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MGT604 - Management of Financial Institutions - Lecture Handout 40

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Financial Crimes

What is Money Laundering?

Defined in non-technical terms, money laundering is the conversion of 'dirty' money into - seemingly - 'clean' money. Dirty money is money that meets the following conditions: (1) it has been derived by illegal means and (2) for an outside observer it is possible to identify that condition (1) applies. Money laundering is the practice of engaging in financial transactions in order to conceal the identity, source, and/or destination of money, and is a main operation of the underground economy. In the past, the term "money laundering" was applied only to financial transactions related to organized crime. Today its definition is often expanded by government regulators to encompass any financial transaction which generates an asset or a value as the result of an illegal act, which may involve actions such as tax evasion or false accounting. As a result, the illegal activity of money laundering is now recognized as potentially practiced by individuals, small and large businesses, corrupt officials, members of organized crime (such as drug dealers or the Mafia) or of cults, and even corrupt states, through a complex network of shell companies and trusts based in offshore tax havens. The increasing complexity of financial crime, the increasing recognized value of so-called "financial intelligence" in combating transnational crime and terrorism, and the speculated impact of capital extracted from the legitimate economy has led to an increased prominence of money laundering in political, economic, and legal

Process of Money Laundering

Money laundering is often described as occurring in three stages: placement, layering, and integration.

  • Placement: refers to the initial point of entry for funds derived from criminal activities.
  • Layering: refers to the creation of complex networks of transactions which attempt to obscure the link between the initial entry point, and the end of the laundering cycle.
  • Integration: refers to the return of funds to the legitimate economy for later extraction.

The Anti Money Laundering Network Recommends the Terms

  1. Hide: to reflect the fact that cash is often introduced to the economy via commercial concerns which may knowingly or not knowingly be part of the laundering scheme, and it is these which ultimately prove to be the interface between the criminal and the financial sector.
  2. Move: clearly explains that the money launderer uses transfers, sales and purchase of assets, and changes the shape and size of the lump of money so as to obfuscate the trail between money and crime or money and criminal.
  3. Invest: the criminal spends the money: he/she may invest it in assets, or in his/her lifestyle.

Can Legal Considerations Stop Money Laundering?

Many jurisdictions adopt a list of specific predicate crimes for money laundering prosecutions as a "self launderer”. In addition, laws typically have other offences such as "tipping off," "willful blindness," not reporting suspicious activity, and conscious facilitation of a money launderer/terrorist financier to move his/her monies.

Financial Institutions & Fight against Money Laundering

The prime method of anti-money laundering is the requirement on financial intermediaries to know their customers - usually termed KYC (know your customer) requirements. With good knowledge of their customers, financial intermediaries will often be able to identify unusual or suspicious behavior, including false identities, unusual transactions, changing behavior, or other indicators that laundering may be occurring. But for institutions with
millions of customers and thousands of customer-contact employees, traditional ways of knowing their customers must be supplemented by technology.

Why Launder Dirty Money at All?

Basically there are two motives for laundering money: avoiding suspicion and avoiding detection. Avoiding suspicion refers to the need to remove all traces that may indicate a crime has been committed - such as dirty money. Avoiding detection refers to the need to shield the money from attempts to confiscate it. If you are not entitled to own or dispose of money or assets someone may take it away!

What do to against money laundering?

Usually one distinguishes between preventive and repressive measures which are complementary rather than mutually exclusive. Preventive measures aim at denying criminals the access to the financial system and tend to rely heavily on the private sector's cooperation. The international standard model envisages that financial institutions identify their customers and keep records, maintain internal compliance programs and actively cooperate with the designated authorities by reporting suspicions of money laundering. The idea of course is that vital information is thereby transmitted from the private sector players that are being 'misused' for money-laundering purposes to the law enforcement agencies. Repressive measures on the other hand are instituted to facilitate prosecution or to have more effective sanctions at hand. Thus, among the repressive measures we find attempts to facilitate international legal cooperation and asset forfeiture or money laundering provisions in the penal code.

Terrorist Financing

Terrorist financing is a topic that shot into the limelight after the events of September 11, 2001. The US passed the USA PATRIOT Act, among other reasons, to ensure that both combating the financing of terrorism and anti-money laundering was given adequate focus by US financial institutions.

The act also had extra-territorial impact and non-US banks having correspondent banking accounts or doing business with US banks had to upgrade their Anti-Money Laundering processes. Although efforts have brought about a huge change to global regulations and have ushered in a new era of information sharing. According to US Government, Islamic charities, which were prime sponsors of terrorist groups around the world, are now under much tighter controls albeit there is still a lot to do in the Middle East and specially Pakistan. Terrorist groups are on the run albeit they are also innovating – in making/moving monies and in hiring of their key operatives - the new terrorist is a western educated middle class technology savvy person and the source for getting information on a do-it-yourself bomb is the internet.

The future of terrorist financing in Pakistan

Looking into the near future, if terrorist groups are replaced by smaller, decentralized groups, the premise that terrorists need a financial support network may become outdated. Moreover, some terrorist operations do not rely on outside sources of money and may now be self-funding, either through legitimate employment or low-level criminal activity, for example, the 7/7 London 9/11 US terrorists .

How we can trapped Terrorist Finances

  1. Bilateral and multilateral diplomacy;
  2. Law enforcement and intelligence cooperation;
  3. Public designations of terrorists and their supporters for asset-freeze actions;
  4. Technical assistance; and
  5. Concerted international action through multilateral organizations and groups, notably the anti-money Laundering departments and the United Nations.

US assistance to control Money Laundering in Pakistan

South Asia, and especially Pakistan, is a priority region for counterterrorist financing, due to the presence of terrorist groups, porous borders, and cash-based economies that often operate through informal mechanisms. All countries in the region need to improve their terrorist financing regimes to meet international standards, including the establishment of functioning Financial Intelligence Units. And both political will and technical assistance are needed to make this region a more effective partner of established countries. Pakistan, specifically, US welcome the concrete actions it has taken to implement its obligations under UN Security Council Resolutions, including the freezing of over $10 assets. Pakistan has also apprehended terrorists, including big names of operational leaders. US, European Union are encouraged by Pakistan's concern about the money laundering & infiltration of terrorist groups into charitable organizations, and would welcome the opportunity to provide technical assistance to help Pakistan meet international standards on preventing abuse of its non-profit sector. US has provided Pakistan assistance on drafting an antimoney
laundering/ counterterrorist financing (AML) law that meets international standards, but this legislation is still awaiting parliamentary consideration. In the absence of an antimoney laundering and counterterrorism financing law, the State Bank of Pakistan has introduced FATF-compliant regulations in know-your- customer policy, record retention, due diligence of correspondent banks, and reporting suspicious transactions. Also in compliance with FATF recommendations, the Securities and Exchange Commission of Pakistan has applied know-your-customer regulations to stock exchanges, trusts, and other non-bank financial institutions. All settlements exceeding Rs 50,000 ($840) must be performed by check or bank draft, as opposed to cash. Speaking generally, South Asian countries lack sophisticated tools to combat the money laundering. Anti-money laundering programs also tend to be absent or not up to international standards. Nonetheless, there is a degree of interest in all countries of the region, and we have seen some progress.

Know Your Customer (KYC) Guidelines – Anti Money Laundering Standards

The objective of KYC guidelines is to prevent banks from being used, intentionally or unintentionally, by criminal elements for money laundering activities. KYC procedures also enable banks to know/understand their customers and their financial dealings better which in turn help them manage their risks prudently.