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How to detect money laundering

Money laundering poses a major risk in today's economy. Discover the different types of money laundering, warning signs of the practice, and how regulatory compliance addresses money laundering.

June 30, 2022
Blog Post
Fintech
Fraud Prevention
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Money laundering is a technique used by criminals to cover their financial tracks after they illegally obtain money from an illegitimate source. 

Profits gained from criminal activity are often referred to as ‘dirty money’. This is because the money is linked directly to the crime and can be traced. Due to this, criminals need to ‘clean’ the money so that it appears legal and can be used for investments.

For money laundering to be successful, the dirty money must enter the financial system. So, how do banks prevent money laundering from happening? Well, the answer is anti-money laundering.

In this guide, we’ll explain exactly how to detect money laundering and the anti-money laundering requirements that obliged entities such as banks need to meet. However, before we do this, let’s first take a detailed look at the money laundering techniques employed by criminals and the signs to look out for.

Understanding money laundering techniques

Before you learn how to detect money laundering and how to address your compliance requirements, you must first have a deep understanding of how money laundering works, including the techniques employed by criminals.

Money laundering involves three stages: placement, layering, and integration.

Placement

The placement stage of money laundering refers to how and where illegally obtained funds are placed into the financial system. Methods used by fraudsters include:

  • Making payments to cash-based businesses
  • Making payments for false invoices
  • Putting small amounts of money (below the AML threshold) into bank accounts or credit cards 
  • Moving money into trusts and offshore companies that hide owner identities
  • Using foreign bank accounts
  • Aborting transactions shortly after funds are lodged with a lawyer or accountant

Layering

The layering stage of money laundering refers to the way that criminals separate the illegally obtained funds from their source.

During this stage complex financial transactions take place and the origins and ownership of the funds in question are disguised. When carried out correctly, the layering process makes it incredibly difficult for AML investigators to trace the transactions back to the source of the funds.

Integration

The integration phase of money laundering happens when the laundered funds re-enter the economy in what appear to be legitimate business or personal transactions.

The money launderers will often do this by purchasing real estate or luxury assets in order to increase their wealth.

Complex money laundering techniques

It’s important to point out that money laundering techniques vary in complexity. That said, the most common method of money laundering is for the dirty money to be processed through another cash-based business.

Many money laundering organizations also own multiple ‘front businesses’ that would usually handle large amounts of cash, such as casinos, restaurants, or launderettes. With the help of the front business, legitimate profits can be mixed with criminal money, meaning that the source of the funds can be hidden effectively.

Alternatively, some money launderers will use a process called structuring. This is the act of dividing large sums of money into smaller amounts and then spreading these sums across multiple accounts. By dividing the money into smaller amounts, the criminal can bypass money laundering policies and make the deposits appear less suspicious.

Other techniques employed by money launderers include:

  • Currency exchanges: Here, dirty money is exchanged by a foreign currency provider (often unwittingly)
  • Laundering money using virtual currencies: Cryptocurrencies are one of the most convenient methods to wash money. This is because they are not connected to a person's identity

What to look out for

When it comes to detecting the signs of money laundering, vigilance is key. Signs that indicate one of your customers may be involved in money laundering include:

  • Unusual financial activity that is out of character when compared with their usual transaction patterns
  • Large cash deposits are made with no justification for where the funds came from
  • They are evasive or defensive when they’re asked about details
  • There are discrepancies in the information they’ve provided
  • Large sums are invested by third parties, with no explanation for the private funding
  • Their financial transactions have become increasingly complicated

What is anti-money laundering?

Now you know how to detect money laundering, we can discuss anti-money laundering and the steps your business needs to take to stay compliant with regulations.  

Anti-money laundering (AML) refers to the activities financial institutions perform to ensure that they achieve compliance with legal requirements. This includes monitoring transactions and reporting suspicious activities to the relevant authorities.

In 1989, the Financial Action Task Force (FATF) was created to combat money laundering. Now, the intergovernmental organization sets the framework for anti-money laundering (AML) policies and supervises countries to make sure that they comply. Individual countries also have their own supervisory schemes that oversee national institutions.

AML regulations make ‘obliged entities’ aware of the red flags they need to watch out for. They also make sure that these businesses proactively monitor the activities of their clients. Obliged entities include banks, payments processors, gaming businesses, and gambling businesses.

Why are anti-money laundering processes important?

Anti-money laundering is incredibly important. This is because the estimated amount of money laundered globally in one year is 2% to 5% of global GDP, or US$800 billion to US$2 trillion.

Plus, it’s not just the scale of money laundering that makes it so problematic. Remember, money laundering is also linked to activities like smuggling, illegal arms sales, embezzlement, insider trading, bribery, and computer fraud schemes.

Although there’s a moral imperative to fight money laundering, financial institutions also use AML tactics for:

  • Compliance with regulations
  • Protection of their brand reputation
  • Avoidance of consent orders, criminal, and civil penalties
  • Cost reduction in relation to fines, employment, IT cost, and risk exposure

How banking AML works

Banks are the foundation of the financial system so it's vital that they spot suspicious activities.

Like all institutions, banking AML policies are shaped by the framework set by the FATF. On top of this, country-specific regulatory bodies have enacted critical AML legislation with compliance requirements banks must follow. These include:

  • US: US Patriot Act, Bank Secrecy Act.
  • Europe: EU Sixth Anti-Money Laundering Directive (6AMLD).
  • Canada: Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA).
  • Australia: Anti-Money Laundering and Counter-Terrorism Financing Act of 2006.

Although AML regulations vary by jurisdiction, financial institutions such as banks undertake the following measures to meet compliance requirements:

Staff training

Frontline employees in banks must be trained in anti-money laundering techniques and are legally required to spot suspicious activity.

On top of this, banks have their own AML compliance officers. These people can boost the company’s anti-money laundering practices and help educate others. These compliance officers are also responsible for developing and writing AML policies, reviewing suspicious transactions, and reporting them when required.

Customer identification programs/know your customer (KYC)

Financial institutions such as banks must have proper customer identification and verification processes in place to ensure that their customers are legitimate people who are making legitimate transactions.

For a bank, AML compliance starts with verifying the identity of a new client. Once a client’s identity has been established, banks are also required to understand the nature of that customer’s activity. Banks are also required to verify that deposited funds are from legitimate sources.

Banks must verify:

  • The name of the customer
  • Their date of birth
  • Their address

This is why banks ask customers to supply identity documents when they open an account. To add an extra layer of security to the process, many banks also now use biometric identification processes, such as facial recognition.

Large transaction reporting

Anti-money laundering requirements call for institutions such as banks to file a regulatory report for transactions above a certain threshold that are made by a single customer during a business day.

Monitoring and reporting suspicious activities

Regulatory agencies publish AML guidelines about behavior that banks and financial service providers should monitor. For example, if a customer makes numerous cash deposits or withdrawals over several days to avoid a reporting threshold, this should be recorded and reported to authorities.

As part of this process, when a bank’s AML compliance officer uncovers behavior that exceeds reporting thresholds and has no apparent business purpose, they file a report with the relevant authority in their country in order to fulfill regulatory requirements.

Before they report a suspicious activity, the compliance officer must determine whether:

  • A client may be using proceeds from illegal activities in a transaction
  • The purpose of the transaction may be related to financing of terrorism
  • The transaction has been made under unusually complex circumstances
  • The transaction seems to have any reasonable economic purpose

Sanctions compliance

Regulatory bodies such as the US Treasury Department, US Office of Foreign Assets Control, the United Nations, the European Union, Her Majesty’s Treasury, and the Financial Action Task Force on Money Laundering have requirements for financial institutions to check customers against lists of sanctioned individuals, companies, institutions, and countries.

To be compliant, banks and brokers must screen new customers against lists of crime suspects, individuals and companies under economic sanctions, and politically exposed persons. This includes foreign public officials, their family members, and their close associates.

Customer due diligence

Customer due diligence is an essential part of a bank’s KYC processes and it can help banks detect common money laundering strategies.

The process starts by ensuring that the information a potential customer provides during the onboarding process is both accurate and legitimate. However, customer due diligence is an ongoing process, which also extends to existing customers and their transactions.

The customer due diligence process requires an ongoing assessment of the risk posed by each client. Clients who are flagged as being at higher risk of non-compliance are then monitored more closely than those who are seen as lower risk.

The process must be continuous because a client’s risk level will change throughout their time with your company. For example, some of your clients may be added to sanctions and AML lists. If this is the case, it’s important that your company is aware of this.

As part of their requirements, banks must develop and implement a written AML compliance policy. This must have been approved in writing by a member of senior management and be overseen by a designated AML compliance officer. These compliance policies must specify risk-based procedures for conducting ongoing customer due diligence. In addition, the bank must commit to conducting ongoing monitoring to identify and report suspicious transactions.

AML holding periods

AML holding periods are put into place by banks in an attempt to foil the ‘layering’ stage of money laundering. As part of an AML holding period, any deposit must remain in an account for a minimum of five trading days before it can be transferred anywhere else.

By slowing down the process of moving funds, banks can assist with anti-money laundering measures and allow more time for risk assessments to take place.

AML transaction monitoring software

Of course, many large banks have thousands of customers and process millions of transactions on a daily basis. Due to this, it’s impossible for them to monitor every transaction manually.

As a result, banks use AML transaction monitoring software to help them monitor transactions on a real-time basis. Software like this can analyze an account holder’s history, their risk level, and the details of their individual transactions (including the total sum of the money, countries involved, and the nature of purchase). If a transaction is considered high risk, it’s flagged by the system as suspicious activity. It can then be reviewed by the AML compliance officer, who can report it if necessary.

Book a consultation with Veriff

Now you know how to detect money laundering and how the crime is committed, you can put processes in place to stop your business from being a target for criminals.

The starting point for AML compliance is online identity verification. After all, when welcoming a new client, you need to make sure that your new customer is real, legitimate, and not subject to any sanctions. Thankfully, our identity verification solution ensures compliance and KYC.

To discover more about how we can help you, contact us today for a personalized demo.