What is Money Laundering?
Money laundering is the practice used by criminals who have made large sums from illegal activities such as terrorist activities or drug trafficking to ‘clean’ money to make it look as if it has come from a legitimate source. There are dozens of different ways to launder money, from time-worn techniques such as inflating the cash receipts of a legitimate business like a casino or restaurant to an ever-increasing array of 21st-century methods, including funnelling illegal funds through virtual gaming or online betting shops and buying and selling cryptocurrencies. At the end of the process, the ill-gotten gains have been ‘cleaned’ and can be used in the regular financial system without raising suspicion.
The cost of money laundering to businesses, economies and society as a whole is enormous and far-reaching. Let’s take a look.
The Effects of Money Laundering on Business
Clearly, there are serious consequences for any organisations found to be money laundering, especially in regulated sectors. Contracts may be lost and financial penalties imposed. And, of course, this kind of scandal tends to generate negative headlines for any company found to be involved, damaging reputations and causing customers to lose trust and take their business elsewhere.
Businesses may not be aware of money laundering and may not have actively participated in any of the underlying criminal activities. As a financial services provider, Infinity is at high risk of being targeted. We have to ensure stringent compliance with Know Your Customer (KYC) and anti-money laundering (AML) regulations looking out for red flags such as customers wanting to pay for policies via third parties, large premiums being paid with cash and channelling payments via offshore banks. We have a dedicated compliance team that keeps up with new legislation concerning KYC and AML, but many companies struggle to keep abreast of the ever-changing regulations, not to mention the constantly evolving tactics employed by the money launderers.
How Money Laundering Affects the Economy
Money laundering reduces tax revenue because activity taking place in the underground economy is undeclared. This has a negative impact on a country’s economy as a whole and also gives illegal businesses an unfair competitive advantage over those operating legitimately.
When money laundering is the raison d’être of a business, generating profit is secondary, and products are often sold for less than the cost of production, which, again, puts legitimate businesses at a disadvantage.
Money laundering is also often a reason why productive businesses, bought for the sole purpose of cleaning money, become unproductive or ‘sterile’. Efficiency in the real sector of the economy is therefore reduced.
Studies show that crime and corruption act as a brake on economic development, slowing economic growth, and this is particularly damaging to developing economies, which have fewer resources to direct towards fighting illegal activity and imposing anti-money laundering regulations. The cycle of corruption can be difficult to break and often requires assistance from the international community.
Dirty money can also trigger exchange rate volatility and fluctuations in international capital flows, causing unpredictable and detrimental changes in money demand.
The Effects of Money Laundering on Society
The fight against clandestine activity is expensive, and government funds are inevitably spent on implementing AML regulations, and other crime-fighting policies are diverted from other areas of public spending such as health or education, so we all lose out.
When criminals successfully clean ‘dirty money’, this leads to more drugs, crime, violence and terrorist acts in an ever-increasing circle of criminality that draws more and more people into its net. When such big money can be made through illegal activities, previously legitimate businesses, as well as public and government employees, might be persuaded to jump on the criminal bandwagon to get a share of the booty.
In recent years there has been a concerted global effort to combat money laundering with the introduction of many new anti-money laundering (AML) laws and a raft of regulations dictating how banks and other financial institutions must guard against, detect and report suspicious activity. If you’re an expat living in Asia, you may have noticed extra checks on international transfers as a result.
Consequences of Money Laundering in Developing Countries
Terrorist financing and money laundering occur not only in the world’s major financial markets but also in emerging markets. The extent of the destruction and social consequences money laundering can cause varies depending on the stability of the country’s financial sector and society. However, developing countries, in particular, are vulnerable to the severe impact of money laundering as their economic development is still relatively young. Therefore, a developing country is more prone to disruption from criminal activity such as terrorist organisations operations.
Money laundering and terrorist financing have a severe impact on countries with fragile financial systems because weak security measures and economic conditions further enable the intentions of criminals in money laundering and terrorist financing.
Foreign Direct Investment and International Capital Flows
If developing countries have any standing or terrorist financing or money laundering, they will inevitably experience a detrimental negative impact on the development and growth of their financial institutions and economy as a whole.
Foreign financial institutions can limit their transactions with businesses from money laundering heavens, resulting in increased transaction fees and scrutiny and potentially a cessation of foreign direct investment.
Businesses dealing with legitimate funds and operations can still be subjected to restricted access to international markets if they reside in money laundering heavens. As a result, if a country does not actively fight money laundering and implement meticulous anti-money laundering measures, eligibility for foreign state help and private investments will be significantly restricted.
Increase in Crime and Corruption
If a country is internationally known to harbour money laundering activities, it will attract higher volumes of criminal activity and transfer the economic power to the criminals, undermining the legitimate economy.
Money launderers and criminals accept the help of bribery before they accept assistance from centralised financial institutions to make a success of their money laundering efforts. Counterparties to the bribery could potentially be employees, lawyers, financial institutions, accountants, prosecutors, police officials, legislatures and courts.
Proficient anti-money laundering practices should be implemented to combat money laundering and protect the integrity and reputation of both financial institutions and designated non-financial businesses and reduce the negative effects of money laundering. The Financial Action Task Force was established for precisely that reason: to reduce the occurrence of money laundering activities and criminal practices, like drug trafficking.
Diminished Financial Institutions
A country’s financial sector and the soundness of financial institutions, such as banks, are highly affected by money laundering. The negative effects of money laundering are defined as reputational, operational, concentration, and legal risks, which are all interrelated.
For instance, the reputational risks of a financial institution will likely result in the loss of public trust in the institutions due to bad publicity.
Operational risks associated with laundered funds include an irregular alteration in money demand, international capital flows, and exchange rates.
Consequently, depositors, borrowers, customers, and investors cease their business relationships with financial institutions involved in fraudulent activities, whose reputation will be significantly hindered by money laundering, terrorist financing, and other criminal activities.
Implications of money laundering in the Private Sector
Money launderers use shell companies to launder money without being conspicuous. These companies may appear legitimate and legal but are, n fact, controlled by criminal activity and those who power it.
Illegal funds are essentially mixed with legitimate funds in shell companies to hide their dissimilar share of income. These companies, in essence, focus on protecting their illegal funds and the underlying criminal activity that initiated it.
Criminals leverage the power of shell companies among other investments in legal companies and use the returns of financial crimes to gain control over certain sectors of a country’s economy. This occurrence promotes financial instability because funds are improperly allocated, resulting in potential financial crises, disrupted tax revenues, and further broadening the gap in income distributions.
With our increasingly digital world opening more and more doors to criminality – Airbnb and Uber, for example, have both been exploited by money launderers – it is clear that the fight against money laundering is going to require global cooperation and innovative solutions.
I have over 20 years of experience in the financial services industry and hold a Chartered FCSI qualification. I ensure that our operations are fully compliant with the rules of our most stringent regulators.