Banking Technology in the Fight against Money Laundering in UK Private Banking - Essay Example

? Chapter Introduction Banking has gone a long way since this was practised in Italy during the Renaissance Period. In other parts of the world, the ancient Persians and Arab traders had used a primitive form banking facilities to ply their commerce. China even had some form of checking facilities where the traders from faraway areas could encash a check for their use while in foreign lands. Globalisation in trade and commerce has made banking a crucial part of a modern economy. The fast growth in world commerce and finance has also brought with it new challenges not seen before. Along the heels of globalisation is the growth of crime syndicates and certain individuals who find it convenient to use modern banking facilities to move large sums of money around. This attempt to hide the monies is known as money laundering and it is the purpose of this research paper to explore how the use of modern banking technology can help in the fight against this pervasive crime. The amount of money being laundered in an estimate given by Asian Development Bank (ADB) is about $2.17 to $3.61 trillion annually or around 3%-5% of the total world gross domestic product. This represents a huge security risk to international finance and presents social, economic and political concerns due to narco-politics. 1.1. Early use of Technology in Banking The early uses of technology in the banking industry were for efficiency and accuracy. At that time, security was not yet a major concern. Use of electronic banking has also gone a long way from initial use of computers to keep customers' records, compute for interest and other transactions. Information and communications technology (ICT) resulted in great strides in efficiency in the financial and banking services sectors but this also spawned cyber-crimes (Shroff, 2007) related to money and banking such as identity thefts, illegal transfers of money or fictitious accounts. The use of computer technology was meant to be a tool for competitive advantage such as improving customer service. The adoption of computer technology in the industry was related to needs of information technology such as creating a niche strategy for bank branches (Violano & Collie, 1992). 1.2. Objectives The primary research question of this paper is to investigate the effectiveness of using banking technology in fighting money laundering in private banking in the United Kingdom. In particular, this research objective is of great importance considering that London is one of the biggest financial centres in the world in terms of banking, investments and fund flows. A lot of the world’s funds pass through the London banking system and the criminals use this opportunity to mingle their funds with legitimate funds of local and foreign investors. Additionally, subsidiary research questions are posed in relation to the main question: 1. What are the steps involved in the money laundering process and what methods are used to launder money (the various ways to cover the tracks of its origin)? It is important to know what steps are involved in money laundering so it is easier to catch the criminals. The point is to disrupt the money flow and catch the criminals as early as possible and it takes knowledge of the money laundering process to do it effectively. 2. What existing banking technologies are used in the fight against money laundering? Existing banking technologies using modern computers are found to be inadequate in detecting money laundering. The urgent need is to use a far more sophisticated technology that is effective in detecting certain patterns from among thousands of seemingly-unrelated transactions. 3. What are the areas that are susceptible to money laundering in UK private banking? There are several areas in which money laundering can be done through the facilities and services of private banking. It can include practically the whole host of investment areas where large sums of money can be profitably invested and more importantly, in the areas where it does not attract unwanted attention from authorities. It is necessary to look at these areas in order to combat it. 4. How effective (success/failure) is the existing anti-money laundering methods? Most reports for anti-money laundering purposes have a high degree of human intervention in them in which humans are susceptible to bribery. The knowledge gained is important to lobby for more strict anti-money laundering methods as this crime undermines the whole society. 5. What are the reasons for success/failure of anti-money laundering methods in the UK? The factors that caused most efforts of controlling money laundering in the UK to fail should be addressed by the political, monetary and banking authorities in the joint effort to combat money laundering. 1.3. Methodology This paper utilized a variety of secondary sources as reference materials to the topic of money laundering. This includes published books, peer-reviewed academic journals as well as newspaper and magazine articles. Additional resources included on-line sources and whenever possible, their URL links are included in the references section to make them accessible. A good number of sources for facts and figures are fairly current in nature. This gives the reader a sense of immediacy. The type of data is mostly secondary but these came from reliable sources. The principal objective of this paper is to investigate how banking technology is utilized to fight money laundering; more recent secondary sources were used to deduce if these anti-money laundering efforts were successful or not, based on those viewpoints and reading a good number of various sources gives a good idea on these efforts. For the first subsidiary research question (steps in money laundering), a good number of on-line sources are available for this purpose since this illegal activity is a relatively simple process. What is complex is the number of variations to the same three-step process of laundering. The second subsidiary question deals with what present banking technology is used to detect this crime. Various secondary sources painted a picture of automation using computers to detect any of the suspicious signs or red flags in money laundering but newspaper articles indicate it is still basically a human process. By this, it means a not fully-automated process of detection makes the whole system of anti-money laundering susceptible to human errors and greed. The third subsidiary question deals with the role of private banking (wealth management) and the growing perception that anti-money laundering efforts have failed in the United Kingdom. More current sources such as newspaper (like former PM Brown’s admission on the failure of the Financial Services Authority due to intense lobbying by the banks, the Sunday Times article which foresaw the failure as early 2003, another article in the same newspaper two years later said about much the same thing while a much recent article in The Guardian showed the magnitude of this problem involving just one big US bank. Another article in the Financial Times has a very recent article dealing with the billions of the family of Col. Qaddafi of Libya) articles point to a competitive setting in which British banks compete for large deposits and have lobbied for looser supervision in order to attract investment and private capital away from other money centres of the world. The fourth subsidiary question concerns with an evaluation of the effectiveness of the existing methods used to fight this so-called “victim-less crime” and by its very nature, a more current type of source is being utilized to make the evaluative process much more relevant. Sources include not only recent newspaper articles but also Internet resources for their currency. The fifth and last subsidiary question uses methodology to analyse the probable causes of the failure of the anti-money laundering efforts in the United Kingdom today. The sources which were utilised pointed to not only a failure of using the right banking technologies but also to the existence of other factors which make the detection of laundered money very difficult. It includes human frailty (failing to make the appropriate reports), an alternative or shadow bank system that makes remittances very easy with little or no documentation required and also the use of new technologies in doing bank transactions such as e-commerce and the Internet. The newspaper article in The Guardian indicated why present anti-money laundering efforts failed. It is a human failure; the bank’s officers ignored several warnings given by their main anti-money laundering officer with several memos sent to their head office. It also illustrated the competitive nature in banking for client funds. 1.4. Summary This paper had reviewed the present system of anti-money laundering in the UK and found out the efforts had largely failed due to a combination of several factors. CHAPTER 2 – LITERATURE REVIEW The formal banking sector plays a crucial role in the fight against the money laundering efforts of criminal syndicates and unscrupulous individuals. It is because the banking system gives their illegal or dirty money a much-needed legitimacy. Once money laundering is successful in the first stage of the three- step process, the money goes on its way to becoming clean and ready for use by the syndicates that will perpetuate their criminal activities. Although monetary authorities are fully aware of the magnitude and dangers of unchecked money laundering, the present banking technologies as used by global authorities are clearly insufficient. There is a paucity of good data as to why newer and more effective computerized banking technologies were not utilized in the first place when these technologies are readily available. It is just a matter of re-programming their IT structures and software to make these anti-money laundering efforts more effective. The present methods allow too many loopholes for bank officers to be complicit. This is a good reason why anti-money laundering should have a minimum of human interventions in place and adopt newer technologies in the detection and reporting of possible money laundering. The authorities are looking into alternative banking and remittance systems a bit more closely through the Serious Organized Crime Agency (SOCA) as good avenues for money laundering (Burns & Peel, 2006). Ironically, Col. Qaddafi and his family have billions stashed away in UK banks. The question is how were they able to move such huge sums without triggering the anti-money laundering laws of the country? Private banking involves investing for select individuals sizable assets in businesses where large sums of money are normal. Examples are insurance, stock investments and building societies (Bicker, 1996). A new troubling area in money laundering in the UK is the use of private trusts (OECD, 2006). Private banking plays a big role in the setting up of various trusts (Kalin and Goldsmith, 2007) for property ownership and wealth management but pose big risks. The present anti-money laundering technologies produce mostly a bunch of data that relies to a great extent on human interventions. Again, these reports are reliable only to the extent on how reliable are the people who reviewed these reports. In other words, the degree of human intervention in reporting makes these efforts to control dirty money mostly wasted efforts because the humans involved (bank officers) compete in an environment that is not very conducive to compliance with anti-money laundering regulations. When the dirty money amounts to substantial sums and banks need liquidity, the incentive to comply with laws and regulations is much lessened. The more crucial priority is the survival of the banking institution itself and so the “dirty money” continues to flow and bank officers turn a blind eye. There is a need to inject a sense of urgency to anti-money laundering efforts because the survival of society itself is at stake. It has social, political, legal and economic implications which are mostly adverse to the well-being of the people. If these efforts fail, it can mean only that crime really pays. It will encourage other people to commit the same crimes and get rich themselves. Money laundering threatens and undermines the thread that keeps a society functioning because of its corrosive effects on the moral values of people. A review of existing literature on money laundering will indicate that people are aware of the seriousness, magnitude and urgency of the problem (ADB, 2003) but there is a lack of materials on why money laundering continues to proliferate. Literature materials on this topic have not discussed or investigated why present anti-money laundering efforts have largely failed to stop the flow of illegal funds around the world (Kalin and Goldsworth, 2007). In fact, money laundering seems to be getting worse over the years, with new technologies being used to launder larger and larger amounts of dirty money. Efforts to control this menace had been limited to passing legislation to make banking institutions more compliant with stiffer penalties being imposed on those who turn a blind eye to this issue. However, this paper tries to address a perceived gap in the research literature by examining how banking technology can be used to counter and disrupt the flow of illegal funds right from the start. Money laundering is a three-step process but it is in the first step where it is most vulnerable. This is the point where technology can be put to most effective use. CHAPTER 3 – ANALYSIS OF THE DATA This chapter gives a brief background on the three-step money laundering process and the existing banking technology used to detect and counter this pernicious practice. There are various methods being utilized to prevent money laundering but these efforts are seemingly futile to stem the tide of dirty money flowing into the legitimate banking system. It further gives the reader an idea of the areas in banking which are most susceptible to these money laundering activities. The section gives the reasons why present efforts have failed despite attempts to stop it. 3.1. Steps in the Money Laundering Process There are essentially three steps in how to launder money successfully. The first step is the placement – introducing illegal monies into the formal financial or banking system. This is the preferred route of money launderers because they want the assurance of a stable and reliable banking system infrastructure to ensure the safety of their funds. In this initial step, large sums of cash are deposited into several accounts in smaller amounts so as not to attract attention, over a period of several days (not one big amount at once). This is the also the stage where it is the most dangerous as any large cash deposit is not only very bulky but also conspicuous and presents plenty of logistical problems (Layton, 2007). The second step involves the layering of the money to hide its origins and make it hard for authorities to trace. A simple scheme may involve transferring the money through several accounts within the same country or a more sophisticated operation may take the approach of moving the money around in several countries to make the paper trail difficult to follow. The other schemes utilized may be more innovative such as changing to different currencies. A common tactic at this stage is to hide big amount by purchasing high-value items such as a luxury car, an expensive yacht, rare painting, real estate or diamonds (ibid.). The third and last step is the integration in which “dirty money” is made to look as if it is obtained from legitimate sources, such as a legal business or in the exercise of a profession. Once successful, the criminal can use the money any way he wants it and invest them in any legitimate investment. 3.2. Existing Banking Technologies Use of bank technologies in the fight and detection of money laundering is still basically a human process. It means there are basically no automatic detection and triggering of alerts regarding possible money laundering activities. A suspicious transaction is scrutinized and still done by designated bank compliance officers. Any of the suspected money laundering transactions can be detected if compliance officers are very well trained to do so, have unquestionable integrity and cannot be bribed to ignore the signs. What is being automated in terms of computerized technology is the reporting system but not the detection process itself. Any suspicious activity will come into the report if and only if the compliance officer is honest enough to include that particular activity in the required report; otherwise, it will go unnoticed. What goes into the suspicious transaction report (STR) as required depends on how alert the compliance officer is. Banking officers are required to make their institutions develop a culture that is oriented towards crime prevention. One of the simple steps involved is the KYC approach (know your customer). A client has to submit valid identification documents before being allowed to open a bank account and an approving officer should know the potential bank client by undertaking background checks. Criminals and money launderers have no real choice but to use the formal banking system’s facilities as they want the legitimacy of banks to give their illicit funds a semblance of legality (World-Check, n.d.). The present methods used in anti-money laundering efforts are nothing but a combination of human vigilance and automated processes (but still subjected to human review and monitoring). A common reporting document used by many governments is the covered transactions report (CTR) which includes suspicious bank transactions. It is still a matter of subjectivity and individual judgment on what transactions are suspicious as based on current guidelines although the discretionary aspect has been narrowed somewhat. Most major banks use another document which is the suspicious activity report (SAR) that indicates suspicious activity by looking at past transactions. This is very useful for banks with a large retail customer base in which several thousands of transactions take place daily. All such reports are submitted to a financial intelligence unit (FIU) which the banks and other big financial institutions have set up. It is the FIU which does the actual investigative legwork if warranted by the reports sent to it. All further investigations require good police work or in the parlance of the intelligence community, the ability to “connect the dots” between a particular SAR and other SARS obtained elsewhere. A good lead may turn out to be nothing or it may be the tip of an iceberg, so to speak. What is needed by the banking system is a more sophisticated approach, perhaps similar to what corporate auditors use to detect accounting fraud (Coderre, 2009). Auditors use the latest computer software to identify areas where there is a high probability of fraud and focus their efforts on those areas using data analysis. A potentially useful approach is the use of “red flags” or warning signs that warn a bank that a possible money laundering transaction took place (Singleton & Singleton, 2010). 3.3. Areas Susceptible to Money Laundering One area that has seen rapid growth is wealth management. It is an integral part of the entire private banking service portfolio for the demanding clients of an established bank (Maude, 2010). The traditional clients in private services are individuals who are incredibly wealthy and the traditionally wealthy who can claim a long pedigree on the provenance of their wealth. Globalized trade has vastly increased the number of rich individuals by virtue of their hard work and business acumen. These rich individuals and also the old rich families demand a personalised and customised type of service that is appropriate to their financial wealth and social status that is essentially a concierge-type of banking service. Services included in private banking are deposit taking, personal payments, and advisor service on tax matters, asset management, stock brokerage advice and even art purchases. The services can cover a wide range depending on the sophistication of the private banking clients and the degree of participation they want in actively managing their accounts. It covers a very broad spectrum of other personalised services other than just core banking services such as insurance, credit cards, home mortgages, margin lending, short selling, art appreciation, wine selections and even hotel, restaurant and concert bookings. Wealth management services and private banking is a very competitive sub-sector of the banking industry, with many new players enticed to enter because of very lucrative fees. A facet of private banking is utter secrecy to safeguard clients from being pirated by rival firms and from criminals such as extortionists and kidnappers and for complete privacy. The Financial Services Authority is more supervisory than regulatory in this regard (IMF, 2003). Stiff competition for clients often precludes banks from asking too many questions. Wealth confers a degree of legitimacy and the sheer number of services available under a private banking arrangement with a major bank allows a money launderer to use those services to cover the origins of money. An area particularly susceptible to laundering is in stock futures which private banking also offers to wealthy clients. The futures markets are used under broker’s names and not that of their principals (this offers complete anonymity). Launderers use futures to buy and sell the same commodity, for example, by paying the losing contract with “dirty money” and receive a cheque for the winning contract (Steel, 2006). Other areas to launder money are the high-priced art market, precious antiques and jewellery. Another area where no questions are asked is the casinos: buy some chips and then return the chips to cash out by asking for a manager’s cheque that creates a legal paper trail. The Financial Services Authority admitted it has inadequate controls against money laundering (Bawden, 2005) and critics call it pathetic. London is one of the world’s financial centres and there is a great inflow and outflow of funds. Monetary authorities admit there is a great deal of money laundering going on but are helpless against it and conceded the fight is lost (Ashworth, 2003). Efforts to curb fund flows would render London uncompetitive and bankers lobbied for laxity rather than more regulations. Former UK Premier Gordon Brown admitted his mistake in establishing the Financial Services Authority and there are moves to return more regulatory powers to the Bank of England (AFP, 2011). The preceding chapter gave a short overview of the money laundering process. It also discussed the steps banking institutions use to counter this illegal activity which are found to be grossly inadequate. Wealth management in private banking is one area which is particularly susceptible to money laundering because of the large amounts involved, the need for confidentiality which makes detection and reporting more difficult, a lax regulatory regime and the stiff competition for client funds. The government made a mistake in regards to policy directions that should balance control of fund flows and the need to attract foreign funds and investments. CHAPTER 4 – RESULT OF THE ANALYSIS This section details the various inventive ways in which criminals use new techniques to circumvent the laws against money laundering. The existence of alternative remittance systems which require little or no documentation helps to facilitate money laundering and has given rise to a new threat which is terrorism financing. This chapter also gives an overview of the reasons for failure of anti-money laundering efforts in the United Kingdom. Money launderers rode on the waves of liberalisation and globalisation to hide their ill-gotten wealth. Ironically, technology also facilitated money laundering by providing new avenues to hide and transfer money. 4.1. How effective are Existing Methods? Sad to say, existing anti-money laundering methods are no match for crafty criminals. These people invent ways to launder dirty money and hire experts on financial transactions to hide or obscure the trails of the money. Most criminals deal in hard currencies or cold cash which presents a logistical problem (Layton, 2007). A $1 million dollars’ worth of cocaine weighs just 20 kilograms while that amount in actual dollars can weigh as much as 116 kilograms and draws an unwanted attention from the authorities. Law enforcement officials are often stymied when the monies are sent to offshore accounts maintained in countries that allow anonymous bank accounts. Besides Switzerland, other major offshore centres are the Bahamas, Dubai, Panama, Cayman Islands, Hong Kong and Singapore. The United Kingdom has been cited in the Interpol Report as one of top three major destinations of laundered money (in the second step of layering). The effectiveness of anti-money laundering efforts are often frustrated by a combination of factors, such as existence of a significant amount of transactions conducted in an alternative or parallel remittance system (Jost & Sandhu, 2002). Monetary authorities encounter difficulties in monitoring and regulating shadow banking systems but regulatory and policy makers have themselves partly to be blamed for this environment. They had allowed an underground banking system to proliferate as part of the liberalisation process in the banking industry in tune with globalisation of trade and finance. The new rules that were adopted in line with this liberalisation are money market funds, securitisation of assets and repurchase agreements (Gorton & Metrick, 2010). The new banking products were designed to entice a new breed of wealthy clients who favoured private banking. It is similar to an American case that involved money laundering; banks ignored controls put up (Browning, 2010). 4.2. Reasons for Failure of Existing Methods in the U.K. The primary reason for the failure of present anti-money laundering efforts in the U.K. is the competition for funds, especially money in vast amounts. The rise of private banking is partly responsible for this failure because some big banks which formed part of the legal and formal banking system did not implement a “know-your-client” or KYC policy. Additionally, many of them also simply ignored the warning signs or “red flags” of money laundering. The persons supposed to monitor suspicious money movements did not report anything at all. An example is Wachovia Bank which is now a part of the larger Wells Fargo Bank. This US bank had been warned repeatedly about the sheer volume of suspicious money passing through one of its accounts to the tune of $378 billion over a short period by one of its officers in London (Vulliamy, 2011). It is generally conceded most big banks do not want to ask too many questions required by prudent banking practices to establish legitimacy of a client. This is within the context of stiff competition among British banks especially in the years following the economic crisis in the United States which also adversely affected the majority of British banks. Laundered money has been a saviour for some banks who were in trouble because it provided them with needed liquidity. Another possible reason for the failure of existing methods is a shadow or underground banking system in the United Kingdom due to a large expatriate community. In this regard, the hawala system of remittance is the biggest culprit. The hawala is an ancient alternative method of sending money used in South Asia, particularly India and Pakistan. This remittance system is based on trust, family connections and regional affiliations. Its attraction is a minimal use of documentation but has the ability to move the money without transferring the money by offsetting accounts (Jost & Sandhu, 2002). It is a cost effective, fast and reliable way of sending and receiving money because there is little documentation. This paper does not condemn the hawala system per se as it is used to send money earned legitimately but its secrecy, lack of documentation and ease of use often lends itself to the needs of criminal syndicates and other money launderers who find it suitable for their requirements. Both the nations of India and Pakistan are cooperating with global authorities such as the World Bank, the Asian Development Bank and International Monetary Fund to curb this practice but this seems to be a cultural thing rather than an intentional attempt to engage in money laundering itself. China has an equally ancient and effective system of money transfers known as a fie chen or flying money and used extensively in many parts of the world (Hass, 1998). It main feature is the use of a chop or chit as a validation mechanism upon its presentation (UN, 1998). A third probable reason for the failure is ironically, technology. The sheer speed and the variety of new information and communications technology (ICT) as applied to the banking industry also helped the money launderers to be more innovative in their methods. The rise of electronic banking has its many appeals to both bank officials and the bank’s customers. It is fast, convenient and secure with the development of the secure socket layer (SSL) system of encryption technology. Internet banking is simply a few clicks away from transferring vast sums of money from its original source to an offshore account (anonymous) and then the additional bank transfers to make the funds “clean” by moving it to another country and the money now comes out effectively clean and ready for use in legitimate businesses. Corollary to the rise of electronic banking is the increasing use of mobile banking through the cellular phones (Digital Transactions, 2008). The use of e-commerce technology in South Asia, Africa and Latin America is intended to help poor people but money launderers find it a convenient way. It forms part of the larger picture of electronic value of money such as cyber payments and the electronic cash or e-money in stored-value cards (Steel, 2006). This chapter gave a background on the reasons why present anti-money laundering efforts have failed so far. With this knowledge, policy makers and monetary authorities should be in a position to draft new regulations that will adequately address identified deficiencies. The need is to have the correct balance between the right controls and the right environment for investment incentives without stifling attraction of London as financial centre in the world of finance. The authorities must likewise use technologies to fight money launderers in the same way these people use new technology. CHAPTER 5 – Conclusions AND RECOMMEnDATION Money laundering is a worldwide problem that requires the cooperation of countries; it cannot be prevented by one country alone. All countries that still operate their banks under secrecy laws must pass new legislation to help in the fight against this crime. Money laundering can be fought on several fronts but the two primary tools are in legislation (making it a crime to abet money laundering with prison terms of up to ten years) and use of more sophisticated banking technologies to minimise the role of human intervention in detecting suspicious fund activity. People can get tired at times, become susceptible to bribes and in general are less reliable than using computer technology to perform data mining tasks. Banking technology can use advanced computer software to “connect the dots” through use of data-mining technologies presently in the fight against terrorism. Considering there are more than 800,000 wire transfers daily (excluding electronic fund transfers), the need for a more robust computer banking technology is clearly identified (UN, 1998). Banking technology in the United Kingdom will most likely follow the policy leads in the fight against money laundering. Strengthening banking regulations will help greatly in this effort and existing laws may need to be revised to reflect new realities. Previous laws had been focused on drug trafficking although some revisions now made money laundering a crime by itself without being a predicate of drug trafficking. Money launderers rode on waves of liberalisation and globalisation; they took advantage of open borders, privatisations and new modes include using free trade zones and international trade as new avenues (ibid.) and it takes greater urgency with the suspected collaboration between money launderers and terrorist groups. A new worry is crime syndicates are buying up banks in weak states resulting in these groups gaining access to bank technologies and also narco-politics in which their influence extends to control of local political institutions, funding of expenses of election candidates, bribery of police forces and subversion of the judiciary. The forty recommendations adopted by the Financial Action Task Force (FATF, 2011) against money laundering is too cumbersome to implement and although these attempt to be quite comprehensive, they make the rationale behind them difficult to adopt in many instances especially in a competitive environment such as wealth management in private banking in the United Kingdom. The easiest way to fight this crime is implement strictly a know-your-client (KYC) policy, without exceptions. Another is a new “whistleblower” program to encourage people with knowledge to report crimes. Another step would be to use sophisticated computer technology to detect patterns in money laundering trail. This can be done with help of computer experts although this is expensive but it is more reliable in the long term. The last recommendation is an information campaign to educate people on the dangers of money laundering. This will identify probable businesses that hide dirty money and let people decide to boycott these businesses to choke off the supply. Read More