Money Laundering: Impact on Economy, Global Strategies, and Preventive Measures

To prepare for INTERNAL SECURITY for any competitive exam, aspirants have to know about Money Laundering. It gives an idea of all the important topics for the IAS Exam and the Economy syllabus (GS-III.). Money Laundering terms are important from Economy perspectives in the UPSC exam. IAS aspirants should thoroughly understand their meaning and application, as questions can be asked from this static portion of the IAS Syllabus in both the UPSC Prelims and the UPSC Mains exams. Even these topics are also highly linked with current affairs. Almost every question asked from them is related to current events. So, apart from standard textbooks, you should rely on newspapers and news analyses as well for these sections. 

Money Laundering: Transforming Illicit Gains into Legitimate Wealth

• Money laundering is the process by which a large amount of illegally obtained money, from drug trafficking, terrorist activity or other serious crimes, is given the appearance of having originated from the legitimate source. It allows the criminals to maintain control over their proceeds.
• The process by which large amounts of dirty money (i.e. money obtained from serious crime- drug trafficking, terrorist activity made to look clean money (i.e. legitimate) is known as money laundering.
• Money laundering is an organized crime which is a prime source for funding terrorism.

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Money Laundering and Its Concealing Techniques

• According to INTERPOL, Money laundering is concealing or disguising the identity of illegally obtained proceeds so that they appear to have originated from legitimate sources.
• It is frequently a component of other, much more serious, crimes such as drug trafficking, robbery or extortion.
• Some of the common methods of money laundering are Bulk Cash Smuggling, Shell companies and trusts, Round-tripping, Hawala, False invoicing etc.
• The advent of cryptocurrency, such as bitcoins, has exacerbated this phenomenon.
• Money laundering is an issue that has gained increasing significance following the events of 9/11. It has recognized it as a source of the funding of terrorist activities. The spread of international banks all over the world has facilitated the transmission and the disguising of the origin of funds.

Process of Money Laundering

• Money is also laundered using the method of Round Tripping – the black money is transferred to the tax-haven countries from India. Then a company from that country will send that money back to India in the form of ‘foreign investment’. Best example of this is Mauritius, Singapore among others.

Steps of Money-Laundering

1. Placement puts the “dirty money” into the legitimate financial system.
2. Layering conceals the source of the money through a series of transactions and bookkeeping tricks.
3. In the case of integration, the now-laundered money is withdrawn from the legitimate account to be used for criminal activities.

Various forms of Money Laundering

• Structuring also called as Smurfing
• Bulk Cash Smuggling
• Cash intensive Businesses
• Gambling
• Trade based Laundering
• Tax amnesties
• Round tripping
• Shell companies
• Black salaries
• Transaction laundering

Hawala and Money Laundering

• The word “Hawala” means trust. Hawala is a system of transferring money and property in a parallel arrangement avoiding the traditional banking system. It is a simple way of money laundering and is banned in India.
• Hawala works by transferring money without actually moving
• In a hawala transaction, no physical movement of cash is there.
• It is an alternative or parallel remittance system, which works outside the circle of banks and formal financial systems.

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Reason why People Prefer Hawala

• The commission rates for transferring money through hawala are quite low.
• No requirement of any id proof and disclosure of source of income is there.
• It has emerged as a reliable & efficient system of remittance.
• As there is no physical movement of cash, hawala operators provide better
• Exchange rates as compared to the official exchange rates.
• It is a simple and hassle-free process when compared to the extensive
• Documentation being done by the banks.
• It is the only way to transfer unaccounted income
• This network is being used extensively across the globe to circulate black money and to provide funds for terrorism, drug trafficking and other illegal activities.

Various Techniques Used for Money Laundering

• Structuring Deposits: This is a method of placement whereby cash is broken into smaller deposits of money which is then exchanged by many individuals (known as “smurfs”) to avoid anti-money laundering reporting requirements. This is also known as smurfing because many individuals (the “smurfs”) are involved.
• Shell companies: These are companies without active business operations. They take in dirty money as “payment” for supposed goods or services but actually provide no goods or services; they simply create the appearance of legitimate transactions through fake invoices and balance sheets.
• Third-Party Cheques: Counter cheques or banker’s drafts drawn on different institutions are utilized and cleared via various third-party accounts. Since these are negotiable in many countries, the nexus with the source money is difficult to establish.
• Bulk cash smuggling: This involves physically smuggling cash to another jurisdiction and depositing it in a financial institution, such as an offshore bank, with greater bank secrecy or less rigorous money laundering enforcement.
• Credit Cards: Clearing credit and charge card balances at the counters of different banks. Such cards have a number of uses and can be used across international borders. For example, to purchase assets, for payment of services or goods received or in a global network of cash-dispensing machines

Cryptocurrency: The New Hawala

• Cryptocurrency like Bitcoin provides absolute anonymity and facilitates terror financing which was evident in the 2015 Paris terrorist attack.
• The Financial Action Task Force in Paris reported in 2015 that some terrorist websites encouraged sympathizers to donate in bitcoins.
• After, demonetisation action by the Government of India in 2016, there was a flood of such digital transactions.
• This new Hawala has a potential to become an easy way to provide funds for terrorists and other illegal activities.
• So, there is a need to have proper regulation over bitcoin in the interest of the economy and the security of the country.

Impact and Effects Of Money Laundering

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Trade-Based Money Laundering (TBML)

• Trade Based Money Laundering (TBML) is the process of transferring money through trade transactions that is achieved through misrepresentation of the price, quantity or quality of import or export.

Techniques of TBML

• Over-invoicing and under-invoicing of goods and services
• Multiple-invoicing of goods and services
• Over-shipment and under-shipment of goods and services
• Wrong information about goods and services.

Challenges In Tackling Money Laundering

• Predicate-offense-oriented law: This means a case under the Act depends on the fate of cases pursued by primary agencies only such as the CBI, the Income Tax Department or the police. (Predicate offense- any offense that is component of more serious offense)
• Growth of Technology: The enforcement agencies are not able to match up with the speed of growing technologies.
• Non-fulfilment of the purpose of KYC Norms: KYC norms does not cease or abstain from the problem of Hawala transactions as RBI cannot regulate them. Also, the increasing competition in the market is forcing the Banks to lower their guards and thus facilitating the money launderers to make illicit use of it in furtherance of their crime.
• Widespread act of smuggling: there are a number of black-market channels in India for the purpose of selling goods offering many imported consumers goods such as food items, electronics etc. which are routinely sold.
• Lack of comprehensive enforcement agencies: Separate wings of law enforcement agencies dealing with money laundering, cyber-crimes, terrorist crimes, economic offenses etc lack convergence among themselves
• Tax Haven Countries: They have long been associated with money laundering because their financial secrecy laws allow the creation of anonymous accounts while prohibiting the disclosure of financial information.

P-notes and Money Laundering

• Participatory Notes (P-Notes) are instruments used by foreign investors not registered with the SEBI to invest in Indian securities. They are issued overseas against underlying Indian securities (like shares).
• P-Notes hides the identity of the investor. According to the ‘White Paper’ on black money (2012) prepared by the central government, a considerable portion of PNs are used by wealthy individuals who use it as a mechanism to channelize black money kept in foreign countries to India. The Special Investigation Team (SIT) on black money also recommended the phasing out of P-Notes.
• In addition, SEBI has no jurisdiction over P-note trading. Although FIIs must register with SEBI, the P-notes trading among FIIs are not registered, leading to concern that P-notes are being used for money laundering.

Framework for prevention of Money Laundering

Statutory framework:

• The Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974 (COFEPOSA)
• The Smugglers and Foreign Exchange Manipulators Act, 1976 (SAFEMA)
• FEMA act 1973
• Prevention of Money Laundering (Amendment) Act (PMLA) 2012:
• Bill has introduced the concept of corresponding law to link the provisions of Indian law with the laws of foreign countries.
• It also adds the concept of reporting entity which would include a banking company, financial institution, intermediary or a person carrying on a designated business or profession.
• The Prevention of Money Laundering Act, 2002 levied a fine up to Rs. 5 lakh. The amendment act has removed this upper limit.
• The act has provided for provisional attachment and confiscation of property of any person (for a period not exceeding 180 days). This power may be exercised by the authority if it has reason to believe that the offense of money laundering has taken place.
• The bill expands the definition of offense under money laundering to include activities like concealment, acquisition, possession and use of proceeds of crime.
• PMLA, 2018:
• Amendment in definition of “proceeds of crime”: It now allows the ED to proceed against assets of equivalent value located even outside the country.
• Bail provisions: It also makes the applicability of bail conditions uniform to all the offenses under PMLA. The proposal comes after the Supreme Court recently struck down the previous stringent provisions.
• Corporate frauds: Corporate frauds are being included as scheduled offenses under PMLA, so that the Registrar of Companies can report such cases for action by the Enforcement Directorate for money laundering probe.
• Details sharing: The amendment also makes it mandatory for the ED to share relevant details with other agencies.
• Restoration of property: The amendment allows special courts to restore confiscated assets to the rightful claimants even during the trial. Earlier, the assets could be restored only after completion of the trial.

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Institutional framework:

• Enforcement Directorate for investigation and prosecution of cases under the PML. The Directorate is under the administrative control of Department of Revenue for operational purposes
• Financial Intelligence Unit – India (FIU- IND) for receiving, processing, analyzing and disseminating information relating to suspect financial transactions as well as for coordinating and strengthening efforts of national and international intelligence, investigation and enforcement agencies against money laundering. FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the Finance Minister.
• Various agencies were created– Financial intelligence Unit, Combating financing of terrorism cell, Terror funding and fake currency cell.

International coordination:

Since money laundering is an international phenomenon, transnational cooperation is of critical importance in the fight against this menace.

• FATF: FATF is an intergovernmental body established by the G7 summit in Paris in 1989 and responsible for setting global standards on anti-money laundering and combating financing of terrorism. Blacklisting of countries by FATF.
• OECD: Automatic Exchange of Financial Information by many countries as part of the OECD initiative.
• BEPS: Base Erosion and Profit Shifting (BEPS) initiative, under which the countries have agreed to take necessary measures.
• UN convention against illicit traffic: It combats drug trafficking organizations by emphasizing attacking the goal of all organized crime, and also its weakest point namely money itself.
• UN convention against organized crime: It is designed to combat the phenomenon of transnational organized crime.
• Vienna convention It was the first major initiative in the prevention of money laundering held in December 1988.This convention laid down the groundwork for efforts to combat money laundering by obliging the member states to criminalize the laundering of money from drug trafficking.
• The Council of Europe Convention-This convention held in 1990 establishes a common policy on money laundering to facilitate international cooperation
• The Egmont Group Of Financial Intelligence Units is an informal network of national financial intelligence units.
• Asia Pacific group: It works with countries in the Asia-Pacific to generate wide regional commitment to implement anti-money laundering policies and initiatives and secure agreement to establish a more permanent regional anti-money laundering body.
• The Basel Committee on Banking Regulations and Supervisory Practices issued a statement of principles which aims at encouraging the banking sector to adopt a common position in order to ensure that banks are not used to hide or launder funds acquired through criminal activities.
• India is also signatory to the International Convention for Suppression of Financing of Terrorism (1999); the United Nation Convention against Transnational Organised Crime (2000); and United Nation Convention against Corruption (2003).

Strategies for International Cooperation Against Money Laundering

• Enlist common predicate offenses: to solve the problem internationally, particularly keeping in mind the trans-national character of the offense of money laundering.
• Awareness and education: To infuse a sense of watchfulness towards the instances of money laundering which would also help in better law enforcement as it would be subject to public examination
• Proper Coordination between center and States: The more decentralized the law would be the better reach it will have.
• Law in every country: The key to making an impact in money laundering is to get all of the countries of the world to enact and enforce the same laws dealing with money laundering so the criminals have nowhere to go.
• Special cell dealing with money laundering activities: It should be created on the lines of the Economic Intelligence Council (EIC) exclusively dealing with research and development of anti-money laundering. This Special Cell should have links with INTERPOL and other international organizations dealing with money laundering. All key stakeholders, like, RBI, SEBI etc. should be a part of this.
• There is a requirement to have a convergence of different enforcement agencies, sharing of information is necessary.
• Laws in line with conventions: Countries should criminalize money laundering on the basis of the United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances, 1988 (the Vienna Convention) and the United Nations Convention against Transnational Organized Crime, 2000

Treating Money laundering as a separate offense

• Central government is considering a proposal to make money laundering a separate criminal offense to be investigated by the Enforcement Directorate, irrespective of a probe by other agencies
• Money laundering can be regarded as a multiplier of criminal activities as it gives economic power to criminals
• The current arrangements in India leave the fate of money laundering cases on probes and prosecution by multiple agencies because the definition of “proceeds of crime” is dependent on predicate offenses listed under schedule of PMLA act.
• Thus, fighting money laundering without fighting organized crime is a waste of time and effort.
• Money laundering as a separate offense begins where the intention to conceal the illicit money ends and it needs to be treated separate offense to break the link between money laundering and organized crime and speed up investigations

Significance of Treating as Separate Offense

• The Financial Action Task force (FATF) in its review in 2010 and India’s Special Investigation Team (SIT) on black money had also recommended the same as this will facilitate quick action against those indulging in money laundering.
• Further it will bring India’s law in line with foreign practices such as the U.K where money laundering is treated as a stand-alone crime and based on circumstantial evidence, they have to just establish that the proceeds had a criminal origin, rather than waiting for the outcomes of various other probes.

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Reason for Emergence of FATF as Effective Body

• It follows a consensus-based model of decision making with no overriding voting rights to any of its members. Thus, countries cannot prevent blocking of finance as in UN. 
• It has adopted a policy of “naming and shaming “with focus on correction. The country can be placed on a list and then removed thereafter seeing the progress made to implement the guidelines. It ensures an improvement in countering terror funding & money-laundering.
• The basis of listing countries by the FATF is on the basis of their compliance with transparent guidelines and their effective implementation.
• Its actions are based more on technical parameters formed after objective and professional analysis and less on geopolitical considerations.
• It gains credibility by its ability to hurt a country’s economic well-being as its indication of a country’s non-compliance with its guidelines affect its ratings with banks, financial institutions and other countries.
• It scrutinizes not just the laws of a country but also their implementation.

FATF’s Key Recommendations:

• Identify, assess and take effective action to mitigate their money laundering and terrorist financing risks.
• Countries should have an anti-money laundering policy and should designate an authority that is responsible for such policies.
• Criminalize on the basis of the Vienna Convention and the Palermo Convention.
• Enable competent authorities to confiscate property and proceeds from money laundering.
• Ensure that financial institution secrecy laws do not inhibit implementation of these measures.
• Prohibit financial institutions from keeping anonymous accounts.
• Require financial institutions to maintain all records on transactions.
• Money transfer services providers should be licensed or registered.
• Identify risks that may arise with development of new technologies.
• Ensure that financial institutions monitor wire transfers.
• Ensure that FIs’ foreign branches and subsidiaries apply these measures.
• Financial Institutions should report suspicious transactions to FIUs.
• Establish a financial intelligence unit (FIU).
• Ensure that designated law enforcement authorities have responsibility for money laundering and terrorist financing investigations.
• Take immediate steps to become a party to important global conventions framed to combat money laundering.
• Provide mutual legal assistance in relation to money laundering.
• Effectively execute extradition requests in relation to money laundering and terrorist financing.

Measures to Stop Fake Currency

• It is necessary to stay ahead of counterfeiters. RBI needs to constantly upgrade both paper based (watermark) and print based (optical variable ink, see through effect) security features.
• Promote digital transactions and increase digitisation of the economy.
• Frequently demonetise higher denomination notes like Rs.500 and Rs.2000.
• Increase cooperation among law enforcement agencies, border security agencies, police, etc.
• External dependence on security paper and ink could be reduced by increasing indigenous production. As most of the paper is imported from the EU, it can be asked to keep tight monitoring over currency rated printing in Pakistan.

Enhancing Anti-Money Laundering Measures: Strategies and Initiatives

• More strict laws related to Anti-money laundering is necessary because money laundering tends to corrupt even the most professional players in the market.
• There is a need to sensitize the Private Sector about their role in anti-money laundering activities
• Continuous up-gradation and dissemination of information is necessary
• There is a need to build a balance between financial confidentiality and this confidentiality turning to a money-laundering haven.
• International regimes attempt to monitor or regulate international relations and activities.
• Intergovernmental groups have also taken action against the rising levels of global money laundering.
• Promotion of The Basel committee on Banking regulations and adopted a statement of principles that targeted money laundering.
• Promotion of The Vienna Convention creates an obligation for signatory states to criminalize the laundering of money from drug trafficking.
• Promote a regional approach to addressing problems, develop and maintain strategic relationships with other organizations.

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Previous Years UPSC Questions

1. Money laundering poses a serious threat to a country’s economic sovereignty. What is its significance for India and what steps are required to be taken to control this menace? (2013).
2. India’s proximity to two of the world’s biggest illicit opium-growing states has enhanced her internal security concerns. Explain the linkages between drug trafficking and other illicit activities such as gunrunning, money laundering and human trafficking. What countermeasures should be taken to prevent the same? (2018)

Also Read: Various Security Forces and Agencies and Their Mandate