Chapter1 – Introduction to Money

Laundering
Certificate in Anti Money Laundering

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Certificate in Anti Money Laundering TCS Business Domain Academy

Table of Contents
Chapter –1 Introduction to Money Laundering...................................................................... 5
1.1 Money Laundering ...............................................................................................6
1.1.1 Sources of Black Money as Classified under Money Laundering:........................6
1.1.2 Stages of Money Laundering: ............................................................................6
1.1.3 Illustrations of Money Laundering Activities: .....................................................8
1.2 Where does Money Laundering occur? ................................................................9
1.2.1 Impact of Money Laundering on Businesses: .....................................................9
1.2.2 Impact of Money Laundering on Economic Development: .............................9
1.2.3 Channels of Money Laundering:....................................................................... 10
1.2.4 Banks need to develop Risk based Anti-Money laundering policies/programs:
10
The entities or organizations that are treated as high risk customers are: ....................... 12
Summary:....................................................................................................................... 14

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List of Figures

Figure 1 Stages of Money Laundering ................................................................................... 7

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Chapter –1 Introduction to Money Laundering

Introduction
This Chapter deals with the basic concepts of Money Laundering.
Money Laundering is one of the biggest threats faced by banks and financial institutions.
Money Laundering is a process of converting illegal funds / property which is derived from
illegal activities into legitimate assets. This is widely used by criminals, tax evaders,
smugglers and it is also used for Terrorist Financing.

Learning Objective
At the end of this chapter, you would have learnt about-
• Concept of money laundering
• Stages of money laundering
• I Impact of money laundering
• Various channels of money laundering
• Concept of Risk Categorization by Banks

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1.1 Money Laundering

Money Laundering is the process of Converting illegal funds into legitimate funds. To put it
logically,
“Money laundering involves disguising financial assets so that they can be used without
detection of the illegal activity that produced them”
- Financial Intelligent Unit (FIU) – India

Through this Money Laundering process, the launderer tries to hide the origin and the
activity from which these funds are derived. The purpose/use of these funds is highly seen in
drug trafficking, bribery and corruption, terrorist financing, purchase of arms and
ammunitions and all those activities which pose a grave threat to financial institutions and
by large to a nation. Such launderers are classified into high risk customers who generally
target banks and financial institutions having poor prevention and detection methods to
pump the black money there.
Through FY 2011, 300+ cases investigated by the FBI resulted in 35+ indictments and 40+
convictions of money laundering fraud criminals. For FY 2012, the following money
laundering accomplishments were achieved for the WCCP: more than $15 million in
restitutions; more than $800,000 in recoveries; and more than $900, 000 in fines.

1.1.1 Sources of Black Money as Classified under Money Laundering:

Following are the activities classified under Money Laundering.

• Conversion of Black Money to White Money

• Initial Public Offering (IPO) Scam
• Bogus Expenditures
• Misleading transactions with related parties
• Bribery
• Over or Understating of expenditure

1.1.2 Stages of Money Laundering:

There are three stages involved in Money Laundering

Placement

Layering

Integration

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These three stages explain the process of converting “Dirty Money” into “Clean Money”.

Illicit Activity

Placement

Stages

Layering

Integration

Figure 1 Stages of Money Laundering

The above figure shows the three stages of money laundering process where black money is
converted into white money. Let us understand these three stages now.

1.1.2.1 Placement:
This is the first stage of money laundering process where illegal money is being introduced
into the financial system. The main objective of this stage is to bring black money into the
financial system so that it is less suspicious to law enforcement and at the same time more
convenient to criminals. There are various means and methods involved in this stage.
Money can be got into the financial system either through Money Transfers, Opening Bank
Deposits, through insurance companies etc.,

1.1.2.2 Layering:
This is the second stage of money laundering activity in which the funds introduced into the
financial system are used to make purchases of other assets or transfers of funds to other
accounts or locations to conceal the audit trial. By doing so, money launderers will
complicate the process of identifying the origin of illegal money. Layering is generally done
by means of investing, encashing cheques, purchase of goods and services etc.

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1.1.2.3 Integration:
Integration is the final stage of money laundering activity where the illegitimate funds are
re-introduced into the economy as legitimate funds. This can be done by means of
investing in a company or purchasing some assets etc.,

1.1.3 Illustrations of Money Laundering Activities:

We shall now look into some basic illustrations explaining how money laundering takes
place.

1.1.3.1 Illustration -1:

Let us suppose that a person has accumulated huge amount of black money and wants
them to be re-introduced in the economy as legitimate funds. Here is how this person does
money laundering.

Let us assume that he sells cocaine and accumulates illegitimate funds.

This person now goes to some Tax Haven Islands, for example: Cayman Islands and
buys a shell company (A shell company is one which has only front office
established but does not involve into any kind of business operations) which is
complete with board of directors.

An account is being opened in the name of a company.

This person deposits all his illegitimate funds into the account of company.

Now, this person comes back and ensures that certain amount is being transferred
from the shell company account to his personal account through wire transfer.

This person now projects this cash flow from shell company account to his personal
account as loan taken from a company and produces receipts of paying interest on a
timely basis.

This is how the flow of illegitimate funds is shown as amount of loan taken from the
company account and are finally projected as legitimate funds.

1.1.3.2 Illustration – 2:
• Money Launderers open a restaurant.
• Make Deposits which comprise a part of ongoing drug business/illegal business
along with proceeds from the restaurant every month into a legitimate bank
account. Money Launderers don’t add too much illegal money; just enough to
make it look as though the restaurant is doing a good, healthy business.

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• They pay all of their taxes on the restaurant deposits, so that the tax authorities
don’t start an investigation.

This is another (another) example showing how money launderers do money laundering by
utilizing the loopholes that are present in the existing financial system.

1.2 Where does Money Laundering occur?

Money Laundering can occur at any time in any part of the world. There are no limitations
on the geography where this could happen. Money launderers study the financial systems
and anti money laundering programs of various geographies on a regular basis to get a
good understanding on their financial systems and thereby exploiting their weakness in
doing money laundering.
Money laundering stages can be segregated as per the geographies. For example: it
generally happens that the money launderer brings illegal funds into the financial system of
a country in which they were originated i.e., Placement stage generally takes place in the
country where illegal funds are originated.
And when coming to Layering Stage, money launderer generally selects a geography which
is very convenient for financial and business purposes. The geography with weak financial
regulations and anti money laundering programs is generally targeted. In this stage, money
launderer also transfers money to various sub accounts of different geographies to hide the
origin of illegal funds.

1.2.1 Impact of Money Laundering on Businesses:

Reputation risk is faced by financial institutions because of money laundering activity. If
money is laundered through any financial institution either by bribing the officials or by
using the loop holes in the security system, this will ultimately result in the reputation loss
of that particular financial institution. Therefore banks and financial institutions have to be
very cautious while implementing the security procedures in their financial institutions.

1.2.2 Impact of Money Laundering on Economic Development:

Money launderers are adopting new ways and methods of routing the illegal money
through various developing geographies with improper security measures. Thus money
launderers try to exploit the difference between different nations’ anti money laundering
security measures and move their network to such economics where security measures are
very poor.

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On contrary, some argue that nation should not be too selective in allowing capital from
various other economies. But at the same time these nations should not also postpone the
implementation of effective security measures thereby preventing frauds and avoiding the
reputation risk.
When any financial institution gets a bad reputation because of weak security measures, the
nation in which this institution is operating also gets a bad reputation and this indirectly
affects the direct foreign investments. Therefore curbing money laundering is very
important to minimize the reputation risk of any nation and these effective mitigation
measures also leads to economic development.

1.2.3 Channels of Money Laundering:

There was a research conducted to understand the various channels of Money Laundering.
It was observed that Banks are most affected and contribute to around 55% of the total
money laundering activities that are taking place.
Next affected sector is Brokerage and Investment Firms and contribute to around 27% of
the total money laundering activities. Apart from Banks and Investment Firms there are
various other channels like Credit Cards, Insurance firms etc., for carrying out money
laundering.
As banks are most affected among various other channels, it is very important for banks to
implement anti money laundering policies.

1.2.4 Banks need to develop Risk based Anti-Money laundering policies/programs:

It is very important for banks to address the control needed based on the:
• Various products and services being offered by those banks,
• Risk categorization of its customers,
• Risk categorization of the geographies in which these banks operate.
Therefore it is necessary for any bank to understand the above mentioned parameters.

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1.2.4.1 High Risk Products and Services:

A. Electronic Banking:
It is a broad term used to describe the service delivery channel of any bank. This delivery
channel is used to communicate with the customer in terms of sharing information about
products and services using telephone lines, personal computers etc., and enable customer
to transact using ATMs or ebanking-. In general the internet banking services include,
viewing account summary (savings, credit card and loan), paying bills, online transfer of
money from one account to another etc., this channel is mostly used for money laundering
and terrorist financing because of:
• Inability to identify and authenticate parties.
• The rapid speed with which transactions are done.
• It enables user to transfer money across various geographies.
• Lack of proper auditing mechanism and transaction monitoring by technology
provider
• Non face to face customers
These are advantageous to money launderers in various ways and hence banks should
categorize this as a high risk services.

B. Wire Transfers and International Correspondent Banking:

Before going further, let us first understand what correspondent banking is:
If a bank does not have a presence in the market, but still wants to deal in that market, it
does by means of correspondent bank. In this case, bank and its correspondent bank
maintain an account with each other. For example: If a bank based in India wants to extend
its services in Zambia, it can do this by having a correspondent banking relationship with a
bank of Zambia.

Money launderers have chosen to indulge in wire transfers, particularly relating to the
corresponding bank accounts. Though this concept has been introduced with a positive
intention, still it poses a grave danger because of illegal activities that can take place
through this channel. Therefore, banks must be careful before entering into any relationship
with its correspondent bank. These banks should verify its correspondent bank’s existence,
its license, its nature of operations, the various policies/programs related to Anti-Money
Laundering, the nature of government in which its correspondent bank is operating etc., All

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these analysis, helps banks to make an effective business decision before entering into a
relationship with any other correspondent bank.

1.2.4.2 High Risk Customers:

If a bank wants to enter into a relationship with an individual then it should follow Know
Your Customer (KYC) norms, like verifying the customer identity, customer address and
his/her source of income. If a bank finds these details to be correct, then it can enter into a
relationship. For example, all salaried employees, Governments and Government aided
companies are treated as Low Risk Customers. In this case proper verification of address
and identity would suffice. But there are certain kinds of businesses which require
Customer Due Diligence (CDD) at the time of account opening. In such cases banks should
conduct risk assessment and should ensure that controls are in direct proportion with the
customer’s risk level. The following parameters should be considered before entering into a
relationship with a high risk customer:
 The Bank’s own Anti-Money Laundering Systems
 Potential for being abused by money launderers
 Their level of risk
 Bank’s ability to control the risk

The entities or organizations that are treated as high risk customers are:

1. Non-Government Organizations. For example, Non Profit Organizations, Trusts,

Charitable institutions etc.,
2. Shell Companies/Front Companies
3. Cash-intensive businesses like Parking Garages, Restaurants etc.,

1.2.4.3 High Risk Geographic Locations:

In order to complete the Anti-Money Laundering Program, it is very much essential for
banks to understand the high risk geographic locations. All banks should understand,
analyze and evaluate the risks that can arise by doing business in high risk geographic
locations by opening accounts of various customers or facilitating the transactions. The
information regarding various high risk geographic locations can be obtained from the
below sources:

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High risk locations are generally classified under “Non-cooperative Countries and
Territories (NCCT)” which is generally published by Financial Action Task Force
(FATF)

Various geographies identified by Office of Foreign Assets Control (OFAC)

Various geographies and jurisdictions as identified by Bank Management

Thus, it is very important for banks to identify high risk geographic locations. Such
identification helps banks to come up with new regulations or policies curbing money
laundering and terrorist financing.

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Summary:
• Placement is the first stage of money laundering process where illegal money is
being introduced into the financial system.
• The main objective of placement stage is to introduce black money into the
financial system so that it is less suspicious to law enforcement and at the same
time more convenient to criminals.
• Layering is the second stage of money laundering activity in which the funds
introduced into the financial system are used to make purchases or transfers to
complicate the trial.
• Integration is the final stage of money laundering activity where the illegitimate
funds are re-introduced into the economy as legitimate funds.
• Money launderers study the financial systems and anti money laundering programs
of various geographies on a regular basis to get a good understanding on their
financial systems and thereby exploiting their weakness in doing money laundering.
• It is mainly the reputation risk that is being faced by many financial institutions
because of money laundering activity.
• Money launderers are continuously looking out for new ways and methods of
routing the illegal money through the economies with growing or developing
financial centers, but inadequate security measures.
• Money launderers try to exploit the difference between different nations’ anti
money laundering security measures and move their network to such economics
where security measures are very poor.
• It is very important for banks to address the control needed - based on the various
products and services being offered by those banks, based on the risk
categorization of its customers, and finally based on the risk categorization of the
geographies in which these banks operate.
• High risk locations are generally classified under “Non-cooperative Countries and
Territories (NCCT)” which is generally published by Financial Action Task Force
(FATF).

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