How does Money Laundering work?

At its core, money laundering is all about disguising illegal origin when it comes to proceeds. It is practiced by criminals to evade law enforcement and tax authorities and to hold onto their illicit activities secretly. Though it may immediately bring to mind some of the more complicated financial schemes, many forms of money laundering exist, ranging from physically smuggling cash over borders to exploiting the secrecy of cryptocurrencies.

The FATF² defines money laundering as "the processing of criminal proceeds to disguise their illegal origin." That is to say, it is the process by which money derived from illegal activities is introduced into the legal financial system in such a way that it appears to have come from a legitimate source.

Money laundering is normally divided into three different stages, each serving a different purpose to make the money harder to trace.

1. Placement
In the phase of money laundering known as "placement," criminals bring their funds into the financial system for the first time—a risky endeavour due to the substantial amounts of cash involved that could attract attention easily.

• Smurfing / structuring³: Engaging in smurfing or structuring means spreading out sums of money in portions across various accounts to prevent detection by authorities.
• Cash-intensive businesses: Criminals frequently exploit cash enterprises such as car washes or restaurants to mix profits with lawful revenue.
• Cross-border smuggling: Cross-border smuggling is a method where cash is physically moved into countries with oversight.

The main objective during the stage is simple. To integrate the money into the system without raising any flags.

2. Layering
Once the money is deposited into the system and ready to go, criminals employ layering as a method to conceal its source. This entails carrying out transactions to construct a tangled network that perplexes investigators. Examples of layering methods comprise of:

• Moving money between accounts and locations
• Transforming currency into assets, like gold, cryptocurrencies or luxury items
• Using companies to conduct transactions or create false invoices

The purpose of layering is to increase the complexity of tracing transactions as much as possible.

3. Integration
The washing cycle's final stage reintroduces the cleaned money into the economy. At this time, it is practically traceable as any other legally derived income. Some common methods to integrate money include:

• Investments in real estate or actual businesses
• Buying high-priced but portable items like artwork, jewellery, or cars
• Financing legal ventures to disguise and integrate the laundered money

Once the money has reached this stage, the criminals can spend or reinvest it freely without being detected.

The criminals continue to devise methods of finding loopholes in the financial systems. The most common money laundering techniques include:

• Trade-based money laundering⁴: This consists of manipulating the trade transactions, like under- or over-invoicing the goods, in order to transfer money across borders undetected.
• Real estate: This may include overpaying for properties, buying in cash, and selling at inflated prices in order to justify their illicit income.
• Digital currencies: Criminals use crypto currencies like Bitcoin as tools to provide anonymity, be it in the conversion from fiat into cryptocurrency or indeed going via a DEX / mixing service.
• Offshore accounts: Tax havens serve as a refuge for money launderers, offering mechanisms to disguise the origins of illicit funds. They facilitate seamless cross-border fund transfers while often evading the watchful eye of international regulatory frameworks.

Banks and other financial institutions play a pivotal role in safeguarding the broader economy from the threat of money laundering. Acting as gatekeepers, they are prime targets for criminals aiming to integrate illicit funds into the legitimate financial system due to the sheer volume and complexity of daily transactions.

To counter this, financial institutions are legally required to comply with stringent anti-money laundering (AML) regulations. This includes implementing robust Know Your Customer (KYC) procedures to verify client identities, monitoring transactional patterns to detect irregularities, and promptly filing Suspicious Activity Reports (SARs) when anomalies are identified. By fulfilling these obligations, financial institutions help disrupt money laundering schemes and uphold the integrity of the financial ecosystem.

Failure to do so could result in significant fines; for instance, in 2022, NatWest Bank was ordered to pay a £265 million fine⁵ over AML lapses.

Money laundering has far-reaching repercussions that extend beyond the financial system, impacting economies, societies, and governments worldwide. Economically, it distorts markets by inflating asset prices, diverting resources away from productive investments, and creating unfair competition. This undermines economic stability and discourages legitimate business activity.

Socially, money laundering enables and fuels other criminal activities, such as terrorism, drug trafficking, human trafficking, and corruption, by providing a mechanism to legitimize the proceeds of these crimes. The funds laundered through financial systems can then be reinvested into expanding criminal networks, perpetuating cycles of violence, exploitation, and societal harm.

Additionally, high-profile money laundering scandals erode public trust in financial institutions and regulatory frameworks. When the public perceives that institutions are complicit or ineffective in combating illicit financial activity, confidence in the financial system and government integrity weakens. This mistrust can discourage participation in the formal economy, further destabilizing financial and social structures.

Addressing money laundering is therefore not just a regulatory obligation but a critical step in safeguarding the economy, protecting vulnerable communities, and preserving trust in financial institutions.

Governments and international organisations are coordinating their efforts in the fight against money laundering. The key efforts so far include the following:

• Financial Action Task Force⁶: This is an intergovernmental body that develops international AML standards, including its 40 recommendations, which describe a comprehensive framework for combating money laundering.
• AML regulations: Laws have been passed in many countries of the world that compel businesses to institute AML programs. For instance, the EU's 6AMLD⁷ introduces more stringent penalties and compliance requirements.
• Suspicious Activity Reporting⁸: Financial institutions should report any transaction that looks unusual or suspicious to help law enforcement agencies track down and prosecute offenders.

Despite significant global efforts, money laundering continues to pose a persistent and evolving challenge. Several factors contribute to the complexity of addressing this issue:

• Innovation in criminal tactics:
  Criminals are constantly adapting, leveraging emerging technologies such as cryptocurrencies, blockchain, and online payment platforms to obscure the origins of illicit funds. These tools provide new avenues for laundering money, often outpacing the ability of regulators and institutions to keep up.

• Regulatory inconsistencies:
  Anti-Money Laundering (AML) laws and enforcement standards vary widely across countries, creating gaps that criminals exploit to move funds across jurisdictions. The lack of a unified global approach hampers effective cross-border collaboration and enforcement, allowing money laundering networks to thrive in regions with weaker regulations.

• Resource constraints:
  Smaller businesses and financial institutions often lack the necessary resources, tools, or expertise to implement robust AML programs. Without advanced screening technologies, dedicated compliance teams, or access to up-to-date data, these entities become vulnerable entry points for laundered funds into the financial system.

• Volume of transactions:
  The sheer scale and speed of global financial transactions create challenges for detecting illicit activity in real time. Advanced laundering schemes are often buried within legitimate operations, making them difficult to identify without sophisticated monitoring systems.

• Emerging threats:
  The rise of decentralized finance (DeFi) platforms, digital assets, and non-fungible tokens (NFTs) presents new and unregulated spaces for money laundering. These innovative financial products often lack standardized oversight, further complicating efforts to trace and combat illicit activities.

Addressing these challenges requires a coordinated global effort, combining advanced technology, harmonized regulations, and enhanced capacity-building for smaller institutions. Only through collaboration and innovation can the international community effectively counter the ever-evolving tactics of money laundering.

Technological advancements are revolutionizing the detection and prevention of money laundering, offering powerful tools to combat this complex and evolving threat. Some of the most significant developments include:

• Artificial Intelligence (AI):
  AI-powered systems are transforming the way financial institutions analyze vast amounts of data. These systems can detect suspicious patterns, flag high-risk transactions, and even predict potential money laundering schemes based on historical data. By automating complex analyses, AI enhances both the speed and accuracy of AML efforts.

• Blockchain analysis:
  Blockchain technology, often associated with cryptocurrencies, is no longer just a challenge for regulators—it is also a solution. Advanced blockchain analysis tools can trace cryptocurrency transactions, offering unprecedented transparency and accountability. This capability helps authorities identify illicit activity, follow the money trail, and disrupt laundering schemes within the digital asset ecosystem.

• Real-time monitoring:
  Automated systems now enable financial institutions to monitor transactions in real-time, a significant improvement over traditional retrospective approaches. This allows immediate detection and response to suspicious activities, reducing the time criminals have to exploit systems and helping to prevent illicit funds from being integrated into legitimate channels.

• Natural Language Processing (NLP):
  NLP tools can process and analyze unstructured data, such as news articles, legal documents, and adverse media reports, to identify risks associated with individuals and entities. This adds a new dimension to customer due diligence and ongoing monitoring.

• Data sharing and collaboration:
  Emerging platforms and technologies facilitate secure data sharing among financial institutions and regulatory bodies. This enhances collaboration and provides a more comprehensive view of potential threats, bridging gaps in information that criminals often exploit.

• Predictive analytics:
  Beyond identifying current risks, predictive analytics uses historical and real-time data to forecast emerging money laundering tactics. This proactive approach helps institutions and regulators stay ahead of criminal strategies.

These technological advancements not only enhance the efficiency of AML processes but also help institutions adapt to the dynamic nature of money laundering threats. By integrating these tools, financial systems can become more resilient, transparent, and effective in deterring criminal activity.