What Is Money Laundering and How Does It Work?

The money laundered annually accounts for 2% – 5% of the global GDP, meaning that 1-2 trillion USD is laundered on a yearly basis (according to the Global Economic Crime and Fraud Survey 2018 – PwC).

Introduction to Money Laundering

Money Laundering is hiding the source of illegally obtained money. This happens when someone receives a certain amount of money in order to do something illegal, such as drug trafficking, payment for murder, terrorist attacks, etc. Such money is dirty money and the source of it (the business transaction) is not legal. If such money would be placed on a bank account, a bank would ask a person to provide the proof of money source, and the source must be from a legitimate business. In case a person cannot prove the source or there are indices that the money comes from illegal activity, the bank is obliged to report such suspicion. If the source is not proved or legitimate there is a risk:
– for the money to be seized by the authorities and
– for the person to be criminally charged.

Money laundering is also an illegal activity. Banks are required to report all suspicious transactions and other signs of money laundering.

In order to avoid the above-mentioned risks, criminals must make dirty money appear as legally obtained money. What criminals do then is that they use one, but usually more foreign, offshore banks and companies, divide the money and spread it over different companies, people and bank accounts so it comes out “washed” and looking clean. 

Phases Of Money Laundering Process

Dirty money normally goes through several steps and phases before it is washed and comes out “clean”. There are three core phases through which criminals put money to wash it, however, these stages are not necessarily consecutive stages but usually overlap.

1. The Placement 

In this phase, money is being put into the legitimate financial system. Criminals usually want to lose cash since keeping physical possession of cash directly links them to criminal activity and makes them exposed and vulnerable. Instead, they place money into the financial system, usually using a company, a retail business, bank accounts, conversion into travel cheques, cryptocurrencies, smuggled out of the country, etc. The purpose of this phase is to move the money from the place of acquisition in order to avoid being detected and transform it into another asset. Money laundering is a cash-intensive business, due to the fact that physical cash and illegal cash transactions are not traceable.

The most susceptible businesses to money laundering are banks, restaurants, hotels, bars, car dealers, accountants, lawyers, casinos, art, and antique dealers, parking lots, retailers, dealers with commodities and luxury goods, vending machine operators, etc.

For example, a criminal organization can use a restaurant or car dealing business (who take cash) and let the dirty money go through this business by inflating the daily cash receipts of the restaurant. The restaurant funnels the money through its bank account and such money is then used as clean money.

2. The Layering

Even if the cash is successfully placed into a financial system, the money can still be traced back to the origin (the person who placed it into the system). This means that the money cannot simply be put in the system and sit there. The money has to be moved around in order to confuse and hide the origin.

This phase has a purpose to hide (conceal) the source of the money using a series of transactions, different companies and persons, bookkeeping gimmicks and other tricks.

This is a process of dividing the illegal cash and channel them through multiple bank accounts, companies, transactions, intermediaries, converting them back and forth, make several wire transfers, orders, letters of credit, cryptocurrencies, stocks, purchasing valuable assets (art, jewelry), gold, etc. Layering includes a very complex system of different transactions. These techniques are designed to hide the trail, blur the source and provide a level of anonymity.

3. The Integration

This is the final phase, laundered money appears to be legitimate, mix it with the legitimate and use it as clean money.

The criminals use several techniques for integrating the money back and so they create an apparent legal origin, such as fictitious loans, dividends, contracts, capital gains, etc. By this stage, it is rather hard to distinguish which money was to be obtained legally and which one illegally.

Electronic Money & Cryptocurrencies

 The rise of electronic money, internet, online banking, peer-to-peer services, online customer identification, etc. has made the detection of suspicious transactions and illegal money even more difficult.

Anonymous currencies make the money lose the trace in the second phase (Layering), but the use of proxy servers and anonymizing software make the third phase (integration) rather impossible to detect – money can be withdrawn or transferred without leaving any trace of an IP address.

The most susceptible online businesses to money laundering are online auctions and sales, crypto exchanges and trading platforms, gambling websites, virtual gaming sites, etc.

International Anti-Money Laundering Combat

Governments combat money laundering with regulations that require financial institutions to put systems in place to monitor, detect and report suspicious activities and to punish those who do not follow the rules. Governments are also working closely together by forming common grounds and international rules for combating money laundering. There most notable are Group of Seven (G-7), Financial Action Task Force (FATF), besides all the national task forces and anti-money laundering authorities.

We have been writing about financial crimes and how the EU is fighting against them with new regulations. If you want to learn more, click here. 

If you need an Anti-money laundering lawyer, we are here to help.