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Money Laundering And Its Effect On Indian Economy Finance Essay

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Published: Mon, 5 Dec 2016

Money laundering is the process by which money earned from illegal activities is converted to legitimate money. Money laundering has been and is taking place all over the world which in turn is affecting the economy of world. In a growing economy like India money laundering is a growing and serious problem but is mainly confined to domestic activities that are far from being only drugs related frauds, corruption and smuggling are obvious additional ones (Lilley, 2003).The governments of various nations have been taking various measures to prevent money laundering, however countries like India which is a developing country, are still suffering with the problem of money laundering as there is a lack of general understanding related to money laundering and how corrupt business and government officials exploit this ignorance for their personal benefit. Even though money laundering has been recognised as a dangerous crime by Indian legislative councils, however the lack of general understanding and insincerity on the governments’ part to enforce the laws properly, the crime of money laundering is growing and having disastrous impact on Indian economy.

According to estimates put forth by international accounting firms, India is estimated to have a parallel economy of nearly 40 percent of its $600 billion Gross Domestic Product. That’s’ some serious parallel banking system (Singh, 2009).

According to Brave (2006), money laundering is the process of turning black money into white money. In India the problem of money laundering is not just limited to hard core criminals but also other division of the society such as like politicians, bureaucrats, stock brokers etc. The Indian Media both electronic as well as print media regularly report various instances of money laundering scams involving political leaders. One of most some of the prominent politicians of India accused of money laundering are the CM’s of UP, Punjab and Kerala and Jharkhand. According to news report published in Indian Express, UP chief minister Ms. Mayawati was accused of laundering money by using novel techniques in order to avoid tax payment legitimately. Huge cash donations were made in her name by people who didn’t existed and by fictitious people. When a CBI inquiry was ordered it was found that most of these persons who made the donations don’t exist or their financial conditions were such that they were in no positions to donate such large amount of money to her (Sarin [online] 2004).

Ketan Parekh who was a stock-broker is another well known Indian who has faced money laundering charges. He was in the news primarily for his manipulative dealings in the stock of 10 companies, which included Digital, Global Tele, Himachal Futuristic, Infosys, Wipro and Zee Tele, better known as the K-10 scripts. Following a CBI enquiry in December 2002, Ketan was arrested. He was accused of transferring the money received from the BoI pay order scam to various tax heavens around the world and finally to accounts in the Swiss Banks (Barve [online] 2006).

According to Jayaseelapandian (2000) if money laundering is carried away successfully it lets the criminals to have control over their money and help them cover their sources of income thus making their illegal money rightful. Money laundering plays a primary role in achieving the desires of drug trafficker, terrorist organisations, gangs of organised criminals, inside dealers, the tax evader as well as others who wish to stay away from any kind of interest from the authorities. The primary objective of engaging in this type of activity is to place the proceeds beyond the reach of any asset forfeiture laws.

As per Agarwal et al (2004), the estimated value of money laundered globally using the banking route is in excess of US$ 500 billion to one trillion per year. They further state that the global money laundering also exposes a country to attacks from terrorists, which is serious threat to any country’s integrity apart from adversely affecting a country’s economy. Also, of the estimated money laundered every year worldwide using banks, half of this amount is laundered by using US banks. As money launderers are increasingly using the banking channel for laundering process, the banks have a key role to play in restricting the outbreak of money laundering. Money Laundering is not a simple process but a complex procedure involving bankers, lawyers, car dealers, real estate builders, accountants and people, who allow their business to be used by someone to launder the financial gains of a criminal activity.

As stated in the above paragraphs, money laundering is a big problem and it doesn’t affect just one or two countries but is present at global level specifically in developing countries like India. India where the financial sector has just been liberalized is at greater risk as criminals and people with ulterior intentions can exploit the ever growing financial sector for their corrupt activities.

This project aims at bringing general awareness among the people working in financial institution, banking sectors etc about money laundering. This aim can be achieved by studying the money laundering activities taken place in India and different countries and what measures are taken to overcome it.

BACKGROUND

Uribe (2003) highlights that the word “money laundering” came into existence in the early 20th Century, but the practice of disguising income earned from unlawful activities can be traced back to the 13th Century B.C at which time the oceans and seas were used as international trade routes. With the changing profile money laundering over the years has become more and more expensive, time-consuming method to carry out and eventually risky.

According to Lloyds (1997) the word money laundering originated from one of the most famous mafia Al Capone or Scarface who created a criminal organization in 1920’s in the United States as a result of to their activities such as gambling, liquor profits etc. They wanted to conceal their illegal money and to do so they opened legitimate business in another country and mixed their illegal money with the white money. He further states that in 1930s mobster Meyer Lansky gave rise to number of ways to launder money in order to hide the money earned from gambling, sale of illegal alcohol etc. He understood the significance of creating businesses, as “fronts” for his illegal activities as well as means to launder money. He bought a Swiss bank to transfer the dirty money through different methods such as shell companies, holding companies and offshore bank account. For carrying out illegal activities casinos are one of the most notorious business “fronts”. In the 1940s Las Vegas was notorious for being a tool of money laundering, and was fully exploited particularly by Lansky and Benjamin “Bugsy” Seigel. It can be said that Lansky was the first to establish modern form of money laundering and tax evasion.

Furthermore, Uribe (2003) states that the concept of money laundering is certainly not new. People who undertake criminal activities for financial gain have always strived to keep all attentions away from their illegal activities and profit from their efforts. Day by day the methods of disguising money earned from illegal activity is becoming sophisticated. There are numbers of reasons for this of which some are given below.

The globalisation of the financial system: In today’s world technological advancements in communications and transportation have allowed the cover up of crime and its proceeds to become a much easier task. In matter of seconds money received from illegal activities can be wire transferred from one financial institution to another;

Crime has gone global: It is no longer enough for enforcement authorities to be aware of what is occurring within their own jurisdiction. They must anticipate and cooperate with other authorities and jurisdictions as criminal activities can spread very fast.

In addition, criminals no longer have the want to be confined to one country. They have understood that in order to avoid detection by law enforcement and local authorities it is safer for them to shift their property and business between countries. Thus as a result, international criminal organisations shift property from one country to another by taking advantage of the negligent legislation present in some countries that offers safe havens for foreigners looking to hide their money.

In simpler terms money laundering can be defined as converting illicit money to legitimate money. This type of money is earned from smuggling, drugs, prostitution, gambling etc. It is the process in which the money earned from criminal activities are transported, transferred, transformed, converted into legal money to hide the actual source of income (Richards, 1999). Money laundering may involve various kinds of financial institution, multiple financial transactions, and the use of intermediaries such as financial advisers, accountants etc from different countries (Schott, 2006).

The people in developing countries like India don’t know what money laundering is and if they are asked about money laundering they would think it is to do with washing or drying of currency notes. Money laundering was not taken as big crime in the beginning but after the terrorist activities this has been taken as a serious issue and government have started taking action to control it (Barve [online] 2006).

According to Jost et al (2002) money laundering in India can be traced way back to 1985 in the Choraria case in which the British courts convicted Choraria for trafficking of controlled drug known as ‘heroin’. Choraria was a banker who enabled payment for heroin imported to Britain illegally to be transferred to India. He had opened two legal businesses one was import/export and the other was a remittance business and part of the remittance business was Hawala. He had dealers transferring the funds in Karachi and Mumbai as part of heroin smuggling.

Kumar (2003) highlights that India was one of the first countries in the world to introduce anti-money laundering legislation, way back in 1939 – which was a wartime measure, in 1973 FERA (Foreign exchange control Act) came into force; more recent laws include the Foreign Exchange Management Act 1999 and the Prevention of Money Laundering Act 2002. But despite these laws in place, it was never forced in earnest. Laws such as FERA and now FEMA are regularly used by politicians to settle political scores against each other.

AIM AND OBJECTIVES

The aim of this project is to bring general awareness among the people working in financial institution in India regarding money laundering and how it is perpetuated and to fill the vacuum created by lack of training and research material related to the topic. Hence creating an environment where exploiting in the situation by corrupt officials and powerful people becomes more difficult and the potential damage to the economy can be minimized. Thus the following objectives would be studied to achieve the aim

. Identify and analyze the process of money laundering and also research over the origin, core concepts and the evolution of money laundering with emphasis on Hawala or Hundi.

Identify the factors which are providing impetus to the crime of money laundering.

Why Anti – Money Laundering laws are needed.

Identify and research the current AML (in brief) in place around the world.

Identify and discuss regulation of money laundering laws in India

Gathering domain expert views over the running practicality of money laundering laws globally in general and specifically in India.

.

LITRETURE REVIEW

Uribe (2003) highlights that the word “money laundering” came into existence in the early 20th Century, but the practice of disguising income earned from unlawful activities can be traced back to the 13th Century B.C at which time the oceans and seas were used as international trade routes. With the changing profile money laundering over the years has become more and more expensive, time-consuming method to carry out and eventually risky.

According to Lloyds (1997) the word money laundering originated from one of the most famous mafia Al Capone or Scarface who created a criminal organization in 1920’s in the United States as a result of to their activities such as gambling, liquor profits etc. They wanted to conceal their illegal money and to do so they opened legitimate business in another country and mixed their illegal money with the white money. He further states that in 1930s mobster Meyer Lansky gave rise to number of ways to launder money in order to hide the money earned from gambling, sale of illegal alcohol etc. He understood the significance of creating businesses, as “fronts” for his illegal activities as well as means to launder money.

Furthermore, Uribe (2003) states that the concept of money laundering is certainly not new. People who undertake criminal activities for financial gain have always strived to keep all attentions away from their illegal activities and profit from their efforts. Day by day the methods of disguising money earned from illegal activity is becoming sophisticated.

Money Laundering Process

Money laundering is the process of changing the source and ownership of capital and assets earned through criminal activities to a legitimate source (Great Britain, 2009)

According to Hopton (2006) Money laundering can be done in many ways. It can be a simple method or a complex method which could include international businesses and investments. However, as per the law money laundering has been defined in three stages namely placement, layering and integration.

Placement: As per Molander et al (1998) placement is the first step in the money laundering process wherein the money earned from illegal activities is processed in the financial system. In this process the illicit takings is most open to detection. Gilmore (1999) highlights that the main aim of this stage is to move the money from the place it has been earned so as to avoid detection from the authorities. In this stage it has the greatest risk as the dirty money is deposited in financial institutions or used to buy asset. Once the money is forwarded to the financial institution placement takes place.

Furthermore, Schneider et al (2008) states that placement can be done in many ways namely primary deposit in which people know that it is the right time to put illegal earnings into a legal financial system without drawing attention of regulatory agencies. The money is separated in limited amounts so that no identification or documentation is required while depositing the illegal money. The other method of placement is by opening new bank accounts in different countries also the corrupted co-workers are used as a way to place illicit money. When money is deposited in banks abroad it helps to enter financial or economic cycle. Another way of placement is through secondary deposit wherein the illicit money is transferred indirectly in the bank system thus converting it into legal money with the help of legal person. The name of unknown individual who work for them is used to open up new accounts, buy assets, open up a company etc. Indirect placement can also be accomplished by forward displacement of the money laundering location onto life insurances, financial service provider and exchange offices

Layering: According to Chaikin (2008) this stage involves separating of illegal money from its origin by involving many layers of financial transactions and transfers. As per Gilmore (1999) it is the converting of dirty money to clean money in which the cash is split through various methods which are specially designed to cover the dirty money. It helps to cover the audit trail and provides secrecy. Layering is achieved by purchasing assets of high value such as diamond or by moving money into banks abroad or by overbilling of the value of imported goods. This stage is also known as agitation stage. Moreover, Schneider et al (2008) states that due to the electronic payment system and lack of efficient criminal prosecution helps to make layering process possible.

Integration: Gilmore (1999) states that this stage takes place once the layering process is successful. The money is transferred back to the launderer as clean money and is mixed with legitimate economy and financial system. Integration process is generally achieved by setting up unknown institution in places where secrecy is assured. New forms of businesses give way to integration process such as a person can open a webpage and change his dirty money to clean money by showing income from the webpage. Figure1 shows the stages of money laundering.

Figure 1: Stages of Money Laundering

(Source: http://money.howstuffworks.com/money-laundering1.htm)

In India the Reserve Bank of India (RBI) panel suggests that the existing anti money laundering laws needs to be strengthened. They have proposed strict rules to fight money laundering activities and according to which the banks need to improve the procedure and policies for creating proper customers profile and coordinate an cooperate with regulatory and other authorities. According to the panel, to stop money laundering the banks working in India must check the sources of funds in deposit schemes offered to expatriate Indians. The banks should appoint anti-money laundering compliance officer to check and maintain profiles of customers. A data bank for suspicious transactions should be created and forwarded to banks to help them identify the method of doubtful behaviors. The anti money laundering software was launched in India on 17th of September 2003 by Infrasoft Technologies known as OMNI Enterprise, which was first software adopted by India globally (Agarwal et al, 2004).

Estimating how much money is actually laundered in the United States, or any other country, or globally is extremely difficult. Money Laundering is a largely secretive happening. The exact number of launders that operate every year, how much money they launder in which countries and sectors, and which money laundering techniques they use is not known (Brigitte Unger, 2007). However, a sustained effort between 1996 and 2000 by the FATF to produce such estimates failed. In fact, no direct estimates exists of how much money passes through the financial system, whether broadly or narrowly defined, for the purposes of converting illegal gains into a non-traceable form (Peter Reuter and Edwin M. Truman,2004).

John Walker (1995) was the first to make a serious attempt at quantifying money laundering and initial output. His model suggests that US$2.85 trillion are laundered globally. As per an estimate of the International Monetary Fund, the aggregate size of money laundering in the world could be somewhere between two and five percent of the worlds Gross Domestic Product. While it is impossible to state how much money is laundered every year with authority, it is estimated that US$300 billion to US$500 billion in proceeds from serious crime (not tax evasion) is laundered each year (Scott, David. 1995). Though data on the size of money laundering is scant, UK and US officials estimate that “the amount of money laundered annually in the financial system worldwide was roughly $500 billion – some 2% of global GDP” (Quirk, Peter J., 1997). According to international accounting firms, India is estimated to have a parallel economy of nearly 40 percent of its $600 billion Gross Domestic Product (Singh, 2009).

Table 1: lists several specific estimations of the value and extent of money laundering worldwide.

Publication year

Estimation year

Estimation of Global ML

Source

1995

1995

US$100-500 billion

John Walker

1998

1997

US$ 300-500 billion

U.S. Department of State

1998

1998

2-5% of the global GDP

Michel Camdessus – IMF

2002

1998

US$ 800 billion to

US$ 1.5 trillion

Simon Maylam

1998

1998

US$ 2.85 trillion

John Walker

2004

US$ 45-280 billion

Reuter and Truman

2005

US$ 1 trillion

Baker

2008

US$ 1.425 trillion

AUSTRAC

2009

2-5% of the global GDP (US$ 800 billion to US$ 2 trillion)

UNODC

(Source: Alkaabi et al, 2010)

Hawala

According to Fritsch et al (2001) the Hundi system can hardly be tracked and was developed many centuries before by bookkeepers who were keen to prevent bandit attacks on transcontinental caravans. In this system the money changer takes money from its customer to transfer it to another person in a foreign city which is often done within a day. The changer calls a colleague in the receiver’s country to deliver the money. To receive the money the beneficiary needs only a receipt which is generally a bank note or a code word mailed by the sender. This method is guaranteed not by fixed assets but by fear. Moreover, in Hawala system Bank notes and pictures are torn in half, and one half is given to the customer and the other is mailed to the beneficiary. The two halves needs to match for the transfer to be completed (Nove, 1991 cited in Carroll, 2007)

However, Lilley (2003) highlights that “Hawala” or “Hundi” is a substitute or parallel process of transferring money. It exists and runs outside of, or parallel to, traditional banking or financial systems. Hawala was established in India before the Western banking system was introduced, and is one of the most common methods used In India and around the world to launder money. This system provides secrecy as there is no paper work and is based on trust. The money is not transferred physically. In this system the client goes to the broker in one country and asks to make payment to another person in another country. The broker then calls his coworker in the destined country and asks to make payment to the recipient. As a result no paper work is done and is based on trust. The funds are physically transferred at a later stage between the brokers. Furthermore, Mirza (1996) cited in Carroll (2007) states that in the Hawala system transfer of money is confirmed through telephone, email and facsimile. This method even offers pick-up and delivery of money.

Dougherty (2006) highlights that Hawala is a value transfer system which has been in use for 1200 years. It can be said as a poor man’s Western union wherein they pay 1% of the value sent. It is described as “informal value transfer system” and is recognized as “alternate remittance system”. As this method of transferring fund is very difficult to track, it is estimated that $100 billion to $300 billion of money is laundered through them every year. He further states that according to Interpol, with language that leaves and error, Hawala system of remittance can be said illegal in India. As per the law in India the conception of Hawala, such as transfer of value is illegal but more than that under the jurisdiction of foreign currency exchange laws, when Hawala deal includes foreign currency it goes beyond the line of illegality. Hawala can be used in any stage of money laundering for instance in the placement stage the customer can give the money to the broker. In the layering stage the money can be separated from the source and leave a puzzling or nonexistence trial and in the integration stage the money transferred from one country to another is difficult to track using Hawala.

Hawala system helps in converting illegal money into legal money. The word “Hawala” is an Arabic word which means moving of money or information from one person to another using the help of third person. This method of transferring money is not traceable by authorities as no paper work is left behind. To launder the money the profits made out of Hawala transactions are put in real estate, films etc (Devi et al, 2010). Also, Hawala is assumed to be used by terrorist to transfer assets (Fernandes, 2002).

One of the well known Hawala or foreign exchange case in India was the S. K. Jain (a Hawala broker) case who was arrested in 1991. Huge amount of Indian and foreign currency, some notebooks and a diary was discovered during the searches done in his and his family’s property. The diary contained the initials of high level politicians to whom large amount of money were said to have been paid illegally (Wescott et al, 2009). Furthermore, Chopra (1996) highlights that the diary which was found during the search listed a sum of $18 million that was given to the government officials. Although Hawala is illegal in India, it is the corrupt politicians who give rise to such method.

Factors which are providing Impetus to the Crime of Money Laundering (Vijay Singh)

Many reasons can be attributed to the rising instance of money laundering around the globe of which some are given below.

No agreements for sharing tax information with other countries

Availability of instant corporations

Corporate Secrecy Laws – as the corporate law of certain countries enable launderers to hide behind shell companies.

Excellent Electronic Communication – internet, mobile phones, phones

Tight Bank Secrecy Laws

A Government that is Relatively Invulnerable to Outside Pressures

A high degree of Economic Dependence on the Financial Services Sector

A Geographical Location that Facilitates Business Travel to and from rich neighbors.

Increase in sophistication and employment of professional people for doing the task.

The politician-criminal nexus

The lack of effective control over contributions to political parties and election expenses. This enables criminal elements to use their contributions to the political process as a safe channel for money-laundering and for gaining political influence to incapacitate the intelligence and investigating agencies so that they cannot effectively act against them(Raman, B., 2009).

According to Agarwal et al (2004) Money Laundering is more vulnerable in the private banking sector due to the following six reasons thus giving rise to instances of money laundering.

Private Bankers as Client Advocates

The main players in private banks are the bankers who are trained to serve their customers. They open up accounts and move the money around the world using secret tools and financial systems. The private bankers are encouraged by their banks to create personal relationship with their customers by visiting their homes and organizing their financial affairs. As a result of this the private bankers may feel loyal for their customers and may avoid the controls made to detect or stop money laundering.

Powerful Clients

The customers of private banks may use political or economic power because of which the banks become concerned to fulfill their needs and ask very few questions. Also if the customer is a government employ with control over the banks in country procedure, the bank has grounds to evade fraud.

Culture of Secrecy

In a private bank secrecy is maintained and one of the examples is that in Swiss banks, accounts are opened by using numbers. Also, the private banks and clients use many levels of privacy to hide accounts and transactions. They open up shell companies to hide the identity of the owner of the bank account and also open up accounts in code names.

Secrecy Jurisdictions

Some private banks follow business according to secrecy jurisdiction and if the banking information of the client is disclosed it may be illegal and action can be taken against it.

Culture of Lax Control

At the time to follow the anti-money laundering controls it is the private banker who is asked to check the enforcement of anti money laundering controls. They check the history of their prospective customers and also monitor existing accounts for any fraudulent activity. Also, they are the ones to open any new account and increase client deposits. The private bankers become the advocate for their customers and do not follow the procedure to check their transactions. They do not ask enough questions about their funds and do not record the information provided in a proper form.

Cut Throat Competition

As a result of competition in the private banks for clients to increase their profitability, money laundering problem is increased.


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