Global Money Laundering

GLOBAL MONEY LAUNDERING − THE SILENT FLOW OF MONEY Sukumar Nandi is invested activities. Money laundering is now a widely circulated phrase and many governments are worried about this phenomenon. Money laundering (ML) refers to all activities and systems intended to camouflage the identity of money earned from activities that are strictly not legal, by the legal system of the country and this is done to create the impression that the money in circulation has a legitimate source. ML is the transactional processing of illicitly obtained funds towards disguising its source, nature, ownership or intended destination. The desired outcome of this process is ‘clean’ money (or money is laundered) and it can be legally accessed through legitimate financial institutions. The Origin The process of ML is driven by a criminal imperative, aimed at generating profits in an illegal fashion. Such funds generated through organized crime or frauds remain ‘outside’ the formal and legitimate financial system. The LM process aims to camouflage such funds by passing them through multiple accounts and shell companies1 towards either totally obscuring the original source, or towards associating the funds with a source that seems to be legal. Once the process is complete, such money 1

A shell company is often a company created as a front company to do business when required. Generally this type of companies do no business and remain on paper, but they are used to cover many business operations.

formally

in

legitimate

The opportunities for generating profits through illegitimate means come for the following factors: (i) Existence of a large unorganized or informal economy, (ii) The porous and illdefined legal system, and poor record of its implementations, (iii) Existence of systemic corruption, and (iv) Lack of proper governance The size of unorganized sector in many developing countries is very large. In India, the importance of unorganized sector in the gross domestic product is above 40 per cent2 and the situation is along similar lines in many countries. Since documentation is absent, tax authorities are denied tax revenue and illicit transactions are difficult to identify. The transactions in this sector are hardly recorded, and this facilitates the use of so-called black money in regular business. The legal systems in many developing countries are not sufficiently full-proof 2

Poonam Gupta and Sanjeev Gupta, Estimates of the Unreported Economy in India, Economic and Political weekly, 17 ( 3), January 1982. This study puts the figure slightly below 50 per cent in 1980 itself. 1

and as a result, many suspect money transactions remain beyond the arms of law. This aspect of inefficient legal system is associated with systemic corruption in many developing countries. This sort of legal vacuum creates a space for the growth of a culture in which money power draws certain respect in the society and that makes people believe in a type of system, where people think in terms of the following dictum: “We live by the golden rules. People who have the gold make the rules”3. Effective governance is a luxury many less developed countries cannot afford and the result is that rule of law does not reach in all regions of countries like Afghanistan, Mongolia, many countries in Africa and also in some regions of Eastern Europe. As a result, private money power is more powerful than state power in those regions. Taking advantage of the vacuum of effective governance interested parties can pursue semi-political ambitions in the guise of some popular issues and that is facilitated by money power. For this reason, it is said sometimes: “The invisible money power is working to enslave mankind. It financed Communism, Fascism, Marxism, Zionism and Socialism”4 Stages of Money Laundering There are three primary stages in the money laundering cycles: (i) The placement stage (ii) The layering stage (iii) The integration stage First, during the placement stage, the hard money generated by the illicit activities (like drug smuggling, sale of illegal arms and other type of cross3 4

A quote by Buzzi Bavasi Quoted in American Mercury Magazine

border trade that has no legal sanction) needs to be placed safely and it is generally deposited in an institution of business, or invested in expensive assets. The whole operation becomes an informal affair and thus, remains beyond the scanning of law enforcing institutions. Second, in the layering stage, the agents try to separate illegally generated funds from the original source and this is done by creating layer upon layer of transactions. The latter take the form of movements of money between different accounts, and/or between businesses through buying and selling of assets on a global basis. This goes on until the original source of funds virtually becomes untraceable. Third, upon completion of the layering process the illegal funds are introduced in the financial system in legal way as payments of services and/or against transaction of commodities. At this stage money becomes legal and laundering is complete. The three processes described above can be explained through an example so that modus operandi of the whole mechanism becomes clear. In the golden crescent5 bordering Pakistan, Afghanistan and Iran, illicit opium cultivation is an open secret. The result is illegal drug dealing. The money generated through sale of drugs is invested in a posh hotel, frequented by travellers from all over the world. Now the proceeds from the drug deals are used for payments related to this legal business, along with other regular trading incomes. The launderer now 5

This mountainous region bordering three countries, Pakistan, Afghanistan and Iran is a huge space that is famous for illegal opium cultivation and known as golden crescent in Asia. 2

opens up other supply companies to serve the business of the hotel. These companies now issue invoices that the hotel settles through cheque payments. The increased amount of such transactions and movement of money along with this make a smokescreen, so that the criminal origin of money is effectively obscured. The whole process continues for the enrichment of the persons involved. The Global Infrastructure: Offshore Centres

foreign capital and that is invested for local development. In lieu of that OFC provides certain services like; (i) (ii) (iii) (iv)

the

The large number of so-called taxhaven offshore centres gives enough facility to keep money in numbered accounts, while keeping the true ownership of money anonymous to the outside world. The existence of offshore finance centres (OFC) is a weak spot in the global financial system, as the regulation of the financial transactions in OFC is seldom effective because of its nature of operations. There are more than one hundred offshore finance centres spread all over the world. Prominent among these are located in Hong Kong, Thailand, Tahiti, Macao, Philippines, Singapore in Asia and Pacific, Andorra, Cyprus, Dublin, Liechtenstein, London, Switzerland in Europe, Bahrain, Israel, Lebanon in Middle East, Bahamas, Belize, Cayman Islands, St. Lucia, United States in Western Hemisphere. International banks in OFCs accept deposits in multiple currencies and conduct banking operations on behalf of clients and they maintain secrecy. In fact, it is the secrecy and confidentiality that is their main product and these banks charge their clients for that. Many small countries encourage the growth of offshore financial services, as these attract large volume of

(v)

(vi)

maintenance of secrecy and confidentiality, no exchange control, absence of any tax burden, the facility of disguising the ownership of corporate vehicles through the use of nominee directors, no reporting requirements for companies like annual reports, no system of supervision of companies such as annual general meetings.

In essence, it is the absence of state (in the form of rules and regulations) that is the main attractions of money flowing to the offshore centres. The above features are ideal for disguising the true origin of money and also true ownership. As a result, OFC has become favourite medium for money laundering. The geography is not important, as same international bank in New York can maintain offshore operations in a separate table, along with normal banking in the branch. Offshore banking services include the borrowing of money from nonresidents and lending to nonresidents. This may assume the form of lending money to corporates, funded by liabilities to the offices of lending banks elsewhere. Some of these transactions are captured in the statistics published by Bank for International Settlements (BIS). But significant volumes of funds are managed by such institutions at the risk of investors, and such off-balance sheet activity is not reported. The OFC in tax-haven zones are often the conduit of capital flight and money laundering. 3

Anti Money Laundering Measures In 1998, Mr. Stanley Morris, Chairman of the Financial Action Task Force (FATF) of the Organization for Economic Cooperation and Development (OECD) stated that “ the need to estimate the size of money laundering and quantify its constituent parts has been a concern of the FATF6 since its initial report”. The report identified the following areas of legitimate demand for quantitative measures of money laundering: the magnitude of the crime so that different agents of legal system can reach agreement on the place of anti money laundering programmes within national and international enforcement systems. (b) Understanding the effectiveness of countermoney laundering efforts with a given baseline and scale of measurement. (c) Understanding the macroeconomic effects of money laundering, as it has adverse effects on the overall economy and financial institutions. ML has undesirable influence on demand for money, exchange rate movement, interest rate and effectiveness of fiscal policies.

observed that “There is not, at present, any economic dues ex machina that will allow the accurate measurement of money laundering world-wide, or even within most large nations. The basis for such estimations simply does not exist”. The Financial Action Task Force ( FATF) is active in its pursuit of anti money laundering measures and it is reflected in its Annual Report of 2008 in which the ministers under FATF have given the mandate to the organization to have four clear objectives, which are:

(a) Understanding

(a) To establish and maintain

global standard and measures for countering money laundering, along with its assessment of implementation (b) To identify money laundering methods , and (c) To expand cooperation with stakeholders and partners in order to make the system work effectively and globally. Prevention of Money Laundering Act, 2002

Considering the above aspects of money laundering, Mr. Stanley Morris

Taking a cue from the activities of FATF, Government of India enacted the Prevention of Money Laundering Act, 2002 that came into effect from July 1, 2005. As per different provisions of the Act, every banking company, financial institutions like cooperative banks, housing finance institutions and mutual funds and other intermediaries7 shall have to maintain a record of all transactions. The nature and value of the

6

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The FATF comprises 34 members: 32 member jurisdictions and two regional organizations ( EU and Gulf Cooperation Council) representing most major financial centers of the world. Again, republic of Korea and India became observers in 2006 and are working to become members.

These include stock brokers, share transfer agents, trustee to a deed, merchant bankers, portfolio managers, and any other intermediaries associated with the securities markets and registered under section 12 of the Securities and Exchange Board of India Act, 1992. 4

transactions have been prescribed in the Act. Such transactions include: (i)

(ii)

(iii)

(iv)

All cash transactions of the value of more than Rs. 10 lakhs in foreign currency All series of cash transactions integrally connected to each other, which have been valued below Rs. 10 lakhs in foreign currency, where such series of transactions take place within one month All cash transactions where forged or counterfeit currency notes have been used as genuine, or where any forgery of a valuable security or a document has taken place, facilitating the transactions All suspicious transactions, whether or not made in cash and including, inter-alia, credits or debits into from any non-monetary account such as demat account, security account maintained by the registered intermediary.

it shows the enormous power of the money launderers. The top ten origins of laundered money in the world are (percentage of the total basis per annum): United States ( 46.3%), Italy (5.3%), Russia ( 5.2%), China ( 4.6%), Germany ( 4.5%), France ( 4.4%), Romania ( 4.1%), Canada ( 2.9%), U.K. ( 2.4%), and Hong Kong ( 2.2%). One estimate puts the USA figure of laundered money per year as USD 1320 billion. This is a huge sum, and it shows the money power of the launderers. Money has no colour as the proverb goes, and it is a fungible asset. This quality is its beauty and present day money transfer technology (SWIFT System) makes transfer of money across the globe very easy. But there is a one-to-one relation between the degree of effective control on the money laundering process and socioeconomic welfare of the country.

In spite of the rigorous implementation of the Act, it is difficult to stop the flow of laundered money because of global connections and India is basically an open economy. Global Position Laundering

of

Money

The power of the money launderers of the world is very high. The annual flow of money through laundering process in the world is as high as 5 per cent of world GDP per year, and this is obviously a scientific guess work. But 5