criminals are getting more sophisticated by the hour. Monitoring, assessing, and reporting vulnerabilities and suspected money laundering is crucial for financial institutions.  

What is Anti-Money Laundering?  

Anti-Money Laundering (AML) regulations comprise laws nullifying money laundering or any associated fraudulent activities. It saves banks and other financial institutions from terrorism financing, drug rackets, and other organized crimes. Comprehensive Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) regulations enable financial institutions to comply with legal requirements and report suspicious financial activities. Technology innovation in  Artificial Intelligence (AI) and Machine Learning (ML) prevents fraudulent activities without hindering customer experience. 

4 Pillars of AML  

For efficient anti-money laundering, businesses need to get the following pillars strong.  

Know Your Customer    

Know Your Customer (KYC) is a critical process for financial institutions. It is a legal requirement for AML laws as it establishes and verifies identity, assesses risk factors, and monitors suspicious activities.  KYC helps banks and financial institutions understand their customers and their financial dealings to serve them better and manage risks prudently. In India, RBI has enunciated KYC guidelines in the context of recommendations made by the Financial Action Task Force (FATF) on AML.  FIs need to get KYC information, not just at the time of opening a new account.  They obtain additional data from time to time in accordance with account conduct or at periodic refresh cycles based on risk categorization.

Customer Due Diligence    

Customer Due Diligence (CDD) is the control process where all the relevant information of the customers is collected and processed for any potential terrorist financing risks. CDD helps identify risks and provides a risk assessment to new customers (via online databases), politically exposed persons (PEPs), government records, watchlists, and sanctions screening.    

CDD is an essential step in KYC that requires ongoing monitoring of money laundering risks posed by each customer. This risk-based approach will conduct a more profound due diligence process for those with higher non-compliance risks by identifying customers added to sanctions and other AML lists. Customer due diligence detects money laundering techniques that include layering and structuring. Also known as smurfing, that is breaking up a huge sum of money into smaller transactions to evade reporting limits and avoid perusal. 

Customer and Transaction Screening    

Banks and other financial institutions are the leading players in the financial landscape with broad customer portfolios. They need to monitor and control the money transfers that take place. As transactions involve several other banks and entities, an average-sized bank mediates thousands of daily money transfers. So even a minor crime can bring significant consequences and lead to severe administrative collapses, hefty fines, and loss of credibility. Hence screening of all customer deposits and other transactions must be treated seriously.

Suspicious Activity Reporting    

Examining bank records for any unusual behavior or irregularity is a common procedure for law enforcement organizations investigating money laundering. To aid law enforcement in locating perpetrators in the current regulatory framework, thorough records are kept on every single financial transaction. Banks must have an unchangeable audit trail that regulators can rely on. However, it’s also crucial that compliance experts at financial institutions rapidly and effectively examine issues and close them.

How do you respond to money laundering suspicions?

Simple. Ask the client for more information. Then you can quickly determine if there is any chance of money laundering or not.  

And remember to tick off this checklist to avoid the risk of money laundering. 

Tick off the AML checklist 

 Ensure you run a deep check on your new clients. Revisit the purpose of the business partnership and try to understand why they chose your firm. Customer Due Diligence (CDD) helps in identifying the clients and helps assess/reduce the risk posed by them.  

 Keep track of the unusual transactions that take place at the client’s end.  

 Unusual sources of funds are another crucial warning that you must consider. Regulation 28 of the Money Laundering, Terrorist Financing and Transfer of Funds Regulations 2017 (MLR 2017) helps in analyzing transactions if they are processed with the knowledge of the clients. In some cases, asking for any documentary evidence like bank statements, recently filed business accounts, or any documents that confirm the source of funds will help identify any trace of money laundering.  

 Consider the purpose of funds coming from third parties. It may seem like a regular feature, but it may act as criminal property sometimes. So, it is better to run a check on the funds from third parties and their source.  

 If there is any change of instructions without prior warning from the client, ask for a reasonable explanation.  

 Money launderers are most likely to misuse trust, company formation, operation of a client account, and so on. To avoid these risks, you must comply with anti-money laundering guidance for the legal sector and apply for appropriate levels of CDD and enhanced due diligence before providing these services.  

 Pay attention to cash transactions, strictly follow your company’s cash policy, and don’t accept cash payments above the specified limit. There is always a high risk posed by cash.

Challenges in implementing AML   

AML compliance is indispensable. But effective implementation is the key challenge for banks and financial institutions.  Increased governance, lack of skilled resources, requisite tools, technology, and in-depth knowledge are a few bottlenecks that impact AML deployments.    

Let’s take a brief look at some of the challenges below.

Increased governance- These financial institutions and banks face difficulties managing cross-border and multi-jurisdictional AML compliance and customer due diligence requirements. The major challenge they face is identifying beneficial ownership and initiating remedial measures to address the prevailing AML gaps uncovered by regulatory reviews.    

Lack of skilled personnel- Fetching professional resources with in-depth knowledge of AML is a tough challenge. Other issues include high onboarding timelines and costs, and attrition. With evolving regulatory requirements, organizations must invest considerable time and effort in keeping pace right.    

Complicated processes and technology- AML compliance requires banks to put in place a multiplicity of processes and technology solutions that will consolidate KYC data and systems in a single repository. They also need to create infrastructure for cross-channel detection of suspicious activities, improve data quality, and standardize data to enable a centralized analysis of fraud and financial crimes. The risk level assigned during onboarding varies according to the transactions undertaken by the customer. Banks must assess the risks dynamically for each customer and change risk levels accordingly to prevent false positives. This necessitates continual transaction monitoring for each customer, which is a daunting task.

In conclusion 

If you are a business looking to combat money laundering, you must invest in a robust AML platform focusing on the four critical aspects. 

Research and Technology – With state-of-the-art technologies like artificial intelligence, you can detect false positives and conduct in-depth research to eliminate wrongdoings.  

Constant Communication – Regular communication should be between the parties involved, including law enforcement, government, regulatory bodies, etc. Communication will keep all parties informed, analyze suspicions, and identify possible networks to tackle money launderers.  

Leverage Data Analytics – Analytics arms you with data and insights to identify and detect patterns concerning money laundering.  

System Standardization – Proper standardization helps to communicate and process data that hinder fraud detection.  

Want to know more about AML deployment?  

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