How does money laundering work?

September 30, 2021
money laundering

Money laundering is a method used by criminals to conceal the illegal source of their revenue. Money is “cleaned” of its illicit origin and made to seem like legitimate business profits by moving it through intricate transfers and transactions, or through a series of businesses.

Source A as money that originates from a clean, legal Source Z. When illegal monies are incorporated into the financial system, they appear to come from legitimate sources such as drug trafficking, terrorism financing, arms and weapons smuggling, prostitution, and human trafficking. Criminals accomplish this by concealing the origins of funds or shifting the funds to a location where they are less likely to attract attention. Placement, Layering, and Integration are the steps of money laundering included in this process.

The Need for Money Laundering

Large, organized criminal organizations such as drug smuggling operations face a severe commercial difficulty in that they wind up with large sums of money that they must conceal in order to escape legal authorities conducting investigations. The beneficiaries of such vast sums of money also do not want to be forced to declare it as income, resulting in massive tax implications.

To deal with the dilemma of having millions of dollars in cash obtained by illicit means, criminal enterprises devise methods of “washing” the funds in order to conceal the illegal nature of their acquisition. In a nutshell, money laundering is the process of concealing unlawfully obtained funds by transferring them to a legitimate financial sector, such as a bank or remittance.

How Money Laundering Works

Money laundering usually takes place in three stages:

  • The initial flow of money gained by illicit activities into a legitimate financial network or institution is known as initial entry or placement.
  • Layering is the process of moving money via several transactions, forms, investments, or businesses in order to make it very impossible to track it back to its illicit source.
  • Final integration occurs when money can be freely used legally without the need for further concealment.

Example of Money Laundering

One of the most common and straightforward techniques of “washing” money is to send it through a restaurant or other establishment with a high volume of cash transactions. In fact, the word “money laundering” stems from infamous mobster Al Capone’s practice of laundering large sums of money through a chain of laundromats he owned.

The following is a typical example of how money laundering works:

Initial positioning

A respectable restaurant is owned by a criminal or criminal group. Through the restaurant, money gained through unlawful acts is progressively put into a bank. The restaurant reports substantially higher daily cash sales than it actually receives.

Let’s say the eatery receives $2,000 in cash in a single day. An additional $2,000 will be added to that amount of money obtained through criminal acts and the restaurant will fraudulently declare $4,000 in cash sales for the day. The funds have now been deposited in the restaurant’s actual bank account and look to be standard restaurant business proceeds deposits.

Criminal entities enter the company ecosystem as a consumer, investor, or vendor at this level. Placement can be done in a variety of ways, some of which are listed below.

  • Physical transfer of currency or financial instruments such as bonds or demand drafts across borders is referred to as currency smuggling.
  • A banker who intentionally accepts deposits from smugglers and criminals and perpetrates scams such as cuckoo smurfing is known as an accomplice bank.
  • Securities broker – A securities broker is someone who divides an investment into multiple tranches to avoid suspicion.
  • Blending funds – To keep their money laundering strategy hidden, criminals may set up shell corporations. Then they begin to combine the filthy money with genuine business money. It’s the equivalent of concealing cash within cash.
  • Asset Purchases – Purchasing large assets is the most obvious way to launder money. It can be difficult to trace back the source of income once the transaction has taken place.
  • Currency exchanges – The 9/11 terrorist attacks demonstrated that currency exchanges were being utilized to transmit criminal proceeds from one country to another.

Layering the money

To avoid a high tax payment as a result of recording more revenue than it earns, the restaurant may invest the additional deposited monies in another legitimate business, such as real estate, to further obscure the unlawful source of the funds. Shell firms or holding companies that control many company enterprises through which the laundered money may be diverted further obfuscate things from authorities.

It may pass through a casino to be disguised as gambling winnings, go through one or more foreign currency exchanges, be invested in the financial markets, and finally be transferred to accounts in offshore tax havens where banking transactions are subject to much less scrutiny and regulation. Multiple pass-throughs from one account or business to another make it more difficult to track money back to its illicit origins.

Final integration

The money is then invested in legitimate businesses or personal accounts in the final phase of money laundering, integration. It can be used to buy high-end luxury items like jewelry or automobiles. It may even be used to set up a new corporate entity to launder future quantities of unlawful cash.

The money has ideally been adequately laundered at this point, allowing the criminal or criminal enterprise to use it freely without resorting to criminal measures. The funds are usually either legitimately invested or swapped for valuable assets such as real estate.

Why Is Money Laundering a Really Serious Issue?

Money laundering has the potential to have severe economic, security, and societal ramifications. It allows drug dealers, terrorists, illicit arms dealers, corrupt government officials, and others to operate and expand their criminal enterprises. The reach of crime has grown increasingly worldwide. Due to significant technology advancements and the globalization of the financial services industry, the financial components of crime have gotten more difficult.

Money laundering is a concern in emerging nations as well as the world’s major financial markets and coastal countries. Emerging markets are becoming more attractive targets for money laundering as their economies and banking sectors open up. Money laundering produces huge swings in global capital flows and currency prices by causing unforeseen movements in money demand.