Money Laundering, Stages of Money Laundering and Its Effect in the Economy - Research Paper Example

Money Laundering Student’s Name: ID Number: Lecturer: Date: Abstract In recent years many policy makers and experts in the financial industry have raised concern in the manner at which cases of money laundering have been on increase. We all of us agree that money laundering has negative effects on the economy and countries all over the world should come up with anti-money laundering measures. The paper will define money laundering, stages of money laundering and the effect of money laundering in the economy. Money Laundering Introduction There has been a significant rise in money laundering cases across the world in recent year. Criminal gangs, drug traffickers as well as terrorist are all involved in making sure that dirty money finds its way into the economy of many countries in the world. Many questions should be asked of how dirty money finds its way into the economy and financial institutions especially banks all over the world are usually the doorways to most of this dirty money entering the legal system (Walker, 1999). It is estimated by the International Monetary Fund (IMF) that the amount of money laundered is at 2-5% of the world gross domestic product (GDP). Money laundering volume in an economy is a function of the extent of crime that generates proceeds, money from criminal activities movement and use and the amount of money from criminal activities. Therefore the volume of money laundered from criminal activities depends on how it is prevented, how it is detected and the deterrence of criminal money movement detention and appropriation of property with criminal origin or use (Morais, 2002). Definition of money Laundering Money laundering is defined as an act used by criminals to transform tainted money into clean money, this is usually making dirty money look clean. Money laundering can also be defined as the process whereby criminals hide the original ownership of money and pretend that the money comes from a legitimate source. It is the process used to conceal the true origin, ownership and or purpose of the proceeds of any criminal activity (Morais, 2002). The characteristics of the offences of money laundering are the same globally, and there are two major elements of offences of money laundering. These elements are, the act itself of laundering where financial services are provided and suspicion or knowledge that relates to the source of fund of a customer or their conduct. The job of a money launderer is to get it out, cover it up, and bring it back (Institute of Chartered Accountants in England and Wales, 2004). Terrorism financing is when a person by any means directly or indirectly, unlawfully and willfully provides or collects funds with the intention that the funds will be used in full or in part to carry out a terrorist act by a terrorist organization or be linked to specific terrorist acts. The main difference between money laundering and terrorism financing is that terrorism financing may come from legitimate or illegitimate in contrast, money laundering only involves proceeds originating from illegitimate sources (Masciandaro, 2004). Stages of money Laundering Money laundering has three major stages; placement, layering and integration. Placement refers to the act whereby cash that is derived from criminal activities such as drug trafficking and human trafficking is disposed into the economy. This is done by criminals at the very initial stage by introducing the money into the financial system (Masciandaro, 2004). The second stage is the layering stage, in the layering stage criminals separate illicit proceeds from their sources by creating complex layers of financial transactions designed to disguise the audit trail and provide anonymity, for example, wire transfers, transfer to bank account of a certain company Z, loan to company Y and payment of false invoices to company X as so on. In other term it can be stated that the money is ‘washed’ and its real source and ownership disguised (HM Government, 2003). The last stage is the integration stage, in this stage criminals attempt to legitimize wealth derived from the criminal activities. If the layering process has succeeded, integration schemes place the laundered proceeds back into the economy in such a way that they re-enter the financial system appearing as normal business funds. This simply means that this is the last stage and the money launderer re-introduces the money into the legitimate economy (Walker, 1999). The scale of money Laundering It is very difficult to estimate the scale of money laundering in any country all over the world. Many countries have come up with financial action task force to produce such estimates but all in vain because no record of laundered money that passes through an economy can be obtained. For instance, in the United Kingdom it is estimated by the HM Customs and Excise that between £ 19bn and £48bn is the annual proceeds from criminal related activities and the best estimate is given at £25bn which represents 19% of all the shadow economy. This can be shown by the table below where the GDP, shadow economies and estimates of money laundering (Masciandaro, 2004). Country GDP %GDP in Shadow Economy Shadow Economy Estimated Money Laundering Confiscations & Seizures UK £964bn 13% £125bn £25bn £80m USA £5,850bn 9% £527bn £110bn £340m Germany £1,290bn 16% £206bn N/A N/A France £940bn 15% £141bn N/A N/A Italy £788bn 27% £213bn N/A N/A Flows of laundered money According to Walker it is estimated that 18% of all the money laundered flow to the USA but he does not demonstrate the countries of origin. The table below shows top 20 countries that money is laundered into. Rank Destination Amount ($USbill/yr) % of total 1 USA 538 18.9 2 Cayman Island 138 4.9 3 Russia 120 4.2 4 Italy 106 3.7 5 China 95 3.3 6 Rumania 90 3.2 7 Canada 85 3.0 8 Vatican City 80 2.8 9 Luxembourg 78 2.8 10 France 68 2.4 11 Bahamas 66 2.3 12 Germany 61 2.2 13 Switzerland 58 2.1 14 Bermuda 50 1.9 15 Netherlands 50 1.7 16 Liechtenstein 49 1.7 17 Austria 48 1.7 18 Hong Kong 45 1.6 19 UK 44 1.6 20 Spain 35 1.2 Forms of money laundering in the economy Money can be laundered in the financial sector Money can be laundered in the real sector Money can be laundered in the financial sector inform of investing in the capital markets by launderers to avoid holding cash in bulky considering the money market less risky and any chances of losing money is minimal. The assets can also be easily converted back to cash because they are so liquid. Launderers also deposit small amounts of money into accounts because they cannot be asked to report the source of origin and this can be wired to another country. The Launderers can also avoid depositing large sums of money in accounts and instead they can lend to individuals who are aware of the dirty money at low interest rate and the loan will be paid slowly to avoid creating any suspicion (Masciandaro, 2004). Money can be laundered in the real sector inform of investing in real estate by acquiring property considering that the property appreciates in value always. Launderers can also own casinos and claim that the large volumes of money are from the profits from the casino (HM Treasury et al., 2004). How money is laundered Money is laundered in different way in any economy all over the world. The method are; Smurfing, Misinvoicing, Barter, Parallel credit transactions and interbank wire transfers. Smurfing is whereby cash is deposited in an account by money launderers is small quantity that does not require reporting multiple times. Misinvoicing is whereby false letters of credits are raised so as to conceal cross-border transfers. Barter is whereby property that is stolen is exchanges across borders or domestically for illegal substances like drugs. Parallel credit transactions are used by criminals in order to avoid the formal economy. Interbank wire transfers are not usually reported and launders usually bribe bank officials to conceal account transfers that are illegal (HM Treasury, 2004). Advantages of money Laundering The only advantages of money Laundering is to the money launders themselves and not much to rest of the economy. Money launders will try as much as they can to introduce money obtained from criminal activities into the economy and this will benefit them so much that it becomes difficult for the authority to track their activities. Disadvantages of money Laundering It is very difficult to quantify the negative economic effect of money laundering in an economy. Money laundering activities are so harmful in an economy that they damage the institutions that are responsible for economic growth, for instance the financial sector institutions. Money laundering activities divert resources therefore reducing productivity in the economy, it also encourage an increase of criminal related activities as well as corruption. All these can affect the economy’s external sector because of slow economic growth because of money laundering. Literature review Effects of money laundering Money laundering has many effects in an economy: Losses because of criminal activities related to money laundering. Many companies around the world lose about $2 billion per year due to crimes related to money laundering. Money from drugs is about 0.4% of GDP per year affecting economic welfare, social welfare and the political welfare. Investments are distorted because of the money laundering; this is mostly in the real estate sector. Large amount of wealth from money laundering is used to invest in the real estate sector because4 the sector is somehow less transparent than most other sector like the financial market. Money laundering affects the development of crucial financial institutions. Financial institutions are eroded themselves because of a correlation between employees of these institutions involved fraudulent activities and money laundering. Corruption particularly in developing countries has made it possible for money laundering to take place through their channels. Money laundering also affects economic growth in the real sector because resources are diverted from gainful use to less productive activities. Money laundering also facilitates crime and corruption and in the long run it affect the economic growth of a country. Developing countries’ economies are also affected by money laundering activities through the countries trade and international capital flows. Domestic financial institutions or the foreign financial institutions for example, offshore financial centre and to the major centers of money such as those in London, Tokyo and New York can be used for illicit capital flight. Usually scarce resources from developing economies are drained by illicit capital flight, but developing country growth is impaired by transnational money laundering activities. Countries imports and exports can be distorted because of money laundering activities going on. On the import side criminals normally use laundered money to import luxury goods and services mostly with the reason of the process of laundering such money. Normally such imports are not of use in an economy because they cannot create employment as well as generating domestic economic activities. In most cases it affects the prices of goods and services by artificially depressing domestic prices and this affects domestic enterprises profitability. Money laundering causes distortion of investment and savings because money launderer’s desires are mainly to avoid detection and any form of control rather than gaining any returns from their investments. Therefore their choices for investment can be unproductive simply because funds can be redirected to those activities that generate minimal economic activity and employment. In most cases money launderers tend to invest in those areas that are more concealed even if the rate of return is very low. Money laundering causes an artificial increase in prices of goods and services in an economy. Launders usually try as much as possible to invest proceeds from criminal related activities in a way that disguises their illegal origin. Therefore money launderers are willing to pay any price for a certain asset even if the price is more than the market price and this normally leads to an artificial increase in the prices of such assets. This also applies to other sectors of the economy like capital market where prices of shares could artificially increase. Money laundering also causes distortion of consumption; this is because when the dirty money is transferred to the offender from a victim the offender will use the dirty money in a different way. Criminals usually spend their money differently from ordinary consumers in a country (Meloen et al 2003) because they purchase those goods and service that are expensive and can conceal their dirty money, for example the purchase goods like expensive jewelry, real estates and other expensive luxury products. These spending choices are different from those of genuine consumers who could use the money for meaningful purchases of daily expenses, rainy days and even old days. Money laundering also has both negative and positive effect on the growth rate; the negative impact on growth rates caused by money laundering is because fund from money laundering are redirected from investment that may be productive therefore affecting growth. Criminals tend to abandon those sectors that seem to be no longer appealing to them and these potentially causing the sector to suffer negatively and eventually easy to collapse causing serious damage to the economy (McDowell, 2001). Sometime money laundering can have a positive effect on growth and this mostly happens to those countries that are used only as gateway transferring criminal money. Money flows in these countries creating additional values to financial services and the countries do not bear the cost of the crime. If the laundered money is transferred to laundering country from a country that criminal activities took place then the latter country is not directly affected by the crime that is associated with the laundered money. Money laundering also has an effect on output, income and employment; this is because money laundering is able to reduce output and employment when resources are diverted from sectors that are more productive, for example he clothing and footwear sectors to those sectors like art, real estate and jewelry that are sterile. Many people get employment to those sectors like cloth and footwear sector rather than the art and jewelry sector. Money laundering leads to lower revenues for the public sector because the government cannot collect all the revenues from the taxes. Launders usually misreport or underreport income from criminal activities because misreporting and underreporting is a form of money laundering and in the long run it affect tax collection efforts by the government. Control measures of money laundering Many countries in the world have come up with appropriate measures to control money laundering. International regulations are done by different bodies that include the United Nations (UN) and the Financial Action Task Force (FATF). FATF is an inter-governmental body which sets standards, develops and promotes policies to combat money laundering and terrorist financing. Governments should request all financial institutions come up with policies that prevent money laundering and terrorist financing. Banks and financial institutions should establish standards that are designed to achieve compliance to applicable anti-money laundering regulations, help prevent organized crime and terrorism and protect banks reputations. If financial institutions fail to comply they expose themselves to fines, loss of reputation and limitation of business. Financial institutions should come up with methods of CDD (Customer Due Diligence) or KYC (Know Your Customer) that involves gathering information about a customer identity and verifying a customer’s identity to ensure the customer is who they say they are. The importance of CDD and KYC is to identify the customer and verify that the customer’s identity using reliable, independent sources documents, data or information. To assist in the review of unusual transactions, assist to obtain information on the purpose and intended nature of the business relations and to align with local and international regulations (HM Treasury, 2003). Financial institutions should also check whether they are prohibited from doing business with the customers due to financial sanctions. The following information’s should be obtained from individual customers by financial institutions; full names, date of birth, nationality, country of residence, occupation, id number and residential address. Corporate entity’s should provide; full business registered name, nature of business, business physical address, date of registration or incorporation, registered office address, shareholders, country of registration and related parties like directors and signatories. The diagram below shows how financial institution should carry out CDD/KYC (HM Treasury et al., 2004). Financial institutions should be aware of high risk customers who need to be subjected to an enhanced CDD process and exhibit the bellow characteristics. Non-national customers and non residents NGOs, Trusts, Charities and organizations that receive donations Politically exposed persons (PEP) and their close family members Non face to face clients High Net worth Clients Clients in high risk countries like Columbia Clients with dubious reputations as per the information available to the public Methodology The use of empirical data in this research has also involved the use of primary data as well as secondary data from the survey. When the two sets of data are combined they produce a good research. Primary data is always considered to be very fundamental because it is always very accurate. Data collection is very crucial part of the research. It is heavily based on though not exclusive to, first-hand research. A well conducted data collection process is the pillar and determines the credibility of the research. The research will also involve reviewing secondary data through the college library using different information sources such as commercial and academic abstracts, internet search engines and other journals. The study also made extensive use of online library materials. Materials . The instruments included the use of one on one interview, questionnaires as well as checklists of documents. The different instruments used improved the suitability of the study as well as the accuracy it carries. Opinions given by experts in this area of study were also very necessary as it encouraged proper understanding of the research and hence it was sought for. The procedure Fieldwork is a technique that was employed for collection of primary data. Fieldwork can be defined as an investigation that is aimed at collecting primary data outside a work place or school. In this case the researchers are always allowed to the field of study to collect the data. This research involved securing of ethical consideration that allowed the researcher to adhere to ethical matters in as far as collection of primary data is concerned. The process was followed by coming up with a good and appropriate questionnaire that assisted in collection of data from the respondents. The researcher followed all the set guideline when preparing this research. The information given in this analysis also makes use of the secondary data. Findings The findings of the research were that majority of the financial institutions that participated said that money laundering is a problem that affects the country and financial institutions must be involved in combating it through the below ways: Transactions monitoring Banks around the world should be able to monitor a suspicious transaction. A suspicious transaction will often be one which is inconsistent with a customer’s known, legitimate business or personal activities or with the normal business for that type of account. The first task is to know more about a customer’s business in order to recognize that a transaction or series of transactions is unusual. Suspicious transactions have the following characteristics; The transactions are not consistent with the nature and type of business or purpose of the account Large transactions that do not match with the size of the business or the incomes of the customer Sudden account activities with huge amounts Frequent fund transfers to high risk countries like Columbia and Somalia Frequent cash deposits followed by an immediate withdrawal or transfer with no apparent economic reasons Transactions are structured in a manner to suggest that someone is evading reporting requirements Offences committed by bank official Tipping off is whereby a bank official informs someone that an investigation into money laundering is being carried out and thereby affecting the investigations. The other offence is knowingly assisting a criminal to perform what is called split transactions to avoid regulatory reporting. It is also an offence of a financial institution to report a money laundering activity to the relevant bodies. Financial institutions should monitor and report suspected money laundering activities, should always verify the identity of customers and strictly establish and maintain customer’s records. Record keeping Financial institutions should maintain and keep records of all transactions for a minimum of seven years from the date of the relevant business or transaction was completed or following the termination of an account or business relationship. This includes all records obtained through CDD measures such as copies or records of official documents like passports, identification cards or similar documents, account files and business correspondence including the results of any analysis undertaken such as inquiries to establish the background and purpose of complex, unusual large transactions. Importance of fighting money laundering Financial institutions around the world must fight money laundering seriously because: It is the right thing to do Reduces incentive to commit crime and reduce the means to commit further crime because profitable crime leads to more crime It becomes our economy and crowds out the private sector Penalties for non-compliance are severe Impacts foreign investment and complicates dealing with other countries To avoid reputational, legal and financial risks to the financial institutions Conclusion Economic growth and development in many countries is seriously affected by money laundering. Money laundering also affects financial systems in many countries all over the world and it is the responsibility of these countries to strongly come up with efforts to discourage money laundering. There has been negative perception in recent years that anti-money laws and regulations will mostly like to hinder efforts to liberalize financial markets. It is recommended that financial institutions should be at the front end to come up with anti money laundering solutions. The institutions should come up with anti money laundering policies across their branches designed to achieve compliance to applicable anti money laundering regulations, help prevent organized crime and terrorism and protect the financial institutions reputation. Failure to comply, the institution will be exposed to fines, loss of reputation and limitation of business. If employees of the said institutions failure to comply with this policy they should be held accountable. References HM Government, Statutory Instrument 2003 No. 3075 – The Money Laundering Regulations 2003, November 2003. HM Treasury et al., Anti-Money Laundering Strategy, October 2004. HM Treasury, Informal Consultation on Third Money Laundering Directive, May 2004. HM Treasury, Full Regulatory Impact Assessment Money Laundering Regulations 2003, November 2003. Institute of Chartered Accountants in England and Wales, Anti-Money Laundering (Proceeds of Crime & Terrorism) – Second Interim Guidance for Accountants, March 2004. Walker, J. (1999). ‘How Big is Global Money Laundering?’. Journal of Money Laundering Control, Vol. 3, No. 1 Masciandaro, D. (2004). ‘Global Financial Crime: Terrorism, Money Laundering, and OffShore Centres’. Global Finance Series, Ashgate: ISPA Morais, H.V. (2002). ‘The War Against Money Laundering, Terrorism, and the Financing of Terrorism’. Lawasia Journal 2002: pp. 1-32 Meloen, J., Landman, R., Miranda, H. de, Eekelen, J. van, Soest, S. van (2003).‘Buit en Besteding, Een empirisch onderzoek naar de omvang, de kenmerkenen de besteding van misdaadgeld’. Den Haag: Reed Business Information McDowell J. (2001). ‘The Consequences of Money Laundering and Financial Crime, Economic Perspectives’. Electronical Journal of the US Department of State, Volume 6, Number 2 Read More