Money Laundering   S. Ganesh General Manager and Member of Faculty Bankers Training College, Reserve Bank of India

 

Overview of Money Laundering

The tragic events that occurred in the United States on 11 September 2001 and other terrorist attacks that are being perpetrated with alarming regularity across the world, are a grim reminder of the power of organised crime. In the wake of the terrorist attacks, a number of governments have called for a rapid and co-ordinated effort to detect and prevent the misuse of the world financial system by terrorists.

Money Laundering refers to the conversion or "Laundering" of money which is illegally obtained, so as to make it appear to originate from a legitimate source. Money Laundering is being employed by launderers worldwide to conceal criminal activity associated with it such as drug / arms trafficking, terrorism and extortion. As per an estimate of the International Monetary Fund, the aggregate size of money laundering in the world could be somewhere between two and five percent of the world?s gross domestic product.

There are three independent steps or stages in Money Laundering as shown below:

1.    Placement: "Placement" refers to the physical disposal of bulk cash proceeds derived from illegal activity.

2.    Layering: "Layering" refers to the separation of illicit proceeds from their source by creating complex layers of financial transactions. Layering conceals the audit trail and provides anonymity.

3.    Integration: "Integration" refers to the reinjection of the laundered proceeds back into the economy in such a way that they re-enter the financial system as normal business funds.

Banks and financial institutions are vulnerable from the Money Laundering point of view since criminal proceeds can enter banks in the form of large cash deposits. Bank officials therefore need to exercise constant vigilance in opening of accounts with large cash deposits and in checking suspicious transactions.

Objectives of Money Laundering and Rules for Bankers

The major objectives of Money Laundering activities are:

·         Concealing the true ownership of illegally-obtained money and

• Placement, layering and integration of such funds

Two cardinal rules that are to be invariably observed by bank officials for steering clear of the Money Laundering Trap, are:

1.    Know your customer (KYC) and,

2.    Know your employee

Money Laundering can be traced back to the Hawala Mechanism, which facilitated the conversion of money from black into white. "Hawala" is an Arabic word meaning the transfer of money or information between two persons using a third person. The system dates to the Arabic traders as a means of avoiding robbery. It predates western banking by several centuries.

The Hawala Mechanism left virtually no paper trail, which would attract investigations. The profits generated from Hawala were surreptitiously invested in real estate, gilt edged securities etc., to launder them.

Crime & Money Laundering

Across the world, banks have become a major target of Money Laundering operations and financial crime because they provide a variety of services and instruments that can be used to conceal the source of money. Money Laundering has a close nexus with organised crime. Money Launderers amass enormous profits through drug trafficking, international frauds, arms dealing etc.

Cash transactions are predominantly used for Money Laundering as they facilitate the concealment of the true ownership and origin of money. Criminal activities such as drug trafficking acquire an air of anonymity through cash transactions.  With their polished, articulate and disarming behaviour, Money Launderers attempt to make bankers lower their guard so as to achieve their objective.

Implications of Money Laundering for banks

What are the implications of Money Laundering for banks? Launderers employ currency deposits, fake businesses and cash being generated through legitimate businesses. Across the world, banks and financial institutions are liable for prosecution if their employees become involved in Money Laundering activities. At the same time, norms for record keeping, reporting, account opening and transaction monitoring are being introduced by central banks across the globe for checking the incidence of Money Laundering. Employees of banks are also being trained to recognise suspicious transactions. The dilemma of the banker in the context of Money Laundering is to sift the transactions representing legitimate business and banking activity from the irregular / suspicious transactions.

The Basle Statement of Principles

The Committee on Banking Regulations and Supervisory Practices of the G 10 at a meeting in Basle in Switzerland, in December 1988, evolved a set of principles to address the dangers posed by Money Launderers. The committee was formed by the Central Bank Governors of Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland and United States. These principles, which are now known as the Basle Principles, deal with the prevention of criminal use of the banking system for the purpose of Money Laundering. Recommendations for banks and other financial institutions have been set out in the Basle Principles so that these institutions can protect themselves against Money Laundering. The Basle Statement of Principles covers all aspects of laundering through the banking system.

The Basle Principles suggest policies and procedures in four areas to curb Money Laundering as shown below:

1.    Customer Identification

2.    Compliance with Laws

3.    Cooperation with Law Enforcement agencies, and,

4.    Adherence to the Statement.

These are dealt with in some detail below:

·         Customer Identification

This reemphasises the adage "Know your Customer" (KYC). KYC requires that banks should make reasonable efforts to determine the customer?s true identity, and must introduce effective procedures for verifying the bonafides of new customers.

·         Compliance with Laws

The laws and regulations pertaining to financial transactions as enacted in different

Banking?related statutes, must be observed. Banks should not offer services or provide active assistance in case of transactions where they have good reason to suppose that these are associated with Money Laundering activities.

·         Co-operation with Law Enforcement Authorities

Banks should co-operate fully with national law enforcement authorities to the extent permitted by specific local regulations concerning customer confidentiality.

·         Adherence to the Statement

Adhering to the Statement implies that banks need to adopt policies that are consistent with the Statement and ensure that all staff members are informed of the bank?s policy in this regard. Some key factors in promoting adherence to the Statement of Principles are staff training and implementing specific procedures for customer identification and retaining internal records of transactions.

The Basle Principles set out an effective guideline for what banks and financial institutions should do to cope with Money Laundering.

The Financial Action Task Force (FATF)

In response to mounting concern over money laundering, the Financial Action Task Force on Money Laundering (FATF) was established by the G-7 Summit that was held in Paris in 1989. This intergovernmental body facilitates the development and promotion of policies, both at national and international levels, to combat Money Laundering. While reviewing Money Laundering techniques and counter-measures, the FATF monitors members' progress in implementing anti-money laundering measures. The FATF also collaborates with other international bodies involved in combating money laundering. Forty Recommendations, which provide a comprehensive blueprint of the action needed to combat money laundering, have been set forth by the FATF. These forty recommendations are being implemented by many banks across the world.

Money Laundering: The Indian Scenario

With increasing sophistication in the use of technology for transfer of funds and given the fact that there has been considerable liberalization and progressive dismantling of controls in the regulatory framework in India, banks in India need to be in a state of high alert so that they can steer clear of Money Laundering. It is important to remember that banks and financial institutions are both transmitters of money and regulators of the flow of money.

In India, we already have certain prudent banking practices which check the proliferation of Money Laundering activities in the country. Some of these practices are outlined below:

·         Identification of prospective clients is carried out prior to the opening of a bank account by obtaining proper introduction. This procedure partly addresses the requirement of KYC.

• Criminal investigation is allowed in banking transactions in India. For example, the Income Tax Department can call for information relating to customers? accounts and transactions. Erring accounts can be frozen. This addresses the Basle Principle on ?Compliance with legislation and law enforcement agencies?.
• Certain statues such as "The Bankers? Books Evidence Act, 1891" and the "Banking Companies (Preservation of Records) Rules, 1985" require the making available / retention of records to investigating agencies, which addresses the Basle Principle on ?Record Keeping and Systems?.

Existing Legal Framework to Curb Money Laundering in India

In India, while the Prevention of Money Laundering Bill is yet to be enacted as a law , we have certain statutes, as outlined below, that incorporate certain measures which attempt to address the problem:

·         The Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974

·         The Income Tax Act, 1961

·         The Benami Transactions (Prohibition) Act, 1988

·         The Indian Penal Code and Code of Criminal Procedure, 1973

·         The Narcotic Drugs and Psychotropic Substances Act, 1985

·         The Prevention of Illicit Traffic in Narcotic Drugs and Psychotropic Substances Act, 1988

·         The Prevention of Terrorism Act (POTA), 2002, seeks to deal with types of heinous crimes like subversion, insurgency and terrorism in place of the existing criminal justice system, which is not designed to deal with such horrific crimes. The Act replaces the Ordinance that was first promulgated on October 24, 2001 and re-promulgated thereafter in December 2001. The Act also meets the requirement of the United Nations resolution calling upon member nations to enact a model deterrent law to curb the growing menace of internal and global terrorism.

Irregular / Suspicious Transactions related to Money Laundering

The list below provides examples of some of the basic ways in which money can be laundered. Banks need to be wary of such transactions.

·         Customers depositing cash through a large number of cash deposit slips into the same account or customers having numerous accounts into which large cash deposits are made. Each deposit is such that the amount thereof is not significant but the aggregate of all credits is sizeable. This is known as "smurfing".

• A substantial increase in turnover in a dormant account.
• Receipt or payment of large sums of cash, which have no obvious purpose or relationship to the account holder and / or his business
• Reluctance to provide normal information when opening an account or providing minimal or fictitious information
• Depositing high value third party cheques endorsed in favour of the customer or other transactions on behalf of non-account holders
• Large cash withdrawals from a previously dormant or inactive account, or from an account which has received an unexpected large credit from abroad
• Sudden increase in cash deposits of an individual with no justification
• Employees leading lavish lifestyles that do not match their known sources of income

Although the above list is only indicative of the possible occurrence of Money Laundering, the need for prompt recognition of suspicious / irregular transactions is emphasised.

To sum up:

Money Laundering is a serious, highly sophisticated and global criminal activity. The degree of organisation displayed in Money Laundering is a major cause for concern of banks and bank supervisors. Banks and other financial institutions can protect themselves against Money Laundering by implementing an effective KYC Policy, knowing their customers, checking the source of funds, monitoring the conduct of accounts, and by learning to recognise suspicious/ irregular transactions.

Acknowledgements , Sources and References:

1.      My article on "Money Laundering" published in the IBA Bulletin

2.      The Web pages of the Financial Action Task Force

3.      The Web pages of the BIS

4.    The Web Pages of the Government of India

The views expressed in this article are those of the author and not of the institution to which he belongs