Gujrathi_Medha

8/20/2019 Gujrathi_Medha

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MONEY LAUNDERING

ABSTRACT

India’s promising position as a financial centre and its system of informal cross border

money flows makes the country’s susceptibility to money laundering. Some frequent

sources of illegitimate earnings in India are narcotics trafficking, corruption, income tax

evasion etc. Combating money laundering is the most important task for the financial

sector. For India, to diminish informal money transfer channels, it needs to fortify

enforcement around the important areas - responsibility of management in Anti Money

Laundering (AML) policies, scrutinizing of AML systems, adoption of appropriate

‘Know Your Customer’ norms, transaction monitoring, staff training towards regulation

compliance.

• JEL Classification Number: 3

• Author name – Mrs. Medha R Gujarathi

• Affiliation – Phoenix – A&G Capital Pvt Ltd, Mumbai

• Full postal address –

2/ Bachubai, Bldg., First Floor, J. Bhatankar Road, Parel, Mumbai - 12

• Telephone (and/or fax) number – +91 - 9819074020

• Brief biography –

Mrs. Medha Gujarathi is MMS Finance from Mumbai University.

She is an Investment Banker with 3 years of work-experience.

Currently working with Phoenix – A&G Capital Pvt Ltd as a Financial Analyst.


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MONEY LAUNDERING

ABSTRACT

India’s promising position as a financial centre and its system of informal cross border

money flows makes the country’s susceptibility to money laundering. Some frequent

sources of illegitimate earnings in India are narcotics trafficking, corruption, income tax

evasion etc. Combating money laundering is the most important task for the financial

sector. For India, to diminish informal money transfer channels, it needs to fortify

enforcement around the important areas - responsibility of management in Anti Money

Laundering (AML) policies, scrutinizing of AML systems, adoption of appropriate

‘Know Your Customer’ norms, transaction monitoring, staff training towards regulation

compliance.

JEL Classification Number: 3


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SECTION I. INTRODUCTION

Breaking News!!!

September 11, 2001 - Plane crash into the World Trade Center, New York,

September 11, 2001 - Attack on U.S. Pentagon,

December 13, 2001 - Attack on Indian Parliament,

1992 – 2008 and still counting - Serial bomb-blasts in major India cities……

Behind all this underground economy, there is only one face – Terrorism!! And who is

behind this malefactor terrorism - ‘White-collar Crime’!!!

All these assaults involved terrific planning, scheduling, huge monetary operations and

the remarkably unlawful criminal intelligence. Nowadays, organized crime groups

becoming more global and are carrying on their activities far away from their geographic

region. What makes them possible to do that???

The answer is Money Laundering……..

SECTION II. MONEY LAUNDERING – BACK TO BASICS

Money Laundering is a highly sophisticated act to cover up or camouflage the identity/

origin of illegally obtained earnings so that they appear to have derived from lawful

sources. It is the process by which illegal funds and assets are converted into legitimate

funds and assets. In other words, it is the process used by criminals to wash their

“tainted” money to make it “clean.”


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The term money laundering is generally believed to have derived from mafia ownership

of Laundromats in the United States (US). Gangsters in the US had been earning huge

cash through extortion, prostitution, gambling, bootlegging liquor, etc. In the past, the

term "money laundering" was referred only to financial transactions related to

organized crime. Today its definition is often expanded by Government regulators (such

as the United States Office of the Comptroller of the Currency) to encompass any

financial transaction which generates an asset or a value as the result of an illegal act.

Money laundering generally refers to earnings or profits generated from:

• Movement of drug money/ drug trafficking

• Financial scandals

• Arms, antique, gold smuggling

• Corruption

• Prostitution rings

• Illegal sale of wild life products

• Avoidance of legitimate tax and false accounting practices

• Money transfer through a complex network of shell companies and trusts based in

offshore tax havens

• Diversion of funds from a legitimate destination and use at another destination, etc.

Several regulatory and governmental authorities cite figures for estimated amounts of

money laundered annually, either worldwide or within a national economy. International

Monetary Fund’s estimated that the aggregate of money laundering in the world could be


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approximately 2-3% of world’s gross domestic product (GDP) or US$ 500 billion- 1.5

trillion. International consultant, KPMG has estimated that money laundering flows into

India are reported to be in excess of US$ 1 trillion every year by drug dealers, arms

traffickers and other criminals. According to Indian observers, fund transferred through

the hawala/ alternative remittance system are equal to between 30 to 40% of the formal

market. The RBI estimated that remittances to India amounted to US$ 28.2 billion.

Money Laundering not only economically weaken a country but also exposes to terrorist

attacks, threatening its integrity and sovereignty. All over the world, banks have become

more susceptible to Money Laundering activities and financial felony. The largest portion

of laundered funds is processed through banks. This is largely due to the fact that

banks are often the first stop in a multi-tiered laundering scheme. Investment firms,

including brokerages, mutual fund companies and hedge funds also see a significant

amount of activity, attracting more than 25% of money laundering activity. Schemes

targeting insurance companies are a growth sector, now accounting for close to 10% of

activity. A plethora of products and services are offered by the banks and financial

services sector is used to mask the original source of money. With their articulate and

refined manners, Money Launderers attempt to make banks/ investment firms lessen their

protocol so as to accomplish their goal. The quandary of the bank/ investment firms here

in the context of Money Laundering is to sort through the banking activities representing

lawful business and suspicious transactions. This reflects the vulnerability of the

financial institutions to Money Laundering and thus urges the necessity of powerful

regulatory framework to control these illicit acts.


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SECTION III. PROCESS OF MONEY LAUNDERING

Money laundering is the masquerading the funds derived from illicit activity so that

the funds may be utilize without revealing of their illegal origin. Money laundering is a

well-thought out process accomplished but not restricted to the following three stages:

1. Placement:

In this process, the launder injects illegal funds or assets into the financial system. It

requires physically placing the funds into legitimate financial institutions. Depositing

structured amounts of cash into the banks, and smuggling currency across international

borders for further deposit, are common methods for placement.

2. Layering:

Once the illegitimate funds have entered the financial system, multiple and complex

financial transactions are conducted to further conceal their illegal nature. Layering

usually involves use of multiple accounts, banks, intermediaries, corporations, trusts,

countries to disguise the origin. Wire transfers between different accounts, purchasing

monetary instruments (traveler’s checks, banks drafts, money orders, letters of credit,

securities, bonds, etc.) with other monetary instruments and changing denominated

currencies facilitate layering.

3. Integration:

Laundered funds are made available as apparently legitimate funds. It involves the

reinsertion of the laundered earnings back into the economy in such a way that they


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re-enter the financial system as usual business money/ resources. This may involve a final

bank transfer into the account of a local business in which the launderer is investing in

exchange for a slice in profits.

SECTION IV. METHODS OF MONEY LAUNDERING

1. Use of Business entities:

Criminals frequently use business enterprises to launder money. These business

enterprises can be sole proprietorships or business trusts and partnerships or close

corporations and companies. Shell companies are normally used to open and operate

bank accounts. These entities will not actually be trading and their main function would

be to provide the criminal with a corporate veil under which he could conceal his identity.

The shareholders, directors or members of these shell corporations are often family

members. The income of crime is simply blended with the legal proceeds of the business

and deposited into the bank account as the earnings of the business.

Another example is, an information technology company which had many call centers

placed all over the country. The company would call residents of a foreign country and

propose access to credit facility for a fee. The money collected as fees were then moved

within the country and to a few other countries, through shell companies. Shell

companies have no corporeal existence in the jurisdiction where they are

incorporated and can be used as an instrument for moving and masking the sources

of funds.


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A few of these shell companies, which have the same postal address, appear to be crucial

in the money laundering scheme. On receiving money from the information technology

company in the form of electronic funds transfers, the shell companies then transfer the

funds to an offshore bank account. According to the International Monetary Fund,

‘major offshore centers’ include the Bahamas, Bahrain, the Cayman Islands, Hong

Kong, Antilles, Panama and Singapore.

2. Residential Real Estate:

Residential real estate-related money laundering is usually linked with mortgage loan

fraud as money launderers may engage in mortgage loan scam to facilitate

laundering through residential real estate. This scam involves a fraudster and a

launderer. Once a fraudulent mortgage loan is funded, the actions of the fraudster and

those of the launderer deviate. The fraudster, who has appointed a deceitful appraiser to

increase the worth of the property and thus the face amount of the loan sanctioned by the

housing finance institution, takes the loan amount and run away. In this case, the

launderer will strive to project an image of normalcy by continuing to make regular and

timely payments on the mortgage loan, thereby integrating his illicit funds. Eventually,

the launderer may re-sell the property, allowing for a trade-up to a more costly property

affording greater laundering and investment prospective.

Mortgage loan fraud by using money laundering includes the purchase and

rehabilitation of distressed property, which is then resold at a price greater than the

original price, inflation of the fair market value of property by appointing a spurious


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evaluator. This counterfeit appraisal is proposed to convince housing finance institution

to grant a mortgage loan on the property for more than the property value. The lending

institution may suffer a loss if the loan goes unpaid, and may be left with a foreclosed

property that has a market value below the fake appraisal value. Launderers may use

several nominees to secure numerous mortgages on diverse residential properties,

thereby forming a means for the exchange of illicit cash into real property while

showcasing the manifestation of many unconnected mortgages paid on a normal and

timely basis.

3. Insurance Policies:

A director of a Company A, set up a money laundering scheme concerning two

companies, each one incorporated under two different jurisdictions. Both the

companies used to provide financial services and providing financial guarantees for

which he would act as director. These companies wired the sum of US$ 5 million to

the accounts of the company director in Country M. It is likely that the funds derived

from some kind of criminal activity and had already been injected into the financial

system. The company director also received transfers from Country N. Funds were

moved from one account to another by making use of several bank accounts. Through

one of these transfers, the funds were transferred to Country P from a current account in

order to make payments on life insurance policies. The investment in these policies was

the main device in the money laundering scheme. The premiums paid for the life

insurance policies in Country P amounted to some US$ 5.5 million and signified the final

step in the money laundering.


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An effort was made to buy life insurance policies for several foreign nationals. The

underwriter was asked to offer life coverage with an indemnity value equal to the

premium. There were also signals that if the policies were to be withdrawn, the return

premiums were to be paid into a bank account in a different jurisdiction to the assured.

The funds were deposited into several bank accounts and then transferred to an account in

another jurisdiction. The money launderer then entered into a US$ 1 million life

insurance policy. Payment for the policy was made by two separate wire transfers from

the overseas accounts. It was purported that the funds used for payment were the

proceeds of overseas investments.

4. Use of Financial Institutions:

India has a robust financial system. Products and services on offer vary from internet/

mobile banking facilities and off-shore investments to small savings accounts. These

financial instruments facilitate depositing a sizable chunk of dirty money into bank

accounts. Launderers often open accounts with false credentials or will open it in the

names of companies or trusts. There is also a tendency of using valid bank accounts of

family members or third parties with prior arrangement. In subsequent investigations, the

family member will perpetually beg lack of knowledge of the true nature of deposited

funds. Bearer documents such as Negotiable Certificates of Deposit have also been

employed in sophisticated schemes.


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5. Structuring Deposits/ Smurfing:

This method involves segregation of huge sums of money into smaller, less-suspicious

amounts. In the United States, this smaller amount has to be below US $10,000 - the

dollar amount at which U.S. banks have to report the transaction to the government. The

money is then deposited into one or more bank accounts either by multiple people or by a

single person over an extended period of time.

6. Fraudulent Investment Schemes:

The case comprises many companies – some of them were trading companies - and

related individuals that were alleged for asking for funds with the assurance of high

returns on investments.

Presume there is an existing BSE-listed company, which is closed and is not trading at

all. Today, there are over 8,000 companies listed on the BSE, of which more than 50%

companies are in the B2 and Z category and are hardly traded. It can happen that two

or three people form an alliance and take over such a company changing its name to an

infotech company. It is even probable that the existing promoters of the company simply

change the name of their company to a software company. In actual practice, these

companies do not even be having the necessary infrastructure or the requisite workforce

essential to run a software company. The next step is to form a subsidiary overseas by

renting a place or just even employing a person to carry out the operations. Most of the

exports are made to duty free ports such as Hong Kong, Singapore or Dubai where

the money can be remitted back.


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After that, the promoters conduct Hawala/ alternate remittance transactions by paying

cash over here and getting dollars from abroad through the subsidiary. The same dollars

transferred from abroad are shown as software exports in the company's books. In this

way the company is able to report decent sales figures in its balance sheet by the way of

export income. The next step is to grab a flashy share broker or market operator

whose gossips about the company can be floated in the market. The share broker or

the operator then spreads stories such as the company has got big software development

orders or tie-ups and is going to post superb profit numbers. Obviously, the fake export

income compels the net profit stating strong Earnings per Share for the company.

Since, the P/E of the company appears to be quite low in comparison with the

industry P/E; the stock appears to be an excellent buy.

The market operators start providing liquidity in the counter by creating demand

for the stock by them. As a result the volumes in the counter start increasing. The stock

price of the company starts touching upper circuits in sequence. The promoters start

taking advantage of this situation by reducing their own stake and offering it to the small

investors who will be willing to buy. In the end we have the small investors who are left

holding the stock which they have purchased at the high prices. Thus the promoters are

able to take advantage in two ways. Firstly they are able to get a superior price for the

dead stocks of their company, which were not being traded at all and secondly are

able to exchange their cash into official export income at a low premium without

paying any income tax.


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However, the query which authority is accountable to make sure whether the companies

are actually occupied in and whether their exports are authentic or not? This is necessary

so that the investors can be more cautious about such companies before investing their

hard-earned money into them.

Ultimately, the technology can be boon or bane depending on its end-user.

SECTION V. MONEY LAUNDERING CASE-STUDY - HAWALA

The Economic Times (March 16, 2005) reported a case of money laundering in the year

1999-2000 when about Rs. 700 crore made its way from the Gulf, through the hawala

route to accounts in bank branches in Mumbai; the money was then diverted to Kerala for

large investments in real estate.

In earlier times, informal fund transfer systems were used for trade financing. They

were created because of the dangers of traveling with gold and other forms of payment on

routes beleaguered with robbers. Local systems were widely used in China and other

parts of East Asia and continue to be in use there. They go under various names -

Fei-Ch'ien (China), Padala (Philippines), Hundi (India), Hui Kuan (Hong Kong),

and Phei Kwan (Thailand). The hawala (or hundi) system now enjoys widespread use

but is historically associated with South Asia and the Middle East. At present, its primary

users are members of expatriate communities who migrated to Europe, the Persian Gulf

region, and North America and send remittances to their relatives on the Indian

subcontinent, East Asia, Africa, Eastern Europe, and elsewhere. These emigrant workers

have reinvigorated the system's role and importance. While hawala is used for the


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legitimate transfer of funds, its anonymity and minimal documentation have also made it

vulnerable to abuse by individuals and groups transferring funds to finance illegal

activities.

At present, many of these so-called software companies were known to be exercising the

Hawala route in order to illustrate income from software exports. Hawala (also referred

to as hundi) substitute remittance scheme. In other words, it is money transfer without

movement. Hawala is old systems began in South Asia; today it is used around the world

to carry out lawful remittances. Let us see how hawala can, and does, play a role in

money laundering. Hawala functions outside of conventional banking system. What

discriminates Hawala from other remittance systems are conviction and the widespread

networking. Let us see how hawala transfer takes place.

Mr. X is a national of country Y residing in country Z. He entered the country on a tourist

visa, which has long since expired. He wants to send US$ 10,000 to his family residing in

country Y. If he goes by normal banking channels, he has to open the account with bank

which again involves all documentation formalities.

A hawala person – Mr. A offers him the following deal:

A 5% 'commission' for handling the transaction; higher conversion rate for dollar

(For example if the official rate is 1 US$ = Rs. 45; Hawala person can offer you at 1 US$

= Rs. 50) and the currency in which he wants to convert including delivery charges. The

money transfer related with a hawala transaction is faster and more reliable than in

bank transactions.


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Mr. X decides to a deal with a hawala person Mr. A. The hawala transaction proceeds as

follows:

Mr. X gives the US$ 10,000 to Mr. A; Mr. A contacts Mr. B in country Y, and gives him

the details; Mr. B arranges to have the money (by taking into consideration conversion

rate described above) delivered to the family of Mr. X.

Even though this is a simple example, it contains the elements of a hawala transaction.

First, there is trust between Mr. X and Mr. A. This money transfer nearly takes place

within a day of the initial payment (a consideration here is time differences) and the

payment is always made in person. Hawala dealers are almost always honest in their

dealings with customers and fellow hawaladars. Breaches of trust are extremely rare. It is

worth noting that one of the meanings attached to the word hawala is 'trust'!

Connections are of equal significance. Hawala networks tend to be slack,

communication usually takes place by phone or fax or email. These associations allow for

the organization of a complex network for performing the hawala transactions. Since

many hawala transactions are conducted in the context of import/ export businesses, the

manipulation of invoices is very common methods of settling accounts after the

transactions have been made. When compared to a 'traditional' means of remitting

money, such as obtaining a check or ordering a wire transfer, hawala seems

cumbersome and risky.


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A few other benefits that hawala transaction offers are:

1. Cost Efficiency –

Some of the reasons for this cost efficiency, namely low overhead, exchange rate

manipulation and integration with existing business activities.

In India, for example, the Foreign Exchange Regulation Act (FERA), 8(2) states that

'except with the previous general or special percussion of the Reserve Bank, no person,

whether an authorised dealer or a moneychanger or otherwise, shall enter into any

transaction which provides for the conversion of Indian currency into foreign currency or

foreign currency into Indian currency at rates of exchange other than the rates for time

being authorised by the Reserve Bank'.

Since hawala dealers do not, in many if not most cases comply with such regulations,

their transactions may be illegal. Hawala persons exploit naturally occurring currency

fluctuations in the demand for different currencies. This enables them to turn a profit

from hawala transactions and they are also able to offer their customers rates that are

better than those offered by banks. In brief, hawala competes efficiently with other

remittance instruments - because of its cost effectiveness.

2. Speed of the Transaction -

A hawala remittance takes place in, at most, one or two days. This can be contrasted

with the week or so required for an international wire transfer involving at least one

correspondent bank.


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3. Lack of administration –

Mr. X is living and working in the country Z on an expired visa. Since hawala is a

remittance system, this question really addresses jurisdiction governing remittance

services. Even though hawala is illegal from a regulatory standpoint in some

jurisdictions, hawaladars advertise their services widely in a variety of media.

Enforcement of these regulations is complicated with respect to hawala.

In spite of the existence of these regulations is another reason hawala is still used. Many

people in these countries have money that they would like to move to another country.

Hawala provides a means of doing this, and its use as a catalyst of 'capital flight' on

both large and small scales is very common.

4. Tax evasion –

In South Asia, the 'black' or parallel economy is 30%-50% of the 'white' economy.

Money remitted through official channels may invite scrutiny from tax authorities -

hawala provides a scrutiny-free remittance channel.

Another aspect of these regulations is the use of the United Arab Emirates, specifically

Dubai, for hawala transactions. There are two main reasons for this. The first is the large

population of expatriate workers from India and Pakistan; they use hawala to send

money home. The second is Dubai's large gold market, which is the source of much of

the gold sent (licitly and illicitly) to India and Pakistan. Dubai, unlike many other South

Asian nations, allows essentially unregulated financial dealings. Because of this, many

South Asian businessmen maintain offices in Dubai, and money is often wired there to


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circumvent regulations elsewhere. In addition, Dubai offers a neutral meeting place for

Indian and Pakistani businessmen, as tension between these countries makes travel

between them difficult if not impossible.

5. Trustworthiness -

Intricate overseas transactions, which might engage the client's local bank, its

correspondent bank, the main office of a foreign bank and a branch office of the

recipient's foreign bank, have the potential to be problematic. However, the hawala

network person can complete the transaction in less than a day.

Hawala can provide an efficient means of placement. In the example, Mr. X gave Mr. A

US$ 10,000 in cash. Since Mr. A also operates a business, he will make periodic bank

deposits consisting of cash and checks. He will validate these deposits to bank officials as

the income from his legal business. He may also use some of the cash received to meet

business expenses, reducing his need to deposit that cash into his bank account.

Hawala transfers leave a mystifying paper track. Even though invoice manipulation is

used, the mixture of legal goods and illegal money, confusion about `valid' prices and a

possibly complex international shipping network create a trace much more convoluted

than a plain wire transfer.

The same distinctiveness of hawala that make it a possible means for the layering of

money also make it ideal for the integration of money. This is when money seems to

become legitimate and hawala techniques are proficient in transforming money into any

form, offering numerous possibilities for establishing a manifestation of authenticity.


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The money transferred through hawala means can be 'reinvested' in a legitimate (or

legitimate appearing) business. Hawala is actually quite simple; much of the density

associated with hawala comes from the immeasurable number of deviations that are seen

in hawala transactions.

This complexity of variation makes it unfeasible to lay out a clear-cut guide to identify

hawala as part of a criminal undertaking. It is, however, possible to provide a few

pointers that may be useful.

One of the most official indicators of hawala transaction in investigations conducted in

bank accounts. A 'hawala' bank account shows noteworthy deposit activity, usually in

the forms of cash and checks, which are often from one or more ethnic communities (e.g.

Afghan, Bangladeshi, Indian, Pakistani, Somali). These checks may also have some kind

of details, consisting of a name or something supposedly indicating what was 'bought'

with the money. These accounts will also illustrate outgoing wire transfers to a major

financial center. Given the flexible characteristic of the hawala business, hawala

accounts will not always be seen to balance. Laws in India, Pakistan and other countries

make it tricky to convert foreign currency. Unlawful activities in these countries may

often involve foreign currency, which pose something of a problem.


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Hawala cases:

1. Terrorism:

The series of bomb blasts in a major Indian city in 1993 was funded through hawala. The

investigation exposed that the funds behind these bombings were routed through hawala

operators in the United Kingdom, Dubai and India.

2. Insider Trading:

A citizen of a South Asian country, who was an investment banker in a major financial

center, is accused of giving 'tips' to various friends and relatives. After some illegal trades

took place, the banker resigned and apparently fled the United States for his homeland.

At the same time, several of his associates also traveled to this same country as well as

several European financial centers. An examination of detained bank records reflects that

money was transferred to persons having the same nationality in at least one of these

financial centers. It is possible that these wire transfers were the first part of hawala-like

transfers of the profits from the illegal trades to the investment banker's home country.

3. Narcotics Trafficking:

Citizens of some countries supposedly importing heroin and are alleged of shaking hands

with bank officer to clean the earnings from the sale of the heroin. This bank officer is

understood to open accounts without following proper 'know your customer' (KYC)

norms and also assists the traffickers with the management of these accounts, which are

used for illegitimate money transfers. In addition, this bank officer may be handling the


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receipt of shipments of negotiable instruments from a south Asian country on behalf of

so-called criminals in that country. These shipments may symbolize part of money

laundering scheme as well as probable infringement of country’s laws regarding the

import of currency.

4. Welfare Fraud:

Certain immigrants from a particular country are charged for committing large scale

welfare fraud. An employee of a rental agency deposits large numbers of checks into a

personal checking account, and then wires money to a variety of offshore locations. It is

suspected that hawala is being used to remit money (which probably includes proceeds

derived from welfare fraud), via couriers.

5. Gambling:

Hawala has been used as a substitute banking system in a South Asian gambling

operation. The gambling operators have engaged hawala operators to accept money 'on

deposit' from gamblers, and pay winnings through them as well. This is something of a

indication to the dependability of hawala. One of the principals in this gambling

operation is that this had been going on for nearly twenty years without any major

difficulties.

6. Customs and Tax Violations:

An individual representing himself as being in the gold business in a large city, especially

as a 'gold broker', is alleged of different customs and tax infringements as well as money


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laundering. This individual has made very large cash deposits at several banks, and at

least one bank has closed this individual's account because of these deposits. This

individual's bank account was inspected in juxtaposition with a tax investigation. This

individual asserts to provide gold shops with gold bullion, and also that he sells gold

coins and jewellery to individuals. It is believed that this individual is acting as a bank for

various individuals and businesses, supplementing them in escaping the tax payment.

In the wake of the recently sensitive concerns that money launderers and terrorist groups

use informal transfer systems, many countries consider the overlooking of the hawala

industry as no longer a suitable policy alternative. The probable ambiguity that portrays

these systems is believed to present risks of money laundering and terrorist financing and

therefore it is required to provide proper attention to these problems.

SECTION VI. MACROECONOMIC EFFECTS ON THE ECONOMY OF THE

COUNTRY

Because crime, underground activity, and money laundering take place on a large scale,

macroeconomic policymakers must take them into account. But, as these monetary

transactions are tough to determine, they deform economic data and make problems in

Governments' efforts to administer economic policy. In addition, the capability to

recognize the country and currency of issuance and the citizenship of deposit holders is

solution in understanding monetary behavior.


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Money laundering can have a range of severe macroeconomic consequences on countries.

Some of these consequences are as follows:

• It can cause unpredictable changes in money demand - To the extent that money

demand appears to shift from one country to another because of money laundering -

resulting in ambiguous monetary data.

• It increases the volatility of international capital flows and exchange rates due to

unanticipated cross-border transfers - It will have adverse consequences for interest

and exchange rate volatility, particularly in dollar denominated economies, as the

tracking of monetary aggregates becomes more uncertain.

• It can cause troubles to the reliability of financial institutional framework of the

country and thus taints legal financial transactions.

The income allocation effects of money laundering must also be considered. For

example, there is indication that funds to evade taxes in India tend to be channeled into

riskier but higher-yielding investments in the small business. Money laundering also has

macroeconomic consequences in an indirect manner. Illegitimate transactions can

discourage legal ones by contamination. For example, some transactions concerning

foreign participants, although completely legal, are reported to have become less

attractive because of a relationship with money laundering. Money that is laundered for

reasons other than tax evasion also tends to dodge taxes, compounding economic

distortions. Accumulated balances of laundered assets are likely to be larger than annual

flows, causing impending destabilization and executing cost-effectively inefficient


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movements, either cross borders or domestically. These balances could be used to

crook markets or small economies.

The above effects are to some extent exploratory; however, the Quirk study (1996) also

conducted empirical tests on the correlation between GDP growth and money

laundering in 18 industrial countries for the first time. It was found that major reductions

in annual GDP growth rates were coupled with augment in the laundering of criminal

proceeds in the period 1983-90.

SECTION VII. ANTI MONEY LAUNDERING LEGISLATION

The trustworthiness of the banking and financial system depends heavily on legal,

professional and ethical skeleton in which it works. As a result the International

organizations and regulators started developing international standards and best practices

to address to money laundering issues in a collaborative manner. Across the world,

banks and financial institutions are required to initiate and execute systems to prevent

anti-social elements from using banking channels for money laundering. Implementation

of apt ‘Know Your Customer measures’ is a vital element of risk management in

banks, in order to protect the confidence and the authenticity of banking systems.


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International Scenario with respect to Anti-money Laundering:

• Mid 1980s - Growing concern of international community to deprive criminal

elements of the proceeds of their crimes.

• 1989 – Financial Action Taskforce (FATF) set up to ensure global action to combat

money laundering.

• Forty Recommendations - Complete set of counter-measures against money

laundering.

• Nine Special Recommendations on Terrorist Financing.

•

1995 - Egmont Group set up to stimulate international cooperation amongst Financial

Intelligence Units (FIUs).

• 1997 - Asia Pacific Group on money laundering (APG) set up to create awareness and

encourage adoption of AML measures.

Indian Scenario:

The Prevention of Money Laundering Act, 2002 (PMLA) enacted to prevent money

laundering and provide for confiscation of property derived from, or involved in, money

laundering. The PMLA act was enacted on 17th Jan, 2003. It was brought into force from

1st July, 2005. It is administered by:

• Financial Intelligence Unit (FIU) for verification of identity of clients, maintenance

of records and reporting

• Enforcement Directorate (ED) for investigation of and prosecution for money-

laundering offences


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Subordinate legislations: Rules under PMLA:

• Various Rules came into effect from July 2005

• Rules detailing Powers of Director FIU and ED

• Rules detailing the method of attachment of property, period of retention etc

• Rules detailing the receipt & management of confiscated assets

• Rules relating to legal obligations of reporting entities

Rules detailing the legal obligations of reporting entities:

Prevention of Money Laundering (Maintenance of Records of the Nature and Value of

Transactions, the Procedure and Manner of Maintaining and Time for Furnishing

Information and Verification and Maintenance of Records of the Identity of the Clients of

the Banking Companies, Financial Institutions and Intermediaries) Rules, 2005

Legal Obligation under PMLA:

PMLA and the Rules impose obligations on - Banking companies, financial institutions,

intermediaries of the securities market – to maintain records, furnish information, and

verify identity of clients.

Reporting entities under PMLA (Section 12):

“Banking Company” under PMLA includes:

• All nationalized banks, private Indian banks and private foreign banks

• All co-operative banks viz. primary co-operative banks, state co-operative banks and

central (district level) co-operative banks


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• State Bank of India and its associates and subsidiaries

• Regional Rural Banks

Financial Institution under PMLA includes:

• Financial Institutions as defined in Section 45-I of the RBI Act namely EXIM Bank,

NABARD, NHB, SIDBI, IFCI Ltd., IDFC Ltd., IIBI Ltd. and TFCI Ltd.

• Insurance companies

• Hire Purchase companies

•

Chit fund companies as defined in the Chit Funds Act.

• Co-operative banks

• Housing finance institutions as defined in the National Housing Bank Act such as

HDFC.

Non-banking financial companies as defined in section 45-I of the Reserve Bank of

India (RBI) Act such as private finance companies - motor and general finance

companies, leasing companies, investment companies etc.

Intermediary under PMLA includes persons registered under Section 12 of the

Securities and Exchange Board of India (SEBI) Act, 1992:

• Stock brokers

• Sub-brokers

• Share transfer agents

• Bankers to an issue


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• Trustees to trust deed

• Registrars to issue

• Merchant bankers

• Underwriters

• Portfolio Managers

• Investment advisers

• Depositories

• Custodian of securities

•

Foreign institutional investors

• Credit rating agencies

• Venture capital funds

• Collective investment schemes including mutual funds

Every reporting entity shall communicate the name, designation and address of the

Principal Officer to the Director, FIU-IND. The Principal Officer shall furnish the

following information:

• Furnish the information referred to in the Rules to the authorities

• Retain copy of such information for the purposes of official record

Reporting of Cash Transactions:

• All cash transactions of the value of more than Rs. 10,00,000 or its equivalent in

foreign currency


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• All series of cash transactions integrally connected to each other which have been

valued below Rs. 10,00,000 or its equivalent in foreign currency where such series

of transactions have taken place within a month

• Cash Transaction Report should be filed by the 15th day of the succeeding month

Reporting of Suspicious Transactions:

All suspicious transactions whether or not made in cash Suspicious Transactions

Report should be filed with FIU within seven working days of establishment of

suspicion at the level of Principal Officer.

Suspicious transaction means a transaction whether or not made in cash which, to a

person acting in good faith –

• Gives rise to a reasonable ground of suspicion that it may involve the proceeds of

crime; or

• Appears to be made in circumstances of unusual or unjustified complexity; or

• Appears to have no economic rationale or bonafide purpose.

Related obligations - Records containing information for reporting purposes:

• Nature of transaction

• Amount & currency of transaction

• Date of transaction

• Parties to transaction

• Manner as prescribed by the regulators (RBI/ SEBI/ IRDA)


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• Maintain & retain reported records for 10 years from cessation of transaction between

client & reporting entities (Rule 6)

• Client identity

• Current and permanent address of client, his nature of business, his financial status

• Maintain records of the identity of clients for a period of 10 years from the date of

cessation of the transactions with the client. (Rule 10)

Legal obligations & guidelines imply:

1. Customer Acceptance -

• Ensure acceptance of only legitimate and bona fide customers

• Issue of mechanism to verify ID

• Issue of Multiple IDs

• Issue of list of suspects/criminals/unwanted elements

• Awareness and training of staff

2. Customer Identification -

• Ensure that the customers are properly identified to understand the risks they may

pose.

• Background check of new customer

• Background check of existing clients

• Issue of List of suspects/criminals/unwanted elements



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3. KYC & CDD - Transactions Monitoring -

• Monitor customers’ accounts and transactions to prevent or detect illegal activities

• Issue of Mechanism to verify financial details

• Transactions inconsistent with customers profile (business)

• Unexplained transfers between multiple accounts with no rationale

• Sudden activity in dormant accounts

4. Risk Management -

•

Implement processes to effectively manage the risks posed by customers trying to

misuse facilities.

• Categorization of customers: high/medium/low risk : a dynamic concept

• Constant interaction between front desk and the compliance team required


• Set up processes and technology to identify and report suspicious transactions

• Capture customer details

• Generate alerts

• Collect and analyse additional information

• Decide whether transactions are suspicious

• Ensuring reporting of quality data electronically

• Alignment of people, process and technology

• Confidentiality and Privacy


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Recently, a Bill to amend the Prevention of Money Laundering Act was introduced in the

Rajya Sabha by Minister of State for Finance Pawan Kumar Bansal. As per the Bill,

money changers, money transfer service providers such as Western Union and

credit card payment gateways like VISA and MasterCard will now come under the

ambit of India's anti-money laundering laws. After the Amendment Bill is passed by

Parliament and comes into effect, businesses like casinos would also come under legal

obligation to report their activities in the country. For fighting the menace of terrorism,

the Bill introduces new category of offences which have cross-border implications.

The draft legislation also empowers the Enforcement Directorate "to search premises

immediately after the offence is committed". The investigating agency can attach any

property and search a person after completing the probe. It can enhance the period of

provisional attachment of property from 90 days to 150 days.

SECTION VIII. PREVENTION OF MONEY LAUNDERING -

NEED OF THE HOUR

India is enthusiastic in combating money laundering and terrorist financing. It is taking

progressive steps to execute Anti Money Laundering (AML) programmes in all the

financial institutions. With systems and procedures are in place, let us hope to be one of

the member countries of Financial Action Taskforce (FATF) and unite in the

international efforts to contest money laundering and terrorist financing.


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The need of the hour is to organize and reinforce collection and sharing of financial

intelligence through an effective national, regional and global network to battle money

laundering and related crimes. Few areas of compliance have seen the constant level of

activity that has come to characterize anti-money laundering (AML) efforts in recent

years. Money Laundering is a highly complicated and epidemic problem driven by vast

criminal and terrorist networks that requires skill and knowledge to discourage. In order

to guard a firm from the malice money laundering, institutions need AML solutions that

cover all areas of the business and all geographies where the firm conducts business.

In the super-charged rivalry for eating market share, firms just cannot jeopardy the

damage to reputation, client trust and market capitalization that results from financial

abuse and illegitimate activity. India has leading position in information technology, with

the help of this capability India can prepare AML software to provide widespread gamut

of analytical money laundering behaviors.

The developed software can control and demonstrate compliance with the letter and

spirit of regulations. This improves status with regulators and results in less recurrent

shorter audits. The software should have advanced alert generation and workflow

patented analysis techniques which can sense key behaviors of money laundering – for

example relationships between accounts – not obvious to rules or profile-based

applications or, manual analysis. Alerts provide a framework of business statistics and

historical information to rationalize analysis and resolution.


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The developed software will enable firms to curtail investigation times and improved

risk management with its aptitude to tailor risk and trust weightings for individuals or

entities to put objectively unusual behavior in context of that individual’s or entities

expected behavior. This will assist the firms in time saving, staff costs savings and will

efficiently manages risk by isolating actual unusual behaviors. The software will also

integrate Behavior Detection Platform which will assist in avoiding risk, exceeding

regulatory requirements, and improving customer relationships. It will analyze the

behavior of customers, employees, and partners in every transaction across the enterprise,

from every angle - past, present, and future - empowering companies to act with

meticulousness and buoyancy. This will create precision, escalating firm’s ability to

comprehend business – both risks and opportunities.

Combating money laundering will bring transparency in the system. Transparency

ensures trust. Trust, along with operational excellence, is the key to retaining

customers and growing market share.

Finally, I would like to sum up the entire paper by making use of the vision of India

articulated by Rabindranath Tagore…

“…… Where words come out from the depth of truth

Where tireless striving stretches its arms towards perfection

Where the clear stream of reason has not lost its way

Into the dreary desert sand of dead habit….’


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This means integrity, honesty and trustworthiness are the essential foundations for a

successful democracy and a prosperous society. Both good governance and commercial

success demand rigorous standards of transparency, accountability and reliability in

word and action. Although we have made progress, money laundering is an impending

threat requiring a dynamic response. As globalization unlock boundaries to travel and

trade, and global payments and clearing systems advance novel money laundering

prospects are created and exploited. Accordingly, Indian Money Laundering Strategy

should responds to established and emerging money laundering trends and modus

operandi both at home and abroad.

Lets us put into practice anti-money laundering methods with the help of which the

threads from Rabindranath’s poem - the vital strands - from which a fulfilling vision of

Dream India can be woven.


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REFERENCES

1. Money Laundering in Insurance business – Ms. B. Padmaja (May 2006)

2. Legal Regime for Anti-money Laundering- Mr. K. P. Krishnan

3. Examples of Money Laundering - IAIS Guidance paper on anti-money laundering

and combating the financing of terrorism (October 2004)

4. Briefing on ‘KYC’ Norms and ‘AML’ Measures for IBA Member Banks – Mr.

Sanjeev Singh (June 2006)

5.

Money Laundering: Methods & Markets

6.

Suspected Money Laundering in Residential Real Estate – A study by Financial

Crimes Enforcement Network (April 2008)

7. Basics of Anti-Money Laundering & Know Your Customer - M.RAVINDRAN

8. Anti-Money Laundering – Role of Technology – Mr. Vasant Godse (L&T Infotech)

9. The hawala alternative remittance system and its role in money laundering, Interpol

General Secretariat, Lyon, (January 2000) - Mr. Patrick M. Jost - United States

Department of the Treasury, Financial Crimes Enforcement Network (FinCEN) and

Mr. Harjit Singh Sandhu - Interpol/ FOPAC

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