The anatomy of money laundering: How it happens and why it's hard to stop

TBS Infograph

From September 2005 to December 2007, $14 billion of laundered money flowed through Wachovia, one of the largest banks in the US. It is, till now, one of the largest money-laundering scandals in history.

During their investigation, the US government found readily available signs of that money being laundered. Yet, Wachovia did nothing.

This problem is obviously not exclusive to the West. The Panama Papers, published in 2016, found two money-laundering entities in Bangladesh called Seven Seas Assets Ltd and Swayne Investments Ltd, proving that it is a larger global problem than we may have perceived.

The recent 'Pandora Papers' is a testament that money laundering has not only been able to survive but also thrive even after national and international legislation and regulatory bodies have tried desperately to prevent it.

The Pandora Papers investigation, the largest of its kind, has uncovered 206 US-based trusts linked with 41 other countries, holding close to $1 trillion. However, the total amount of laundered money in the world is estimated to be around $32 trillion.

So the question remains, how can such a vast sum of wealth be appropriated under the noses of the world's governments? The answer however is not simple, precisely because it is designed to be this way.

Existing anti-laundering mechanisms

Defining money laundering is a difficult task in and of itself. But to put it simply, money laundering is the process that makes dirty money appear legitimate. This 'dirty money' can come from multiple sources such as proceeds of a crime like drug trafficking, bribery, extortion or tax fraud.

After the adoption of the UN Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances in 1988, countries started to criminalise money laundering in all its forms. Currently, the OECD's Financial Action Task Force (FATF) and the EU's Moneyval try to thwart global money laundering attempts.  

As money laundering looks like ordinary financial transactions to the naked eye, they are mainly identified through Suspicious Activity Reports (SARs) from financial institutions like banks.

These SARs are filed whenever large sums of money are transferred between many accounts randomly to mask their ownership. But in today's globalised economy, where acquiring sophisticated financial tools is easier than ever, money laundering does not follow the patterns we anticipate.

The sharpest tools in the shed

Financial tools can be incredibly powerful for quick and easy transactions and efficient allocation of capital. But in the hands of money launderers, they can be the best instruments for bypassing the global anti-laundering system.

Take, for example, a government employee who wants to receive a bribe of $10 million. Transferring such a vast amount of money in his own personal bank account is undeniably suspicious. So, he gets in touch with a lawyer and a financial advisor. With their help, he sets up three companies in the British Virgin Islands where these companies do not have to declare their ownership to get registered.

He also sets up a trust and transfers the ownership of these companies to it. As trusts require no registration, he can be completely anonymous. The companies and trusts are manned and maintained by various Corporate Service Providers and his family becomes the beneficiaries of the said trust.

Money laundering cuts out a significant portion of the government's revenue. As the rich continue to dodge taxes, the poor have to pick up their slack and pay more. It also enables government employees to get away with the abuse of power, perpetuating a cycle of poverty, crime and corruption.

Now, the bribe payer can just transfer money to the employee's companies' accounts and the employee can enjoy the benefits of his illegal income without raising any suspicion, as he has bypassed the established mechanism which is meant to identify money laundering.

He can also add other companies, trusts or foundations to this basic structure to protect his identity and facilitate safer transactions of illegal proceeds. 

The blurred borders

The concept of 'offshore' comes up very frequently when discussing money laundering. But what exactly is 'offshore'?

Offshore basically means outside someone's native jurisdiction. As a Bangladeshi, if I open a bank account in India, then India will be 'offshore' for me. But in the context of money laundering, offshore is used to mean a group of jurisdictions that has very little to no taxation, along with very low regulatory standards for financial institutions.

Countries like the aforementioned British Virgin Islands, Jersey, Panama, Cyprus or St. Kitts and Nevis are almost infamous for being offshore centres. Such countries have little to no natural resources and very little potential for trade. As a result, they almost have to act as tax havens to attract capital to their economies.

But it does not mean that their law is not beneficial for criminals. Switzerland, one of the most famous tax havens in the world, has a 'dual criminality' rule. If a criminal launders money into a Swiss bank, his earnings will only be returned if the crime he committed is also illegal in Switzerland.

TBS Sketch of Readus Salehin

But the often demonic portrayal of these countries is simply not true. Their model has worked so well that developed countries like the US, the UK, Ireland and the Netherlands have tried to adopt it.

The UK, for example, has decided to exempt foreigners living in the UK from taxation on any income arising from outside of the UK. These rich individuals have invested heavily in real estate. According to Oliver Bullough, author of the book "Moneyland," more than 100,000 homes in England and Wales are owned through offshore companies, about half of them are not even being used.

The Pandora papers attest to this. According to the leaks, more than 1,500 properties are being held through offshore accounts. The Qatari royal family, Jordan's king and Azerbaijan's presidential family bought properties in the UK to avoid taxes.

The investigation also exposes many US states working as offshore tax-havens. South Dakota, Nevada, Delaware and Alaska now hold money from people who have been accused of fraud, bribery and human rights abuses, like the Central Romana Corp.

A 2012 study has also shown that it is three times harder to establish a shell company in well-known offshore centres than it is in developed economies.

But why are developed countries partaking in fueling global money laundering? Because attracting capital is a zero-sum game for countries. If capital flows out of a country in favour of an offshore destination, the first country will try to do everything in their power to stop it from happening.

Countries have tried to prevent it by making anti-money laundering legislation, which clearly does not work. They clearly cannot beat launderers, perhaps they can join them.

The rat-race for profit

According to the US government, $881 million of drug money flowed into the country from 2012 to 2017 through HBUS, the US branch of HSBC. The money came from Mexico, through HSBC's Mexican branch. How can such a vast sum be laundered without raising any alarms?

Because both of HSBC's branches did not follow the standard procedure. HBMX enabled risky wire transfers from various Mexican currency exchanges, a favourite sport for drug traffickers to turn their dollars into peso. HBUS, on the other hand, marked HBMX as one of the safest partners. Consequently, dirty money came into the US financial system with impunity.

Such examples are abundant in the global financial system. But they do not stop there. According to the Pandora Papers, Baker McKenzie, the largest law firm in the US, helped Jho Low - an advisor to Malaysia's former Prime Minister - steal hundreds of millions from Malaysia's economic development fund.

Baker McKenzie also suggests a favourable policy for money launderers internationally, like when it opposed a measure meant to curb offshore tax avoidance in Australia.

In the highly competitive market, every institution fights for itself. As a result, it becomes foolish to turn down a client with significant wealth to just comply with some measly rules. Making the most profit becomes the primary motivation for all financial institutions.

A losing battle for the people

The Pandora Papers is not the first of its kind and it sure will not be the last. Money laundering has been able to flourish in the modern global economy, where anybody can set up a company without even being in the same continent or any amount of transaction is possible with the click of a button. There are more opportunities for anonymity and secrecy, something precious to launderers.

According to the estimates of French economist Gabriel Zucman, 10% of the total wealth of Western Europe is hidden offshore. The number rises to 30% for African countries. Meanwhile, 52% of Russia's wealth is in tax havens. For Gulf countries, the number is 57%.

Money laundering cuts out a significant portion of the government's revenue. As the rich continue to dodge taxes, the poor have to pick up their slack and pay more.

It also enables government employees to get away with abuse of power, perpetuating a cycle of poverty, crime and corruption.

This article does not have a message of hope and neither does the Pandora Papers. With the integration of world superpowers in the tax haven game, regulations regarding money laundering will probably not change much in the near future. After all, there is no interest group more powerful than the rich.