Detecting money laundering: A comprehensive guide

What is money laundering?

Money laundering is a technique criminals use 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 (AML).

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 it works, including the techniques employed by criminals.

Money laundering involves three key 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 happens when the laundered funds re-enter the economy in what appear to be legitimate business or personal transactions.

Money launderers will often do this by purchasing real estate or luxury assets that increase their wealth.

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

Six money laundering red flag indicators

To help you spot the signs of money laundering, keep an eye out for these six red flags:

1. Unusual transaction patterns: different transactional patterns can indicate when money laundering occurs. Rapid payment transactions, significant increases in frequency or value, structuring schemes to break down deposits, and inconsistent transactions with customer activities should all raise suspicion and suggest potentially dubious activities.

2. Cash-intensive activities: cash is the major facilitator of money laundering, so cash-related businesses are prime targets for money launderers. They offer an unparalleled opportunity to move funds with minimal monitoring, and relatively easy ways to escape controls. Businesses with a high volume of cash transactions (casinos, restaurants, grocery stores) or with no apparent justification for cash transactions (construction companies, service providers) may contribute to money laundering schemes.

3. Third party relationships: finding the beneficial ownership of companies in tax havens is an uphill battle, and will remain so, especially in countries with less clear regulations. Money launderers may use third parties to create complex transaction chains, involving multiple accounts or intermediaries, to obscure the trail and source of illicit funds. Some laundering schemes will also appeal to complex international ownership structures, and leverage shell or offshore companies with nominees to hide beneficial ownership. Transactions originating from Politically Exposed Persons must also be considered when looking for signs of money laundering.

4. Specific geographical areas: some countries are more exposed to corruption, organized crime, and money laundering than others, due to weak regulatory systems and poor governmental oversight. When monitoring transactions, geolocation data might be a factorof suspicious activities.

5. Deficient financial systems: “finding the weakness” could be the motto for money launderers. Whether it is corruption-enabled, lack of proper KYC/AML program implementation, or simply weak regulatory framework, some financial systems are easier than others to launder money. In particular, inadequate due diligence processes or weak internal controls within a financial institution are especially interesting for people looking to hide the source of their funds.

5. Technology-enabled money laundering: Digitalization and technological developments have been powerful enablers of money laundering, and opportunities are endless. The emergence of cryptocurrencies and virtual assets provides an additional layer of anonymity to be exploited, on top of decentralized or peer-to-peer exchanges. For example, funds going through an account and instantly converted into crypto might be flagged as suspicious.

Why are AML processes important?

AML is incredibly important. This is because the estimated amount of money laundered globally in one year is 2%-5% of global GDP, between US$800 billion and US$2 trillion, according to Europol.

And it's not just the scale of money laundering that makes it so problematic. Remember, money laundering is also linked to activities such as 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 deploy AML measures to:

• Comply with regulations
• Protect their brand reputation
• Avoid criminal, and civil penalties

How banking AML works?

Banks serve as the cornerstone of the financial system, making it imperative for them to detect suspicious activities. Their advanced technology and comprehensive services ensure security and trust, reinforcing their expertise and reliability in safeguarding financial transactions.

Like all regulated 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 legally required to report 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 genuine people who are making legitimate transactions.

For a bank, AML compliance starts with verifying the identity of a new customer. Once an individual’s identity has been established, banks must also understand the nature of that customer's activity. Banks are also required to verify that deposited funds are from legitimate sources. Banks must verify key information to confirm customer identity and legitimacy for KYC and AML compliance. This includes:

• Personal Identification: Full name, date of birth, and government-issued ID (e.g., passport, driver's license).
• Address Verification: Residential address, supported by utility bills or official documents.
• Source of Funds: How the customer funds their account (e.g. salary, investments).
• Employment Information: Employment status and occupation, especially for corporate accounts and high-net-worth individuals.
• Tax Identification: Tax identification or social security numbers for tax compliance.
• Purpose of Account: Intended use of the account (e.g. savings, business transactions).
• Risk Assessment: Performing due diligence to assess the customer's risk, such as Politically Exposed Persons (PEP) checks, sanctions list screening, and adverse media searches.
• In addition to these fundamental details, banks may also need to verify the customer's employment status, source of income, and any existing credit history to help assess financial reliability and reduce the risk of fraud. These verifications help banks mitigate risks related to fraud, money laundering, terrorist financing, and other financial crimes, while complying with local and international regulations.

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 facial biometric analysis as part of remote identity verification.

Large transaction reporting

AML requirements call for institutions, such as banks, to file a regulatory report for transactions above a certain threshold. A single customer makes that during a business day.

Monitoring and reporting suspicious activities

Regulatory agencies publish AML guidelines about the 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 to fulfill regulatory requirements.

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

• A customer may use 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, regulated institutions such as banks, brokers, cryptocurrency exchanges, and real estate firms must meticulously screen both new and existing customers daily. This involves checking against various watchlists, including sanctions lists, politically exposed persons (PEPs), and adverse media reports. Insurance companies, casinos, and luxury goods dealers are also required to perform similar screenings due to the high-value transactions they handle. These processes ensure that institutions adhere to regulations and mitigate potential risks associated with illegal activities or reputational harm. By maintaining this diligent oversight, these businesses play a crucial role in upholding the integrity of the financial system and preventing financial crime.

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 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 customer. Customers who are flagged as at higher risk of non-compliance are then monitored more closely than those seen as lower risk.

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

Banks are required to establish a comprehensive AML compliance policy, a cornerstone of their security measures. This policy, crafted with precision and expertise, must receive written approval from senior management and be under the vigilant oversight of a designated AML compliance officer. These steps underscore the bank's commitment to trust, reliability, and leadership in financial security.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 transaction monitoring software

Of course, many large banks have thousands of customers and process millions of transactions. 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

With a comprehensive understanding of money laundering detection and criminal tactics, implement robust processes to shield your business from becoming a target. Leverage advanced strategies and industry-leading practices to ensure your organization remains secure and trustworthy.

The starting point for AML compliance is online identity verification. After all, when welcoming a new customer, you need to make sure that your new customer is  genuine person, within your organization’s risk profile, and not subject to any sanctions. Thankfully, our identity verification and AML Screening solutions help you towards meeting your compliance and KYC requirements.