What is Money Laundering?

  • October 25, 2020
  • Posted by: OptimizeIAS Team
  • Category: MMN
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What is Money Laundering?

  • Money laundering is the process of making the proceeds of criminal activity appear to have been legally obtained.
  • According to the IMF and World Bank, criminals launder an estimated two to nearly four trillion dollars each year.
  • Money laundering is the illegal process of making large amounts of money generated by a criminal activity, such as drug trafficking or terrorist funding, appear to have come from a legitimate source. The money from the criminal activity is considered dirty, and the process “launders” it to make it look clean.
  • The prevention of money laundering has become an international effort and now includes terrorist funding among its targets.

How is money laundered?

1. Initial stage of money laundering :placement

The launderer introduces his illegal profits into the financial system. This might be done by breaking up large amounts of cash into less conspicuous smaller sums that are then deposited directly into a bank account, or by purchasing a series of monetary instruments (cheques, money orders, etc.) that are then collected and deposited into accounts at another location.

2. Secondstage : layering

In this phase, the launderer engages in a series of conversions or movements of the funds to distance them from their source. The funds might be channelled through the purchase and sales of investment instruments, or the launderer might simply wire the funds through a series of accounts at various banks across the globe. This use of widely scattered accounts for laundering is especially prevalent in those jurisdictions that do not co-operate in anti-money laundering investigations. In some instances, the launderer might disguise the transfers as payments for goods or services, thus giving them a legitimate appearance.

3. Third stage – integration

In which the funds re-enter the legitimate economy. The launderer might choose to invest the funds into real estate, luxury assets, or business ventures.

Who launders money?

  • Among those who seek to disguise the illegal proceeds of their crimes are drug traffickers, terrorists, corrupt public officials, and organized criminal groups. Introducing illegally obtained funds into the stream of legitimate commerce and finance allows criminals to profit from their illegal activity, taints the international financial system, and erodes public trust in the integrity of the system.
  • Some criminals use the financial system to support terrorists or acts of terrorism. Terrorist financiers and other criminals use the formal financial system, new payment methods such as bitcoin and Ripple, traditional methods of value transfer such as hawala*, trade based money-laundering, and cash couriers, particularly in countries with non-existent or weak national anti-money laundering/countering the financing of terrorism (AML/CFT) tools.

SOURCES OF TERROR FINANCING

1. INTERNAL

  • Extortion and Taxation, The biggest source of internal funding for terrorist groups in India remains extortion or taxation. This is especially relevant for groups in the Northeast and the Maoist affected areas.
  • The nexus between the regional political leaders and terrorist groups has allowed a degree of safety from prosecution, especially in northeast IndiaCorruption creates an environment, which facilitates the growth and sustainability of terrorism finance
  • Crime All acts associated with crime that are used to raise funds for terrorism go through a similar process as extortion to include committing the criminal act, moving the proceeds and finally using it for terrorism the former Home Minister, Chidambaram notes: It is our experience that the networks of terror overlap with the networks of drug-peddling, arms-trading and human-trafficking.
  • Non-Governmental Organizations A large volume of funds flow to non-governmental organizations (NGOs). This funding is received for a large variety of social work undertaken by the NGOs. However, unless there is close scrutiny of the funds, there remains the possibility of their diversion for terrorism.
  • the Financial Action Task Force (FATF) under five distinct factors. These are:
    • They enjoy public trust.
    • Have access to considerable funds.
    • Have a global presence, which facilitates transnational financial transactions.
    • Some of the beneficiaries can be vulnerable to radicalisation.
    • They often have little or no government oversight.

2. EXTERNAL

  • Narco Terrorism Narco terrorism also provides distinct trends in the Indian context. This form of terrorism finance operates at three distinct levels. First, taxation of drugs yielding crops like opium. Second, based on money earned from protection and trafficking through areas controlled by terrorist groups. Third, as a result of direct involvement of terrorists in cultivation and control of the drug trade. In case of countries like Afghanistan, all three levels of operations are functional and capable of supporting terrorism
  • Counterfeiting: Counterfeiting is an international trend. As per estimates of Chad Wasilenkoff, the CEO of banknote-maker Fortress paper, the global estimate is 100 counterfeits per one million.

SOURCE: IDSA Report on “the life blood of terrorism”

IMPACTS OF MONEY LAUNDERING

  • Business

unchecked money laundering, one can cite inexplicable changes in money demand, prudential risks to bank soundness, contamination effects on legal financial transactions, and increased volatility of international capital flows and exchange rates due to unanticipated cross-border asset transfers.

  • Society

it rewards corruption and crime, successful money laudering damages the integrity of the entire society and undermines democracy and the rule of the law.

  • Ethics

The integrity of the banking and financial services marketplace depends heavily on the perception that it functions within a framework of high legal, professional and ethical standards. A reputation for integrity is the one of the most valuable assets of a financial institution.

  • Economic development

There is a damping effect on foreign direct investment when a country’s commercial and financial sectors are perceived to be subject to the control and influence of organised crime. Fighting money laundering and terrorist financing is therefore a part of creating a business friendly environment which is a precondition for lasting economic development

  • Crime

It can also be the Achilles heel of criminal activity. Criminal funds are derived from robbery, extortion, embezzlement or fraud, a money laundering investigation is frequently the only way to locate the stolen funds and restore them to the victims.

Is Money Laundering an Independent Offence or predicative offence?

A reading of Section 3 of the PML Act shows that the offence of money laundering is inextricably linked to the proceeds of crime. So, if the accused is acquitted of the alleged Scheduled Offence, it would be possible to continue the prosecution of the offence of money laundering. The main object of the PML Act is to prevent money-laundering and confiscate the proceeds of crime. In that light, there exists an indissoluble link between the PML Act and the occurrence of a crime. Although it cannot be disputed that the offence of money-laundering is treated as an offence under Section 3, which is punishable under Section 4, the offence of money-laundering relates to the proceeds of crime, the genesis of which is a scheduled offence. The irresistible conclusion flowing from the statutory scheme, therefore, is that the offence of money laundering cannot be an independent offence. The decision of high court in Mahanivesh Oils & Foods Pvt. Ltd It is only after the registration of the predicate offence, investigation can be launched by Enforcement Directorate into whether proceeds of crime generated from the scheduled offence have been laundered or not 

ANTI-MONEY LAUNDERING (AML)

The AML Basel Index 2017, India ranked #88 (out of 146 countries) with a risk score of 5.58 (risk of money laundering and terrorist financing); US and UK were ranked 116 and 118. UNODC indicates that around 2-5 percent of worldwide GDP is laundered globally every year.

Anti-Money Laundering (AML) refers to a set of rules, policies, procedures and regulations implemented to mitigate the risks of money laundering and terrorism financing. AML procedures act as a safeguard against the risks associated with money laundering, including supporting crime and corruption, undermining the legitimate private sector, weakening financial institutions, and causing reputational, operational, legal and concentration risks.

Globally, AML regulations and policies are framed and monitored by the Financial Action Task Force (FATF), United Nations Office of Drugs and Crime (UNODC) and the Wolfsberg Group.

AML Framework in India–

FATF: In June 2010, India became a member of the FATF and was placed in the category of countries which required ‘regular follow up process’. In June 2013, India attained a satisfactory level of compliance and was removed from the regular follow up process.

PMLA: The act came into effect in July 2005; and was amended in 2009 (in force from June 2009) and in 2012 (effective February 15, 2013). The 2012 amendment brought India’s AML legislation at par with global norms. According to the Finance Ministry, as of February 2018, approximately 884 companies are under the scanner for money laundering and assets worth Rs.50 billion have been attached following probes initiated under PMLA.

A predicate offense – or predicate crime – refers to a crime which is a component of a larger crime. In a financial context, the predicate crime would be any crime that generates monetary proceeds. The larger crime would be money laundering or financing of terrorism. The plain reading of Section 3 and Section 2(u) of the PML Act would indicate that to constitute money laundering:

  1. There should be a property that is obtained directly or indirectly as a result of a criminal activity relating to a scheduled offence;
  2. A person should be involved in any activity relating to the concealment, possession, acquisition or use of the said property;
  3. A person should project or claim such property as untainted property.

The scheme of the Act mandates that pre-requisite for initiating an investigation into the offence of money laundering is the registration of a “predicate offence”. Predicate offence(s) are offences listed in the Schedules ‘A’ to ‘C’ to the PML Act.

Regulatory bodies –Financial Intelligence Unit (FIU) under the Finance Ministry, Government of India is the nodal agency for AML measures prescribed in PMLA.

Other Regulators for AML Checks are RBI (for Banks); IRDA (for Insurance); SEBI (for Asset Management companies), Enforcement Directorate (ED), CBI, Police and NCB.

What is round tripping AND its relation with P-NOTES?

  • Round tripping refers to money that leaves the country though various channels and makes its way back into the country often as foreign investment. This mostly involves black money and is allegedly often used for stock price manipulation. Round tripping is often done through a series of transactions that don’t have any substantial commercial purposes, which makes it fall within the trappings of GAAR.
  • It could be invested in offshore funds that in turn invest in Indian assets. The Global Depository Receipts (GDR) and Participatory Notes (P-Notes) are some of the other routes that have been used in the past. There are a number of observed factors that promotes round tripping. Mainly, Tax concessions allowed in the foreign country encourages individuals to park money there and then reroute it.

Financial action task force

  • The Financial Action Task Force (FATF) is an inter-governmental body established in 1989 during the G7 Summit in Paris. The objectives of the FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system.
  • Its Secretariat is located at the Organisation for Economic Cooperation and Development (OECD) headquarters in Paris. Member Countries: As of 2019, it consists of thirty-seven member jurisdictions. India is one of the members.
  • The FATF Plenary is the decision making body of the FATF. It meets three times per year

FATF lists:

  • Grey List: Countries that are considered safe haven for supporting terror funding and money laundering are put in the FATF grey list. This inclusion serves as a warning to the country that it may enter the blacklist.
  • Black List: Countries known as Non-Cooperative Countries or Territories (NCCTs) are put in the blacklist. These countries support terror funding and money laundering activities. The FATF revises the blacklist regularly, adding or deleting entries.

FATF & Pakistan

  • Pakistan was placed on the grey list by the FATF in June 2018 and was given a plan of action to complete by October 2019, or face the risk of being placed on the black list with Iran and North Korea.
  • Pakistan was previously placed on the FATF’s grey list in February 2012, and had been removed from the grey list in February 2015 after it passed a National Action Plan (NAP) to deal with terrorism after the Peshawar School massacre in December 2014.It was placed under severe restrictions in the years 2008-2012.
  • Pakistan addressed only 5 of the 27 tasks given to it to control funding to terror groups like the Lashkar-e-Taiba and Jaish-e-Mohammad — both responsible for a series of attacks in India.
  • The FATF noted the insufficiency of Pakistan’s implementation as “serious concerns”.
  • The latest decision to keep the country in ‘Grey List’ means that Pakistan was given time until February 2020 to fulfil its commitments or risks being blacklisted. However In its third plenary held virtually in June 2020, the FATF decided to keep Pakistan in the grey list as Islamabad failed to check flow of money to terror groups like Lashkar-e-Taiba (LeT) and Jaish-e-Mohammed (JeM).
  • The main purpose behind the decision is to not punish rather than incentivise, to make the required changes and make them faster.
  • In latest review October 2020, Islamabad cleared only 21 of 27 action points on terror financing Pakistan is unlikely to exit the Financial Action Task Force (FATF’s) grey list next week, when the plenary session of the Paris-based global terror-financing watchdog is held, after its latest evaluation saw it clear 21 of 27 action points, with six key areas outstanding where Pakistan has yet to show progress.
  • According to sources, there is still no consensus amongst the 39-member FATF, which includes the U.S., U.K., France, Germany, China and Russia, to blacklist Pakistan, despite its failure to meet its original deadline in September 2019, which would mean the group would maintain status quo and continue Pakistan on the grey list until February 2021.
  • Impact on Pakistan:
    • By remaining on the “Grey List”, it would be difficult for Pakistan to get financial aid from the International Monetary Fund (IMF), World Bank and European Union, making its financial condition more precarious.
    • However, there are no immediate implications for the recent $6 billion loan negotiated with the IMF that is to be disbursed over the next three years.
    • Fiscal deficit is projected at 7.1% of GDP in 2020, the highest in the last seven years.
    • Inflation is set to touch 7.3% in 2019, up from 3.9% in 2018, and rise to 13% in 2020.
    • The country is facing a number of economic challenges with its economy expected to grow at 3.3 % in 2019 and 2.6% in 2020, according to IMF.

COUNTERFEIT CURRENCY

Counterfeit money is imitation currency produced without the legal sanction of the state or government, usually in a deliberate attempt to imitate that currency and so as to deceive its recipient. Producing or using counterfeit money is a form of fraud or forgery. Fake Indian Currency Note (FICN) is a term used by officials and media to refer to counterfeit currency notes circulated in the Indian economy. Fake Indian notes are mainly used in terror related activities. The money mainly flows from Nepal, Pakistan and Bangladesh. The terrorists are using it to cripple the Indian economy and to create economic terror

How it happens in india?

  • Porous borders with Nepal
  • Inadequate strength of border forces
  • Criminal gangs act as conduits for smuggling currency
  • Inadequate availability of technical equipment to evaluate counterfeits
  • Inadequate incentives to detect counterfeit at banks
  • Laborious procedures to follow up counterfeit in banks
  • Movement in small amounts through legal channels like physical carriage by air
  • Corruption on borders

Steps to counter –counterfeit currency

  • Improved border management and technical sophistication can reduce counterfeit threat
  • Move from cash to cashless economy
  • Linkage of transactions with a unique citizen number
  • Improvements in technology can assist in making currency more difficult to counterfeit
  • Invoke international provisions to build pressure on Pakistan
  • Cases of counterfeit should be dealt under provisions of UAPA

RECCOMENDATIONS TO TACKLE MONEY LAUNDERING

IMF in its report

“India: Observance of Standards and Codes FATF Recommendations for Anti-Money Laundering and Combating the Financing of Terrorism “India continues to be a significant target for terrorist groups and has been the victim of numerous attacks.

  • improve the reliability of identification documents
  • effectively implements the AML/Combating financing of terrorism (CFT) requirements;
  • enhance the effectiveness of the financial sector supervisory regime

RECCOMENDATION BY IDSA PAPER “LIFE BLOOD OF TERRORISM”

  • MHA should be the apex policy making and coordination agency for Combating financing of terrorism (CFT).
    • The principle enforcement agency should be the NIA.
    • While intelligence will continue to flow from all central and state agencies, coordination, collation and analysis of intelligence specifically related to CFT should be handled by the NIA.
  • The NIA will remain in close coordination with the IB and the MAC to begin with and subsequently the National Counter Terrorism Centre (NCTC), as and when established to take on leads that may be provided for further action.
  • At the second tier, a High Powered Coordinating Committee (HPCC) will be headed by the Home Secretary and include members of all ministries and agencies involved in CFT.
  • third tier should be the Monitoring and Coordination Committee (MCC) fourth tier will comprise of task forces,
  • In order to encourage better coordination and inter-agency support, the annual report of each agency should indicate the number of cases taken up as a joint task force.

UN key aspects of terrorism finance:

  • Criminalisation of the willful provision or collection of funds.
  • Freezing of funds and financial assets of persons involved in terrorism.
  • Prohibition of any person or entity to make funds or economic resources available for terrorism in any form.

FATF RECCOMENDATIONS

  • recommends close cooperation both at the domestic and international levels,
  • suitable measures to not only criminalise money laundering but also apply legislative powers to confiscate property and proceeds associated with money laundering
  • Criminalisation of terrorism finance as well as application of tough sanctions to force adherence to international norms and conventions.
  • The role of NPOs in financing terrorism is well documented, both internationally and in India.12 the recommendation aims at stopping their misuse.
  • the role and responsibility of financial institutions, specific measures required to be taken to ensure additional and more stringent procedures in respect of individuals, groups and countries(The recent cases of poor and insufficient assessment of these norms came up in the case of Hongkong and Shanghai Banking Corporation (HSBC) bank, which associated itself with branches located in vulnerable areas, despite clear indicators of the involvement of these countries and branches in money laundering)
  • Regulation and supervision.
  • Providing requisite powers to agencies to give them the ability to obtain information, documents for prosecution, monitoring of communications, computer systems and attaching property and assets.

 

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