What banks must do to prevent money laundering

• Law enforcement agencies have designed strategies based on the three-staged money laundering cycle, which is rarely used by financial institutions to identify risks.
• The risks a bank faces during the money laundering cycle are classified into two categories – criminal environment and product and service risk.
• Banks should overlay the relevant Anti-Money Laundering and Counter Financing of Terrorism legislative elements once it has mapped out the risks it faces to ensure preventive measures on illegal activity are effective.

Recent action by Australian Transaction Reports and Analysis Centre (AUSTRAC), Australia's anti-money laundering regulator and financial intelligence unit, against the Commonwealth Bank of Australia (CBA) has highlighted again the significant, though inadvertent role, banks play in laundering illegal money.

Almost all money from crime, other than most crimes involving violence, ends up in a bank somewhere in the world. Either the money is deposited in a bank, in a country where the predicate crimes occurred and transferred offshore to another account or it is smuggled from the country where the illegal funds originated and deposited offshore.

The money laundering cycle with its three stages - placement, layering and integration, was developed to enable financial institutions and law enforcement agencies to better understand money laundering and design measures to counter it. Law enforcement agencies that have designed strategies based on the money laundering cycle, has enabled them to position resources where they are likely to achieve the best results.

But the money laundering cycle is rarely used by financial institutions to identify the risks they face from money laundering. Instead, Anti-Money Laundering and Counter Financing of Terrorism (AML/CFT) policy and frameworks are developed around relevant local and international laws. Gaps in the law are easily exploited by criminals, which is why compliance is not effective in preventing money laundering. Rather than design policy and responses to ensure compliance with AML/CFT law; a bank should first identify the risks it faces during each stage of the money laundering cycle. Those risks would be classified into two categories: (1) The criminal environment, comprising local and international crime groups, and (2) product and service risks.

Both elements would vary from bank to bank and country to country. For example, Australia is a large drug producing and consuming country. Placement risk would include large amounts of cash from crime being deposited into bank accounts, as was the case involving the CBA. While financial centres such as Singapore would have a higher money laundering risk during the layering stage, as illegal funds are transferred in and invested. Risk would also originate from corporate service providers both in Singapore and offshore who incorporate companies and provide nominee services; disguising the true owner. Australia, Singapore and Hong Kong would perhaps have significant risks in the integration stage as criminals invest in lucrative property markets. With Australia incurring a higher risk as from real estate clients as that sector is not covered by Australia’s Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) Act.

Once a bank has mapped out the risks it faces during each stage of the money laundering cycle from criminal groups and its products and services being used to launder money, then it should overlay the relevant AML/CFT legislative elements it is required to comply with. Using this combined approach ensures that the threat from crime groups and use of the banks’ products and services in money laundering are clearly understood and measures are implemented by the bank to prevent or detect illegal activity.

The issues confronting CBA occurred during the placement stage. The bank by rolling out intelligent deposit machines and not assessing the risks involved, created an entirely new money laundering methodology in Australia. It also failed to adequately respond to the risk posed by money laundering groups using the cuckoo smurfing technique. These issues could have been avoided, if the bank had understood the threat posed by criminal groups in Australia that is, the amount of cash generated from illicit drug supply and the methods used by criminal to launder money. These issues are difficult to undertake for a law enforcement body let alone a bank. But it must do so if a bank is to design and implement effective money laundering counter measures.

Chris Douglas is owner, financial crime consultant and trainer at Malkara Consulting. The views expressed herein are strictly of the author.