The term “money laundering” derives from the fact that gangsters in the 1920s commingled the proceeds of their illegal operations with the basically untraceable proceeds from coin laundries operated by the ring, thus making the funds appear as if they been derived legitimately. Although the term may have started in the 20th century, the practice of disguising unlawful proceeds traces its roots back to the dawn of banking itself. For example, when the Roman Catholic Church in medieval times banned lending money at interest, financiers developed methods to get around this restriction.
Criminal organizations have three objectives for laundering the proceeds of their illegal activity. These are:
o To pay expenses related to their illegal activity.
o To invest their proceeds in the criminal cycle and boost illegal activity.
o Eventually, to enjoy the profits of their criminal activity.
Today, money laundering represents an estimated 2 percent to 5 percent of the world’s gross domestic product. Estimates of money laundering worldwide range from $800 billion to $1.6 trillion; 47 percent of the launderers use banks to clean dirty money. While some observers have challenged the accuracy of these numbers, this problem is one of huge proportions even after several years of strong lobbying by the inter-governmental Financial Action Task Force (FATF) to assure that banks and non-bank financial institutions adopt the FATF’s Forty Recommendations on combating money laundering.
Three Stages of Money Laundering
The money-laundering process comprises three main stages:
1. Placement is the physical disposal of bulk cash proceeds derived from illegal activity.
2. Layering is separating the illicit proceeds from their source by creating complex layers of financial transactions. Layering confuses the audit trail and provides anonymity.
3. Integration is re-injecting of the laundered money back into the legal economy in such a way that funds re-enter the financial system as legitimate business proceeds.
Is Terrorist Financing Similar to Money Laundering?
Terrorism financing is the process of reverse laundering, but tends to use smaller amounts than is the case with money laundering. This process uses funds raised from legitimate sources such as personal donations and profits from businesses and charitable organizations, as well as from criminal sources. Terrorists use the same money laundering techniques to evade authorities’ attention and protect the identity of their sponsors and the ultimate beneficiaries of the funds.
Challenges in the Middle East
Fighting money laundering is not easy for any financial institution. In the Middle East, cultural customs, terrorism and smuggling make the detection of doubtful cash transfers particularly challenging. That is why banks and other financial institutions must be more alert in monitoring customer activities and knowing their customers.
In order to implement a robust anti-money-laundering (AML) program in a financial institution, senior management must support it and empower employees to ask uncomfortable questions; set up proper controls and strictly enforce them in order to detect suspicious transactions or activities; and make timely reports to financial intelligence units about suspicious activities.
In some Middle Eastern countries, these obligations are often perceived as conflicting with customer relationships and cultural customs. For example, a bank employee who fails to discharge AML compliance responsibilities – whether wittingly or to avoid asking a customer uncomfortable questions – can negatively impact efforts at other institutions by not demonstrating a unified front and by making that institution more appealing to both money launderers and to customers who find AML obligations uncomfortable.
Financial institutions generally have decades of experience implementing AML programs and ensuring compliance. But many Middle Eastern financial institutions are adopting corporate cultures that weaken AML and anti-terrorist financing efforts, or continue doing business in ways that can undermine global AML compliance efforts.
One of the biggest problems for AML initiatives in the Middle East is cultural customs that accept deference to customers and anonymity. Accounts lacking full identification details or with misleading information are not unusual in the region. Verification of customer information is often difficult, if not impossible.
“Know your customer” is an element lacking at many Middle Eastern financial institutions which follow local traditions of accommodating customers’ requests. Gathering customer information is generally a sensitive issue, as customers may view banks’ requests for additional information as intrusive or offensive. For example, it can be difficult for a bank to refuse to enter into or to exit a relationship with a politically connected person. Doing so could mean trouble for the staffer involved.
Lack of adequate information has a significant impact on other aspects of AML programs, such as transaction monitoring and the bank’s ability to apply a risk-based approach to its clientele base. Bank officials frequently claim that they do not want to offend customers and lose business to a less law-abiding competitor.
One region-specific challenge is that it can be very difficult to perform a check against a sanctions lists based on a customer’s name due to the multiple available spellings of names used in the region.
Financial institutions often have a formal program in place to test the effectiveness of their AML systems and controls. However, the quality of some of this testing can be questionable. Internal auditors commonly carry out this independent testing, but a major concern is whether internal auditors have sufficient experience and knowledge to perform this testing efficiently. Moreover, reviews often take place infrequently and some time after the event.
Challenges at the National Level
The governments in the Middle East are taking steps towards enforcing AML/counter-terrorism financing laws, regulations and guidelines. However, there are several deficiencies in the legal and financial systems which need to be addressed:
o Although money laundering is a criminal offense, terrorist financing is not specifically prohibited in some countries.
o There is often an overreliance on suspicious transaction reporting to generate money laundering investigations
o A large informal cash economy exists, and many financial transactions do not enter the banking system.
o Cash reporting requirements are not consistently enforced and some countries do not have currency reporting requirements for individuals leaving the country.
o Financial intelligence units have been created in accordance with international standards, but some of them lack adequate organization, expertise and independence.
o There are deficiencies in monitoring the operations of local charities abroad.
o The presence of underground banking (Hawala) presents a potential means for laundering funds
o It is difficult to find a balance between the privacy of individuals’ rights versus the need to protect society against criminals and terrorists.
Recommendations for Improvement:
o Implement a nationwide awareness campaign about the risk of money laundering and terrorism financing. Such campaigns must be able to send a strong, convincing message to the public at large that financial institutions are implementing “know your customer” programs with the objective of safeguarding the country and soundness of the financial system from terrorists or criminals.
o Improve the efficiency and independence of financial intelligence units and encourage them to provide feedback on suspicious transaction reports to reporting institutions as well as sharing information with foreign financial intelligence units.
o Improve enforcement of cross-border currency controls, specifically allowing for seizure of suspicious cross-border currency transfers.
o Empower law enforcement and customs authorities to examine and investigate trade-based money laundering, informal value transfer systems and customs fraud. They should take the initiative and proactively generate leads and investigations and be able to follow the financial trails wherever they lead.
o Update AML laws against terrorism specifically to address the threat of terrorism financing, including asset identification, seizure and forfeiture.
o Encourage countries to ratify the UN Convention against Transnational Organized Crime; UN International Convention for the Suppression of the Financing of Terrorism; and UN Convention against Corruption.
o Strengthen charity oversight, especially in overseas operations.
o Implement and enforce a uniform cash declaration policy for inbound and outbound travelers.
More needs to be done to combat both money laundering and terrorism financing. While governments and financial institutions in the region have taken effective and advanced steps, the political and cultural environment in the region will continue to present challenges.