What Is Money Laundering? Making Criminal Proceeds Look Ordinary

The standard model divides the process into three phases, which may overlap and may be repeated:

• •Placement: getting cash into the financial system, the riskiest step, done by depositing amounts below reporting thresholds, mixing proceeds into a cash-heavy legitimate business, buying casino chips, or physically moving currency across borders
• •Layering: moving the money through a sequence of transactions designed to break the audit trail, using transfers between accounts and jurisdictions, shell companies, loans to oneself, trade transactions and purchases and sales of assets
• •Integration: bringing the money back as apparently legitimate income, through property, business revenue, investment returns, salaries or the sale of an asset at an inflated price
• •The classic front is a business with high cash takings and hard-to-verify volumes, historically laundries, car washes, restaurants, nail bars and vending operations, which is where the term is popularly said to come from
• •Trade-based laundering, now one of the largest channels, works by misstating the price, quantity or quality of goods on an invoice so that value moves across a border disguised as ordinary commerce

The central tool of layering is the corporate entity whose real owner cannot be identified. A company registered in a jurisdiction that does not require beneficial ownership to be disclosed can hold a bank account, own property and enter contracts while the person behind it remains invisible, and a chain of such companies across several jurisdictions makes tracing a matter of obtaining cooperation from each in turn. Trusts and nominee directors add further layers. The Panama Papers in 2016 and the Pandora Papers in 2021, both leaks of documents from firms that create such structures, demonstrated the scale of their use and that a substantial share of it is legal, since the same arrangements serve tax planning, privacy and asset protection as well as crime. Property is a favoured destination because transactions are large, prices are subjective, and until recently many countries applied far weaker checks to a house purchase than to opening a bank account.

The international framework is set by the Financial Action Task Force, established in 1989, which issues recommendations that countries adopt into national law and which assesses compliance, placing weak jurisdictions on a grey or black list with real consequences for their banks. The obligations fall on financial institutions and on a growing list of other businesses including lawyers, accountants, estate agents, casinos and dealers in high-value goods. In outline they must verify who their customers are and, for companies, who ultimately owns them; assess the risk each customer presents and apply enhanced scrutiny to higher-risk ones, including politically exposed persons; monitor transactions for patterns inconsistent with the customer's profile; report suspicious activity to a national financial intelligence unit; and keep records. Crucially, a firm that files a report must not tell the customer, an offence known as tipping off, which is why banks decline and close accounts without explanation.

The United Nations has long used an estimate that two to five percent of global output is laundered annually, a figure whose provenance is weak and which is used for want of anything better. Against that, studies have repeatedly estimated that law enforcement intercepts well under one percent of criminal proceeds, and a widely cited 2020 analysis by Ronald Pol described the system as the least effective anti-crime measure anywhere, with compliance costs running to tens of billions a year and outcomes barely detectable. Several structural reasons are offered. Reporting volume is enormous and the vast majority of reports are never acted on, so the system generates data nobody has capacity to use. Penalties fall on banks as fines rather than on individuals, and are treated as a cost of business. Enforcement stops at borders while money does not. And the incentives of a compliance department are to avoid being blamed, which produces defensive reporting and the closing of accounts belonging to anyone who looks unusual, a practice that has cut off remittance corridors and charities operating in difficult countries.

Three shifts are under way. Beneficial ownership registers, requiring companies to disclose their real owners, have been introduced in a number of countries, though a 2022 European court ruling restricted public access on privacy grounds and several registers have been criticised for holding unverified self-declared data. Cryptocurrency has changed the technical picture in both directions: it offers a way to move value across borders without a bank, and because most blockchains are public ledgers, analysis firms can trace flows with a precision that cash never permitted, which has produced some significant seizures, while mixing services and privacy coins work against it. And there is a growing argument that the whole framework should be rebalanced from measuring compliance activity, the number of checks performed and reports filed, towards measuring outcomes, meaning criminal proceeds actually recovered, which is what the system was created to achieve and what it currently does least.

Laundering moves criminal proceeds through placement into the financial system, layering to break the audit trail, and integration as apparently legitimate income, using cash-heavy businesses, shell companies whose owners are undisclosed, property and mispriced trade invoices. An international task force sets rules requiring banks and many other businesses to verify customers, identify ultimate owners, monitor transactions and report suspicions without telling the customer. Recovery rates are estimated well below one percent of proceeds against compliance costs in the tens of billions.