The Origins of AML

Anti-money laundering (AML) guidelines came into prominence globally after the ‘September 11’ attacks on the US World Trade Centre in 2001 and it has become a universal crime strongly and strictly opposed by all countries. The average person, however, might not necessarily pay attention to AML because it can appear to be a victimless crime, which affects the economy and performance of countries and institutions rather than the individual.

Money laundering is the age-old process of disguising the illegal origin and criminal nature of funds, and converting illegal money into clean money, gained through illegal or criminal activities to create a legitimate explanation for the source of funds.

Before delving deeper into the subject of AML, we should take a look at the roots of money laundering such as how the money flows into the market in the first place.

Hawala: The Origin

Hawala originated in the Middle East thousands of years ago and means ‘transfer’ in Arabic. Hawala is the traditional banking system invented by Phoenicians around 3,000 years ago and then introduced by Jewish immigrants into Europe. No-one is really sure when money laundering first began but the common assumption is that in the earlier ages merchants had to hide their wealth from rulers in order to protect it but always faced the possibility that their wealth might be found and stolen by them. As a result, merchants decided to move their wealth and invest it in businesses in remote provinces or outside their own country.

The hawala system is based on a combination of ancient trade credit systems and trust-based networks that involve language, society and modern communication systems, such as mobile phone networks and offshore banking. The result is an efficient, fast and reliable remittance system.

Hawala is an informal value transfer system based on performance and honor among a huge network of money brokers, which are primarily located in the Middle East, Africa and Asia. It is an alternative or parallel illegal remittance system within which money is transferred via a network of hawala brokers. In this process, a customer hands over a sum of money and the recipient (residing in another usually foreign city) gives the details to the hawala brokers to transfer the funds to the recipient. The hawala broker contacts another hawala broker in the recipient’s city and gives deposit instructions for the funds (usually minus a small commission), and promises to settle the debt at a later date.

The unique feature of the system is that there are no written documents and the transaction takes place entirely based on the honor system. No records are produced of individual transactions and settlement of debts between hawala brokers can take place in a variety of forms (not necessarily in the form of direct cash transactions). Hawala is attractive because it provides a fast, convenient and safe transfer of funds, usually with a far lower commission than that charged by banks.

Hawala networks are closely related to Islamic banks throughout the world and commodity trading in South Asia. There are more than 200 Islamic banks in the US alone and many thousands in Europe, North and South Africa, Saudi Arabia, the Gulf States (especially in the free zone of Dubai and in Bahrain), Pakistan, Malaysia, Indonesia and other South-East Asian countries.

Most experts believe that modern hawala networks took shape in the 1960s and 1970s as a way of circumventing bans on gold imports into South-East Asia and allowing diaspora communities to send money to their families in Africa, the subcontinent and the Middle East. The hawala network in India was totally demolished by Indira Ghandi (during the emergency regime imposed in 1975) but Indian nationals still play a big part in international hawala networks. Similar networks in Sri Lanka, the Philippines and Bangladesh have also been eradicated.

Hawala – A Target for Money Launders

The main reasons for using the hawala system is trust, timeliness and cost-effectiveness. Banks have a business relationship but the Hawala system has a network of contacts and connections that individuals rely on to do their business and it has grown through their existing customers.

For example, if an individual wants to make a wire transfer through a bank, it can be time consuming and commissions are excessively high (opening an account and wires take 7-10 business days with commission charged for each transaction whereas the hawala system can be performed on the next business day with an average commission on the amount transferred). Today, true hawala transactions come from migrant workers from Asia (Indian and other Asian countries) who work in the oil-rich Middle Eastern countries such as United Arab Emirates and Saudi Arabia, for example, and send money home to their families.

This system has been unregulated and has become a fixture over the centuries for people in this region. Gradually, money-laundering rings moved their operations to these new, accommodating territories where the laundered funds are used to purchase assets in real estate, existing businesses and to finance trading operations.

The next frontier is cyberspace with the rise of Internet banking, Internet gambling, day trading, foreign exchange cyber transactions, e-cash, e-commerce, fictitious invoicing of the launderer’s genuine credit cards. Impossible to track and monitor, ex-territorial, totally digital, amenable to identity theft and fake identities – this is the ideal vehicle for money launderers. This nascent platform is too small to accommodate the enormous amounts of cash laundered daily but in 10 years time, it might. The problem is likely to be exacerbated by the introduction of smart cards, electronic purses and payment-enabled mobile phones.

The growing hawala market operates without any external regulatory or supervisory oversight and that lack of regulation poses serious macroeconomic management problems for the country.

First, the Central Bank lacks control over financial or monetary policy because most monetary activity in the country occurs outside its realm of influence. Conventional central bank prudential and open market operations cannot function effectively when financial institutions and currency reserves fall outside the formal system. These conditions are fundamentally destabilising.

Second, a large informal financial system, with the potential to facilitate large anonymous financial transactions – particularly for the settlement process – makes the system itself and the country as a whole particularly vulnerable to money launderers and those seeking to finance terrorism.

Money Laundering – Risks and Measures

Let us now move onto money laundering, which generally refers to ‘cleaning’ the proceeds (funds) or profits generated from various illegal activities, such as drug trafficking, people smuggling, arms, antique, gold smuggling, prostitution rings, financial fraud, corruption, or the illegal sale of wild life products and other specified predicate offences. The risks associated with money laundering are:

• Legal/reputational risk: The potential for negative publicity regarding an institution’s business practices will cause a decline in the customer base, costly litigation or revenue reductions.
• Operational risk: Failed internal processes, people and systems and technology.
• Concentration risk: The potential for loss resulting from too much credit or loan exposure to one borrower.

All these risks are inter-related and together have the potential of causing serious threat to the survival of a bank. So what measures can they employ to protect themselves?

Know your customer (KYC) is a term commonly used for the customer identification process that helps banks to identify suspicious transactions and is one the most important preventative measures against AML. KYC means making reasonable efforts to determine the true identity and beneficial ownership of accounts, sources of funds and identify the nature of the customer’s business and customer’s customer. It is also important to take the follow measures to help identify AML risks across daily processes:

• Install adequate controls over systems to identify, assess and manage money-laundering risks. Prepare a timely report at regular intervals on the operation and effectiveness of the systems and control.
• Prepare appropriate documentation of risk management policies, their application and risk profiles.
• Screen employees before hiring them and those who have access to sensitive information.
• Ensure the appropriate training of staff so that suspicious transactions are noticed immediately and action taken quickly.

Latest Developments

Banks are aware that they must implement stringent controls for money laundering and there is evidence within the industry that AML prevention is being taken seriously:

• If you hold an account with a major bank, chances are that all the transactions in your account are scrutinised by AML software. Billions of dollars have been invested in these applications to track suspicious transfers, deposits and withdrawals based on overall statistical patterns.
• Bank directors who are exposed under the USA PATRIOT Act face personal liability if cases of money laundering are found within their establishment.
• Banks maintain a database for blacklisted and sanctioned customers and the Bureau of Industry and Security for US Sanctions’ database is updated on a regular basis.
• Financial regulations have been strengthened and there has been the creation or enhancement of compulsory (as opposed to industry or voluntary) regulatory and enforcement agencies.

At the same time as these developments, however, privacy and bank secrecy laws have been watered down while collaboration with offshore ‘shell’ banks has been banned and business with clients of correspondent banks has been curtailed. Banks have effectively been transformed into law enforcement agencies, responsible for verifying both the identities of their (foreign) clients and the source and origin of their funds. And the securities and currency trading industry, insurance companies, and money transfer services are subjected to growing scrutiny as a conduit for ‘dirty cash’.

Processing systems are continuously updated with any current sanction details; hence whenever the end user receives a suspicious payment request for particular clients, banks or countries, the system will prompt a warning message to the user. Suspicious transactions details will also be sent to the AML officer for further investigation. The AML officer will, in turn, investigate the origin of the transaction and co-ordinate with the remitter of the funds through the relationship manager.

When contacting a Proceeds of Crime Unit concerning a suspicious transaction, you may be asked to provide specific information, such as:

• Value (amount), date, time, and location of the transaction.
• Name, age, address, telephone number, description of the person(s) involved in the suspicious transaction and their associates.
• Bank, credit card or other personal information about the subject that might be available.
• Description of vehicle and licence plate number associated with the suspicious transaction/activity.
• The circumstances, details, and events that raised your suspicion.

In addition, risk awareness training will be conducted by the risk management team to update the end user about latest developments.

Conclusion

According to the UN Global Programme Against Money Laundering (GPML), estimates on worldwide money laundered are as high as US$500bn a year – about half of which is channeled through drug trafficking, while the rest is derived from other criminal activities. However, other sources estimate that the scale of worldwide money laundering operations has reached as high as US$1500bn and that US banks alone launder nearly one-third of the world’s dirty money. Despite this magnitude, the money thus far confiscated by security authorities hasn’t exceeded US$500m – less than 0.1% of suspected laundered money. The need for AML prevention and detection has never been so important.

More than 150 countries have promised to co-operate with the US in its fight against the financing of terrorism and some countries have frozen assets of suspicious individuals, suspected charities, and dubious firms, or passed new AML laws and stricter regulations. Each and every individual is responsible for their country’s growth and economy so even though we might not deal with the transfer of funds or money laundering in our daily lives, everyone should be aware of the risks and measures associated with money laundering.