Tossing a stone into a lake with ripples spreading so far that you can no longer tell where the stone landed! This is an analogy to what money launderers do to erase the origin of an illicit financial transaction i.e. creating multiple layers to obfuscate the source of funds.
Every year, criminal activities such as drug trafficking, arms smuggling, cybercrime, and corruption generate trillions of dollars. According to the United Nations, an estimated ~2-5% of global GDP, i.e. ~US$1.6 trillion, is laundered annually.
What is money laundering?
Money laundering is the process of turning illicitly obtained money into legitimate transactions, usually in three stages:
- Placement introduces illegal money into the financial system.
- Layering creates a complex trail of transactions that hides the origin of the financial transaction.
- Integration reintroduces the “legitimate” money back into the economy.
Process of Layering
Layering, or Structuring, is the most critical stage as it obscures the source of funds and makes tracing their origin far more difficult. A few ways are:
– Wire transfers between multiple accounts across different countries.
– Purchasing luxury goods like art or real estate for reselling.
– Using shell companies and even charities to disguise ownership.
– Trade-based laundering (retail/restaurants) with goods over or under invoiced to shift the value.
The Impact on the Economy
The effect of layering extends far beyond financial crimes. For banks and financial institutions, failure to detect such activities can result in regulatory sanctions and irreversible reputation damage. The impact reaches Governments who lose tax revenue that could otherwise support public services and national development. Beyond financial damage, such funds are used to fund terrorist organisations which amplifies threats to both national security and global stability.
Spotting Early Red Flags
Identifying early warning signs is critical for mitigating the risks associated with money laundering. The following indicators often signal potentially suspicious activity:
– Unusual transactions – transfers between unrelated accounts/countries without clear business rationale.
– Mismatched profiles – transactions inconsistent with a customer’s stated occupation or income.
– Use of shell companies – complex ownership structures with little or no legitimate business activity.
– Rapid movement of funds – money deposited and swiftly withdrawn or transferred.
– High-value purchases – luxury goods or property by entities without appropriate obvious wealth.
Once red flags are identified, prompt action is essential. Businesses and financial institutions require robust KYC procedures, maintain continuous transaction monitoring, and ensure that suspicious activities are reported to appropriate authorities.
Regular employee training and a risk-based approach to monitoring clients and transactions further strengthen the ability to respond effectively and safeguard both the organization and the broader financial ecosystem.
Strengthening AML Compliance
India’s AML framework, led by the Prevention of Money Laundering Act 2002 (PMLA), and supported by the regulations of the Reserve Bank of India (RBI), Securities Exchange Board of India (SEBI), and the Insurance Regulatory and Development Authority of India (IRDAI), requires banks and regulated entities to maintain detailed records, verify client identities, and report suspicious activity.
As financial systems become more digital and complex, institutions must adopt advanced analytics, real-time monitoring, and automated compliance tools. Proactive risk management and staff training are essential to detect anomalies.
Conclusion
As financial systems evolve, layering techniques are becoming faster, more complex, and global. Traditional monitoring alone is no longer sufficient. Institutions must integrate automated risk detection to identify suspicious patterns in real time. By combining robust AML frameworks, proactive risk management, and trained personnel, organisations can stay ahead of illicit financial activities and protect the integrity of the financial ecosystem, especially those that FATF member countries, and those that aspire to become members.