Money laundering is the process by which large amounts of illegally obtained money (from drug trafficking, terrorist activity or other crimes) is given the appearance of having originated from a legitimate source. In simpler terms, money laundering is the act of making money that comes from Source A (illegal) look like it comes from Source B (legal).
In practice, criminals disguise the origins of money obtained through illegal activities so it looks like it was obtained from legal sources. Otherwise, they can't use the money because it would connect them to the criminal activity, and law-enforcement officials would seize it.
Although it is thought of as a victimless crime, money laundering is a very serious issue. Without it, international organized crime would not be able to function. Some estimate the size of the problem is in the range of $500 billion to $ 1 trillion (Rs. 50 lakh crore) annually in India alone.
3 basic steps in a money laundering activity are:
- Placement - Launderer inserts the ‘black’ money into a legitimate financial institution, often in the form of cash bank deposits. This is the riskiest stage of the laundering process because of the large amounts of cash and banks are required to report high-value transactions.
- Layering - It involves sending the money through various financial transactions to change its form and make it difficult to follow. It may consist of several bank-to-bank transfers, wire transfers between different accounts in different names in different countries, making deposits and withdrawals to continually vary the amount of money in the accounts, changing the money's currency, purchasing high-value items to change the form of money. It is the most complex step as it's all about making the original ‘black’ money as hard to trace as possible.
- Integration - At this stage, the money re-enters mainstream economy in legitimate-looking form i.e. it appears to come from a legal transaction. E.g. a final bank transfer into the account of a local business in which the launderer is ‘investing’ in exchange for a cut of the profits or sale of high-value items bought during the layering stage. It's very difficult to catch a launderer during the integration stage, if there is no documentation during the previous stages.
There are several methods by which money may be laundered. Some common ones include:
- Structuring / Smurfing: A method of placement by which cash is broken into smaller deposits of money, used to defeat suspicion of money laundering and to avoid anti-money laundering reporting requirements. Money is deposited into one or more bank accounts either by multiple people or by a single person over an extended period of time. A sub-component of this is to use smaller amounts of cash to purchase bearer instruments, such as pay orders or demand drafts, and then ultimately deposit those, again in small amounts. The Cobrapost.com expose threw light on this method.
- Bulk cash smuggling: Physically smuggling cash to another jurisdiction, where it will be deposited in a financial institution, such as an offshore bank, or with one having less rigorous money laundering enforcement.
- Shell companies and trusts in certain jurisdictions disguise the true owner or beneficial of money.
- Overseas banks and Round-tripping: Money is deposited in a controlled foreign offshore account, preferably in a tax haven with minimum jurisdiction and strong bank secrecy laws. A complex scheme can involve hundreds of bank transfers to and from offshore banks. It can then be shipped back as a Foreign Direct Investment, exempt from taxation.
- Cash-intensive businesses: A business typically involved in receiving cash will use its accounts to deposit both legitimate and criminally-derived cash, claiming all of it as legitimate earnings. Best suited is a service business or one with very low variable costs such as a casino.
- Trade-based laundering: Under- or over- invoicing to disguise the movement of money.
In India, The Prevention of Money-Laundering Act, 2002 came into effect on 1 July 2005. The Act prescribes the obligations on banks, financial institutions and intermediaries to maintain records detailing the nature and value of transactions and to furnish information as prescribed. At present, banks must record all the transactions more than Rs. 10 lakh and maintain these records for 10 years. Banks are also required to make cash transaction reports and suspicious transaction reports whose amounts are more than Rs. 10 Lakhs within 7 days of doubt. This report is required to be submitted to enforcement directorate and income tax department.