Money Laundering: History, Regulations, and Techniques
- Benjámin VillányiBenjámin VillányiDepartment of Economics, Bar-Ilan University
The goal of money laundering is to hide the tainted origin of criminal revenue. In this sense, it is a secondary crime that is always connected to another breach of law. These offenses can be different types of theft, trade in illicit goods, as well as other non-violent acts such as tax fraud, bribery, and, nowadays more relevantly, cybercrime. Depending on the size of the unlawful income, criminals may launder on their own or collaborate with other specialists. Especially in cases of large-scale tax evasion, grand corruption, transnational drug trafficking and similar highly organized forms of crime, laundering can entail very complex schemes performed in multiple countries. To describe and analyze this activity, a three-stage model is a widely accepted framework. The placement is the first step, when the illicit money is introduced into the financial system. The layering involves multiple transactions to remove the traces of these funds, while in the last stage criminals attempt to integrate the laundered money into the legal economy through various kinds of investments.
Beginning with the 1970s, increasing international cooperation aimed to counter this activity and set standards that were later adapted to national judicial systems. Different types of crime were the focus of such approaches, which also shaped the methods used. During the Prohibition era rum-running and illegal gambling raised the most concern, later the war on drugs, and from the early 2000s the war on terror, and more recently the cryptocurrencies are in focus of anti-money laundering. The financial extent of worldwide money laundering is difficult to estimate with reasonable precision, but it is comparable to national economies in magnitude. Money laundering can have a social as well as financial impact, especially when it helps corrupt politicians to stay in power, decreases tax morale to unfeasible depths or enables organized criminals to take over whole economic sectors and geographic areas.
Definition and Origins
Money laundering is the conversion of criminal incomes into assets that cannot be traced back to the underlying crime (Reuter & Truman, 2004, p. 1). Other authors may use a slightly different wording, but generally they stress two basic elements: the first is the illicit source of the funds, while the other is the process to make them appear as legal. The illicit source refers to a predicate offense, which can be either a typical “blue-collar” crime, such as various forms of theft (e.g., robbery or burglary), drug trafficking, pandering, or other less violent, “white-collar” crimes, like tax evasion, corruption, and embezzlement.
In contrast with this economic approach, the legal point of view focuses on four distinct groups of activities: the conversion or transfer of property knowing its illicit source; the concealment or disguise of its unlawful origin; the acquisition, possession, or use of such property; and any kind of participation in the illegal activities (UNODC, 1988). This became a standard definition for many international organizations, and numerous countries adapted it in their national legal systems (EU, 2015; Levi & Soudijn, 2020, p. 7).
Although it lacks evidence, it is a widespread belief that the term comes from the notorious Prohibition-era gangster Al Capone, who allegedly used laundries as cover firms to hide his illegal revenues. However, the first well-documented use of the phrase can be dated back to the Watergate scandal, around 1973, as the Oxford English Dictionary states. While preparing this article, another earlier example emerged from the Life magazine as well (Oulahan & Lambert, 1967). Whichever is true, both illustrate the mechanism of the process. A gangster can illegally sell alcoholic beverages and then put the money into the cash register of a laundry, claiming falsely that the money is coming from a legal activity. In the Watergate scandal large amount of cash was deposited in Mexican banks, which was later transferred back to the United States, thus hiding the origin of the money and the identity of the donors funding the Republican campaign (Rosenbaum, 1974).
Bulk Cash Smuggling
Before the process of money laundering, several organized crime groups need to transport their revenues back to their native countries. As bulk cash smuggling increases the risk of being caught, many authors consider this stage as a preliminary phase, which precedes money laundering itself. To mention a well-known example, Latin American drug cartels typically generate their income in European or North American states and use a specialized network to smuggle their illegal revenue back to their country of origin (USDT, 2018, pp. 20–23). In the absence of significant economic ties between these countries, which could cover up the illicit flows, they usually contact a money broker to organize the smuggling. These brokers have connections in the target countries, known as coordinators, whose role is to find cash couriers and other complicit individuals (Soudijn & Reuter, 2016, pp. 273, 279).
The criminal income is typically in smaller denomination banknotes, which needs to be changed into the highest denomination available to make the smuggled amount physically the most compact as possible (Riccardi & Levi, 2018, pp. 141–142). It is the task of the coordinator to find high denomination banknote suppliers, who usually work at banks, post or exchange offices. While in the United States it is not uncommon to pay with a $100 bill, in the Eurozone the €500 bill is frequently called the “Bin Laden banknote,” as it is mostly used in questionable transactions (Sands, 2016, p. 12). According to a European Central Bank report, on average, 81% of the respondents have not had either a €200 or a €500 note in their possession for a year (Esselink & Hernández, 2017, p. 44). To a limited extent, the 1,000 Swiss franc bill plays a similar role (FATF, 2015b, p. 54).
Soudijn and Reuter (2016, p. 278) found that the caught cash couriers carried on average €300,000, which only weighs approximately 0.7 kilograms and has a volume of 3 litres in €500 banknotes (Sands, 2016). These cash couriers often volunteer from the ethnic group of the offenders, and they retain a certain percentage for their services along with getting a free flight ticket. There are specialists to modify suitcases, transport couriers to the airport, and ensure check-in, while others collect the smuggled money if the couriers can eventually circumvent the border control. Soudijn and Reuter (2016) estimated that the total cost of the smuggling can be above 10% of the total value.
Authorities report various methods to conceal banknotes. Besides suitcases fitted with a concealed compartment, cash couriers can hide the money among their clothes or on themselves. There were cases when transporting vehicles had secret compartments filled with cash, but customs officers of several countries caught large amount of money bundles in different types of cargo as well. The quickly growing e-commerce also offers criminals an opportunity to send money in mail parcels with less suspicion. Others may try to circumvent cash declaration rules by either underreporting or willfully neglecting declaration (FATF, 2015b).
Process of Money Laundering
Before discussing the different stages, a distinction should be made, whether a criminal needed the help of another person to launder the illicit revenues or not. Evidence suggests that most offenders self-launder, simply because they do not make that much money which would necessitate a specialist (Levi & Soudijn, 2020, p. 16). A pickpocket or a low-level drug dealer in most cases does not raise any suspicion by paying the rent or the utility bills in cash; therefore, they do not need to launder in a classic sense. A slightly larger amount may need laundering, but it can be still easily commingled with legal revenues of a cash-intensive front company, like the laundry or a bar.
For more complex cases a three-stage model, proposed by William Rosenblatt, is a widely accepted framework to analyze the process of money laundering (FATF, 1991; Levi & Soudijn, 2020, p. 4; US Senate, 1990, pp. 4–5). The procedure starts with the placement, when the illicit funds are collected from their sources and are introduced into the financial system. Then comes the layering, when various, often complex transactions are executed in order to distance the money from the committed crime. During the last stage, called integration, these assets are converted into seemingly legitimate funds using a formally legal business entity (USDT, 2018, p. 2). Other authors distinguish more steps and stress that not all stages are necessary during the process (Levi & Soudijn, 2020, p. 4; van Duyne, 2003, p. 79).
More traditional forms of crime, such as drug and human trafficking, are cash-intensive activities and usually require placement. Criminals may partially sidestep this stage by directly paying co-offenders or other partners in cash or handing over valuables (e.g., jewels, gems, or gold), but if they generate a significant illicit profit, this is not viable. During the placement, the goal is to deposit the cash into an account of a financial intermediary or transfer it using a money remittance provider. However, criminals want to avoid being detected, so they use several techniques to conceal the unlawful origin of their revenues.
The illicit income is often split into multiple parts (structuring or smurfing) to circumvent reporting thresholds (USDT, 2018, pp. 23–25). In the absence of a proper monitoring system, a criminal could deposit smaller amounts several times at various branches of a bank if these transactions were not connected. Obviously, the criminal would still risk confiscation, so straw or front men or women are frequently employed to open and operate bank accounts. One possibility is to find complicit relatives or friends, in many cases the offenders’ wives or girlfriends (Kleemans et al., 2014, pp. 27–28; Soudijn, 2010, p. 409). Another solution is to recruit a money mule who will open an account, transport cash, or deposit it as needed. They are typically socially marginalized people having economic difficulties, who offer their services in exchange for a smaller amount. Many of them are homeless people, drug addicts, alcoholics, or students in a dire financial situation, who either do not understand their role in the illegal activity or are willingly turning a blind eye to it (Kruisbergen et al., 2019, p. 576; Levi & Soudijn, 2020, p. 33). If criminals have complicit connections in a bank, they may steal and use the documents of a third person, which is called identity theft.
In the next stage of layering a complex scheme of wire transfers or foreign money orders is used to hide the origin of the deposited cash. Higher reporting standards increased banking transparency in recent years, so criminals started to use more sophisticated methods to achieve their goal. However, financial innovations, globalizing financial markets, and less detailed reporting of ultimate owners in certain jurisdictions facilitated their job.
The more illicit revenue the offenders make, the more likely it is that they would employ a professional money launderer. Depending again on complexity, this can be a single individual who may have professional expertise in accounting, financial advisory, legal counselling, or company registration. For more complicated cases such experts can create a professional money laundering organization, where the members can specialize to separate fields, thus offering criminals a more advanced service. These organizations may cooperate internationally and form a professional money laundering network. Due to the general problem of limited observation, it is hard to tell to what extent criminals use such networks, but highly organized crime groups, tax evaders, and high-ranking corrupt politicians typically collaborate with professionals to obfuscate the illicit source of their revenues (FATF, 2018, pp. 12–13).
The role of money mules is crucial in the layering stage. Their work is often coordinated by a money mule herder, who is directing their activities and is responsible for their recruitment and remuneration. Money mules often apply for online job advertisements offering a transaction manager or a seemingly similar administrative position. Their task is to either actively perform transactions with their bank accounts, or just to pass their credentials to their herder (FATF, 2018, pp. 22–24). As Cifas (2019) reported, in 2018 authorities detected 40,139 money mule accounts in the United Kingdom, which is a 26% growth with respect to the previous year. Of the individuals in their sample 70% were males and 50% of them were 26 or younger, who were mainly recruited via social media and instant messaging (Cifas, 2019, p. 10).
The money mules usually quickly forward the illicit income abroad or to companies with an opaque ownership. There are certain jurisdictions, where bank secrecy provides a haven for money launderers, and it is easier to open bank accounts owing to lax customer due diligence. Another issue is the case of shell companies, which are firms that do not conduct real economic activities, and just have a bank account and a letter box. Again, many countries and states facilitate the obscuration of the beneficial owners of such firms, consequently, foreign authorities may find it difficult during an investigation to identify the ultimate natural person who actually owns the company. Trust are especially suitable for this purpose because the settlor (i.e., the person who provides the assets to the trust) can create significant legal distance from the beneficiary (i.e., the person who is entitled to the benefits of these assets). There are specialized enterprises, called trust and company service providers, who may willingly assist criminals to set up such complex networks. To further decrease suspicion, they can offer their clients shelf companies, which had been founded in advance and were left without a real business activity, just to be taken over by a prospective client. Once having a network of shell companies or infiltrated firms with real activity, the money launderers can create fictious contracts to provide a seemingly satisfactory documentation, which would, at least on paper, necessitate such transactions (FATF, 2010).
One of the oldest money laundering schemes, called loan back, is anecdotally attributed to another notorious Prohibition-era mobster, Meyer Lansky. After learning in 1931 that Al Capone was sentenced to 11 years in prison for tax evasion, he realized the necessity of moving his illicit income abroad and removing its traces as much as possible. Switzerland had long been known for its bank secrecy, but the Federal Act on Banks and Savings Banks of 1934 raised existing regulations to a federal level. The most important feature was the possibility to open numbered accounts, and it became a federal crime to disclose the owners and the transactions of these accounts, unless the owner consented, or a Swiss court approved such request. Lansky started to move his funds to Swiss numbered accounts, and many journalists connected him with the Banque de Crédit International in Geneva and other banks in The Bahamas. As soon as the money from illegal gambling was deposited into these numbered accounts, he could get a seemingly legal “loan” secured by the unlawful account balance at these complicit banks (Farnsworth, 1975; OECD, 2019, pp. 63–66; Oulahan & Lambert, 1967).
Trade-based money laundering, a type of invoice fraud, is a similarly widespread scheme. In its simplest form, the criminals have two infiltrated companies at their disposal, which can be owned by professional money launderers. Depending on need, these businesses can be registered in different countries. To transfer money between the places, they trade in various types of goods, which can be physically delivered or solely exist on paper (phantom shipping). To move funds from Firm A to Firm B, the latter will over-invoice or deliver less than written in the packing list, called short shipping. To transfer money in the opposite direction, Firm B may under-invoice or do an over-shipping. The seller can also issue multiple invoices for the same goods, one for the shipment and another for accounting purposes (Cassara, 2016, pp. 13–31; OECD, 2019, pp. 59–63).
During the last stage, known as integration, criminals attempt to use the funds from the layering to perform ostensibly legal economic transactions. The money from the loan back scheme can cover the acquisition of real estate, other forms of investment or luxuries. Organized criminals can infiltrate the legal economy by founding new firms using figureheads or by taking over existing ones with coercion. In different countries diverse economic sectors can attract them, yet they commonly target cash-intensive businesses, like the catering industry, tourism, entertainment, transportation, and construction. Labor-intensive industries with high unreported labor also facilitate laundering, although criminals may decide to formally employ themselves and their relatives in fictious positions to decrease suspicion. In Italy sectors with high public spending are also prone to infiltration due to collusion between the organized crime and public officials (Mirenda et al., 2019, pp. 14–15). Nonetheless, it does not mean that other sectors are totally free of criminal presence. A notorious case resulted in the Italian anti-mafia authorities seizing €1.3 billion of a businessman who operated one-third of the Sicilian wind farms (Faiola, 2013).
For trade-based schemes, the goods bought at a below market price can be sold on the legal market with an excess profit. In 2016 a Europe-wide cooperation of the authorities uncovered an Iraqi organized crime group laundering income from heroin trafficking. The offenders shipped used cars, machinery, and construction equipment from Germany to Iraq, where they sold them on the legal market. Later they transferred the revenues back using remittance providers and an informal value transfer system called hawala, which is widespread in the Middle East and North Africa (FATF, 2018). The hawala has been facilitating long-distance trade for centuries. Assuming that Individual A owes money to Individual B in a distant country, A approaches a hawala broker X, called a hawaladar. Then A shares a password or token with both X and B, while X contacts another hawala broker Y in the country of B, who, upon B tells the correct password, pays the sum to B. If a significant balance accumulates over time, X and Y settle it. A key element of the whole system is honor, where individuals not keeping their word are excommunicated (FATF, 2013, p. 23). Hawala is known as hundi on the Indian subcontinent, but several similar systems exist, such as the fei chien or flying money in China (Cassara, 2016, pp. 73–88).
Money Laundering in the Information Age
By the first years of the 21st century internet has become a commonplace in the Western world, and a couple of years later the developing world also followed this trend. Mobile phone usage is now self-evident in Asia and Africa as well, and in a few years smartphones and online banking will have a similar penetration. Criminals have to adapt to the new environment, and they definitely will, just as they switched from horse theft to car theft, and evidently nowadays more smartphones are stolen than car radios. This adaptability skill is essential in crime, and money laundering is no exemption.
The relevant feature of this technological development is the introduction of monetary transactions on the internet. Electronic commerce and banking have a growing share in the economy, and new forms of crime have developed to exploit the new vulnerabilities. Classic confidence tricks are now done online (e.g., Nigerian Prince scam, romance scam), and new ones, like ransomware, have been developed to extract money from victims. A common element of these frauds is that, except for a few cases, they do not involve cash, hence the placement stage is mostly skipped. Criminals either trick or coerce victims to wire transfer the demanded money to their account, thus they can directly start with the layering phase (Levi & Soudijn, 2020, p. 4). The advent of digital marketplaces also reshaped illicit trade. Illegal drugs, firearms, child sexual abuse images, animal products are widely sold at specialized sites on the darknet, and many professional money launderers advertise their services on such pages (FATF, 2018, p. 11). On multiple occasions criminals tried to launder their illicit revenues using gift cards of a leading technology company (BBC News, 2020; FATF, 2020, pp. 23–24), while the ease of opening bank accounts online and having pre-paid cards pose a significant laundering risk.
In 2009 bitcoin was launched, the first cryptocurrency to become widely used. This type of digital currency enables quick, cheap, secure, and fully anonymous transactions in the virtual space. Although payments by means of bitcoins in the real world have not yet become prevalent, it is possible to exchange them and other similar cryptocurrencies into conventional money. This possibility is widely used in cybercrime, especially malevolent, black hat hackers extort ransom in form of cryptocurrencies although current evidence shows that, at least for the time being, it has only gained limited popularity in offline crime. There are various possible explanations, among them the volatile exchange rate, the limited convertibility to real products and services, security concerns, and the unfamiliarity with the new technology. Another threat from the money laundering perspective is the presence of cryptocurrency tumblers or bitcoin mixers. Originally these platforms aimed to increase anonymity by obscuring the origin of the mixed amount, since cryptocurrencies record each transaction in the given unit itself utilizing the blockchain technology. Nevertheless, this has soon become a common tool of cybercriminals to hide their traces in monetary transactions. Both cryptocurrency exchanges and mixers retain a certain transaction fee for their services, which is higher when the money is known to be unlawful, but still lower than the costs of cash smuggling. During the layering stage money mules are used in a similar way as in the case of conventional money (Kruisbergen et al., 2019, pp. 574–578).
Many sectors getting digital are jeopardized by criminal activity, and the quick growth of online gambling was expected to pose a threat to the fight against money laundering. Betting and gaming have been for long used by criminals to launder money. Even if there are no fixed matches, marked decks, rigged slot machines and roulettes, offenders can still obtain winning lottery or horse racing tickets at a premium to cover up the source of their wealth (Reuter & Truman, 2004, pp. 28–29). Yet there are risks that need to be addressed in online gambling. A concern arises when sites are registered in countries with lax regulation, but should that occur, countries may decide to block access to them. Winnings and unused money may be transferred back to a different account than from which the bet was made, which is a way to move funds across borders. There are other risks associated to front gamers acting on behalf of others such as game fixing to incur deliberate losses and payments from banks in less regulated countries. Yet all of them apply to gambling in person, and there are considerably more ways on the internet to collect data and monitor activity, not to mention the better traceability of payments. Proper customer identification, betting limits, sanctions for unfair playing, and statistical profiling of gamers can prevent abusing legal providers, and they are frequently easier to implement in the virtual space than in the real world. Limited evidence also suggests that online gambling does not mean a bigger risk than its traditional counterpart (Levi, 2013).
Social and Economic Impact
It is difficult to see the direct effect of money laundering on people’s everyday life (Unger, 2013, p. 20). Usually classic criminal offenses, such as violent crime, substance abuse, corruption, or internet fraud, raise more concern in society. In this sense money laundering is a secondary crime, a side product of various predicate offenses. However, if money laundering conceals the evidence and prevents corrupt politicians and officials to be indicted and removed from power, it can lead to unfair competition in elections, which eventually results in democratic backsliding. Terrorist financing, which is closely related to money laundering, can also facilitate democratically elected governments to be overthrown with all its consequences (Jojarth, 2013, pp. 23–24).
The economic effect is similarly less clear cut. In the long term, infiltrated companies using laundered money have an unlawful advantage compared to those ones adhering to the law. If money laundering is not restricted to a minimal level, not the most profitable projects are realized, but the ones with the lowest risk of detection, which can ruin in the end certain economic sectors without state intervention (Jojarth, 2013, p. 23). Evidence shows that the presence of organized crime harms economic growth (Pinotti, 2015), and public procurement contracts awarded to politically connected firms suffer from lower performance both from a cost and a quality perspective (Schoenherr, 2019). Evidently, both organized crime and grand corruption are resorted to money laundering.
Several attempts have been made to quantify the extent of money laundering, although these estimates should be treated with much caution (Levi & Reuter, 2006, p. 327; Reuter, 2013). A classic method of estimating criminal revenues is to compare the gross domestic product calculated from the production and the consumption side. Theoretically, they should match, any difference is due to measurement or methodological errors and crime, even though it is extremely difficult to tell the two apart. This estimate has to be further elaborated by taking into account the profit and its share that is eventually laundered (Walker & Unger, 2009). To name a few other approaches, one may similarly analyze the errors and omissions in the balance of payments or compare the printed amount of currency with the quantity that is actually circulating (UNODC, 2011).
Besides money laundering, another term was popularized during the presidency of Richard Nixon, namely the war on drugs. In connection with the Comprehensive Drug Abuse Prevention and Control Act of 1970, substance abuse was declared a public enemy. Almost all current national and international money laundering regulations are the result of the struggle in those years to counter illegal drug trafficking, because the main part of money laundering activity in the United States was related to the market of illicit substances. Since the origins of these revenues needed to be disguised, serious efforts were made to fight against it, which promoted international cooperation leading to the first worldwide agreements.
Financial Crimes Enforcement Network lists the timeline of the most important laws related to money laundering in the United States. The Bank Secrecy Act of 1970 required financial institutions to report large cash transactions. A second important step was the Money Laundering Control Act of 1986, which established money laundering as a federal crime, and listed drug and human trafficking, smuggling, bribery, fraud, and murder among others as predicate offenses. A completely new era began, when the September 11 attacks destroyed the World Trade Center in New York. Despite the main objective of the USA PATRIOT Act of 2001 to combat terrorism, as a side effect it introduced measures against terrorism financing which improved reporting standards and enhanced customer identification procedures as well. More recently, the 2020 coronavirus pandemic contributed to the efforts to fight illegal trade of animal products (FATF, 2020).
The United Nations also created three major treaties against illegal substances, and the Vienna Convention in 1988 raised the attention on money laundering too (United Nations, 1988). The G7 summit of Paris in 1989 was a milestone on a supranational level, which established the Financial Action Task Force (FATF) on money laundering. FATF released 40 recommendations that required the member states to pass laws in order to criminalize money laundering, enable confiscation of assets coming from this activity, introduce customer due diligence, report suspicious transactions, and cooperate with other countries (Levi, 2001). In the subsequent years on multiple occasions these recommendations were amended or new ones were added to them (FATF, 2019).
As of 2020, the European Union has passed five directives about money laundering and set up a FATF-like monitoring body, Moneyval, which reports to the Council of Europe. The first directive, 91/308/EEC referred to the 1988 UN treaty. In addition, it aimed to include terrorism and revenues from various forms of organized crime other than drug trafficking. The second, 2001/97/EC extended the scope regarding both the covered institutions and types of crime. The 2003 revision of FATF recommendations included terrorism financing, which were added in the third directive (2005/60/EC). The fourth directive (2015/849) implemented the 2012 FATF revision, reduced the reporting threshold, added letting agents, gambling service providers, and art dealers to the obliged entities, required central beneficial ownership registers to be created, and gave a more precise definition of politically exposed persons (PEP) among others. The fifth directive, (EU) 2018/843, formally amending the fourth one, made the beneficial ownership registers public, increased the transparency of trusts, addressed the issue of virtual currencies, and required the disclosure of pre-paid card owners above a certain threshold.
Since 2000 the FATF publishes the list of non-cooperative countries or territories, which are the jurisdictions that do not implement the recommendations on a satisfactory level. The methodology of this blacklist was later revised many times, and different categories were introduced to better reflect the level of cooperation. In spite of a serious, worldwide level improvement in money laundering regulation, many people criticized FATF for adding or omitting certain countries (Jojarth, 2013, pp. 25–26). As of February 2020, only North Korea and Iran were among the high-risk jurisdictions.1 The grey list, referred to as jurisdictions under increased monitoring, included mostly developing countries with high rate of poverty (e.g., Albania, Yemen, and Zimbabwe) and only two more familiar countries were present (The Bahamas and Panama).
Numerous authors argued that the biggest offshore centers, which made money laundering remarkably easy through their high secrecy and low customer due diligence, operated in highly developed countries. Delaware, Wyoming and Nevada in the United States are states notorious for facilitating the creation of secretive shell companies (Tax Justice Network, 2020, pp. 5–7; van Duyne et al., 2018, p. 236). The United Kingdom is known for the high secrecy in its overseas territories and crown dependencies, like Bermuda, British Virgin Islands, Cayman Islands, Jersey, and Guernsey (Garcia-Bernardo et al., 2017). These territories offer both offshore services and no need to disclose beneficial ownership, which, on the one hand, enable unethical, yet formally legal tax-base erosion and profit shifting, but also serves as a haven for layering transactions of outright illegal tax evaders, corrupt politicians, and organized crime groups.
But not only remote islands are prone to regulation deficiencies. Several countries have recently improved their anti-money laundering regimes after a scandal causing international outrage. In 2007 and 2009 data on tax evading clients was leaked from leading Swiss banks, which contributed to the fact that Switzerland joined the Agreement on the Automatic Exchange of Information and has been sharing taxation data since 2018 (Swissinfo, 2019). Cyprus had a significant offshore banking sector, which attracted many Russian investors, including a few criminals. However, the 2012–2013 financial crisis in the country totally reshaped the banking sector, which puts now a far greater emphasis on fighting money laundering according to the 2019 Moneyval assessment. Following the murder in 2017 of Maltese investigative journalist, Daphne Caruana Galizia, who reported in detail about corruption and money laundering, Moneyval and the International Monetary Fund sharply criticized the inefficient Maltese regulation and incompetent authorities, and demanded swift changes (Borg, 2020). The 2017–2018 Danske Bank scandal demonstrated how fragile the system was, as approximately €200 billion could have been laundered through Danske Bank’s Estonian subsidiary. Investigative journalists connected the transactions with high-ranking corrupt Russian and Azerbaijani politicians (Milne & Binham, 2018). The Financial Crimes Enforcement Network of the United States Department of the Treasury (FinCEN, 2018) named the Latvian ABLV Bank an institution of primary money laundering concern cooperating with the North Korean regime, which eventually led to the bank’s voluntary liquidation. Although Cyprus, Estonia, Latvia, and Malta are full members of the European Union, they all failed to implement a sound monitoring system.
Anti-Money Laundering in Practice
International treaties and their national counterparts significantly changed the way how the financial system operates now. By reorganizing and reinforcing previously existing institutions, financial intelligence units (FIU) were set up in the participating countries. Various government organizations can supervise these units, but in all cases a strong cooperation is needed among the different government departments, the central bank, the tax authority, the police, and the judiciary. It is the role of these institutions to adapt and implement the recommendations to the national legal system and to enforce them.
The relationship of these measures and the private sector is ambiguous because financial institutions lose the income generated by their criminal clients, while reporting and compliance entail a substantial cost. The financial sector typically passes on these costs to their clients, who sometimes cannot even afford a bank account (Jojarth, 2013, pp. 27–28). Consequently, lower social classes and poor countries may maintain high cash usage, which provides an ideal environment for money laundering. To prevent this, the European Union introduced affordable payment accounts with basic features through the directive 2014/92/EU, although in many countries no similar solutions are available for marginalized citizens, and instead various informal value transfer systems are used.
Financial intermediaries must perform numerous tasks to comply with the regulations and mitigate money laundering risks. The first step is to thoroughly identify new customers and then track any further changes (know your customer—KYC). All cash transactions above a certain threshold (currency transaction report—CTR), wire transfers from FATF blacklisted countries, various suspicious transactions (suspicious activity report—SAR), activities of PEP have to be reported. If these reports are not well-designed, and obliged entities are excessively punished for not informing government agencies of certain activities, it can have an undesirable effect of over-reporting. This poses a serious challenge to authorities that may not be able to select the important ones when flooded with irrelevant cases (Takáts, 2011).
In order to efficiently allocate resources both at financial institutions and supervisory agencies, the 2012 update of the FATF recommendations transitioned to a risk-based approach. Besides banks, now insurance companies, money and value transfer providers, different brokerage firms, and legal counsellors must use this method as well. The supervised institutions need to identify and mitigate risks related to customers, geographic area, and type of service. For example, a foreign cash-intensive business from a country infamous for corruption executing remote transactions should deserve more attention than a local pensioner, who may execute high-value cash transactions but has enough savings and does not receive any money, except for the monthly pension.
Even so, these systems can utterly fail if the only goal is to tick all the boxes. In 2014 a Hungarian newspaper reported on a former drug addict who applied for a job at a construction company. His employment was never reported, and his only task was to withdraw cash from the bank account of the firm. He withdrew approximately €6 million equivalent, which he handed over in bags to his employers in cars or cafés. It turned out that the manager and one of the owners were foreign nationals, one having a travel visa, while the other entered the country illegally. During the investigation the manager vanished, and the owners claimed that they had been victims of identity theft and did not know anything about the company, which was registered in an unfinished building. Despite all, the tax authority, which coincides with the local financial intelligence unit, debited a €4 million fine to the account of the straw man, and the real tax fraudsters were never caught, as the statute of limitations expired. This case illustrates the necessity of awareness, good communication and sound procedures both from the bank and the authority side (Halmos, 2014).
Review of the Literature and Primary Sources
Crime literature is usually more concerned with the laundered money of criminal organizations. Levi (2015) has listed various research projects in American and European countries, where illegal funds were coming from human and drug trafficking. Crime infiltration in legal economy is another current topic, where firms are used as vehicles to disguise the illicit origins of money (Mirenda et al., 2019). As money laundering has close ties with terrorism financing, after the September 11 attacks both legislature and research had more focus on it (Verhage, 2011, p. 39). A different example that has lately gained wide attention is the laundering of revenues from oil and antiquities smuggling in the Islamic State (FATF, 2015a).
Economists are more interested in analyzing the “white-collar” part, such as the relationship of tax enforcement and misuse of corporate funds (Desai et al., 2007), and the effect of tax evasion on firm value (Mironov, 2013). In 2016 a worldwide scandal erupted, when millions of documents were leaked from a Panamanian corporate service provider, containing detailed information about corrupt politicians and tax evaders. Since data is usually scarce on money laundering, the Panama Papers fostered research in this topic (O’Donovan et al., 2019). The effect of cryptocurrencies on usury and the money laundering risks of initial coin offerings were simulated Barone and Masciandaro (2019), and more research is expected in the field of this technology.
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1. Owing to the pandemic, the FATF suspended the mutual evaluation process on April 28, 2020.