A Brief History of Money Laundering

On: September 30, 2017

With all the talk of anti-money laundering (AML) activities, and given the emerging threat of digital money laundering (a.k.a. transaction laundering) we thought it would be a good time to get a historical perspective on money laundering itself.

Money laundering, not surprisingly, is as old as taxation itself. As early as 2000 BCE, Chinese merchants were documented as hiding their wealth from the state to avoid taxation or confiscation, by moving it to remote provinces or even outside of China.

Over the centuries, offshore banking and tax evasion became more sophisticated – often leveraging informal value transfer systems like Hawala and others to keep money out of the hands of tax collectors.

Fast forward to modern times, and we can see that although the means have changed dramatically – the core concept of money laundering has not.

Modern Money Laundering Legislation

The history of modern money laundering – or, more correctly, the fight against modern money laundering – really began some 50 years ago.

The Bank Secrecy Act of 1970 (also known as the Currency and Foreign Transactions Reporting Act) forced financial institutions to record and report large cash transactions, and generally inform the government about any suspicious fiscal activity that might indicate money laundering, tax evasion, or criminal activity.

In the following decade, the Money Laundering Control Act of 1986 criminalized money laundering – making it a federal crime to engage “in a financial transaction with proceeds that were generated from certain specific crimes.”

These core elements of the emerging AML legal framework were followed by the Anti-Drug Abuse Act of 1988, which required some businesses to report large currency transactions, and the Anti-Money Laundering Act of 1992, which gave birth to the Bank Secrecy Advisory Group (BSAAG) – which is still active today.

A series of additional laws were passed throughout the 1990’s, shaping the powers and reach of the AML regime. And then came the attacks of September 11, 2001

9/11 – The AML Game-Changer

After 9/11, the Patriot Act granted sweeping powers to the US government to combat terrorism. A separate part of the Patriot Act, called Title III: International Money Laundering Abatement and Financial Anti-Terrorism Act, directed financial institutions to expand their AML programs and step up their due diligence reports on foreign bank accounts. Title III essentially amended parts of the previously-mentioned Money Laundering Control Act of 1986 and Bank Secrecy Act of 1970, and was divided into three sections, with three key goals:

  1.  Strengthening banking rules with regards to money laundering, specifically international money laundering
  2. Improving communication between law enforcement and financial institutions, and in-between institutions, in addition to mandating tighter record keeping and reporting
  3. Fighting currency counterfeiting and smuggling – which included a provision to quadruple the penalty for counterfeiting foreign currency

As the US tightened its AML regime, so did the rest of the world. Across the globe, major financial institutions invested heavily in both human and IT solutions to avoid regulatory action, and AML/KYC services became a major industry that continues to grow today. According to Wealth Insight, spending on AML will grow to more than $8B by 2017.

The Digital World and the Evolution of Money Laundering

While anti-money laundering and counter-terrorism financing regulations have been adopted worldwide, a new online world has emerged.

Today, almost every entity has an active online identity that is, in many ways, qualitatively different to what most traditional KYC programs are designed to address. Financial institutions, such as banks and payment processors, quite often have customers that have only a limited connection to the physical world. Online marketplaces and ecommerce merchants are excellent examples of these online-only customers. Surprisingly, AML regulations are still not catching up with this new reality.

The discrepancies between AML programs that fail to recognize complex digital identities and the reality of the digital world where such entities proliferate, result in a situation where financial institutions need to comply with ever-more stringent, yet increasingly inefficient demands to their AML procedures.

The Problem: AML Lags Behind on Digital

Today’s money laundering, though adhering to the same principles as those of ancient China, is measurably different due to its scale, velocity and ease. And AML regulations are lagging behind the technological developments that make this possible. For example, current KYC procedures are simply unable to detect most transaction laundering cases – one of today’s key online money laundering threats. To lower their exposure to money laundering liability Merchant Service Providers turn to technological solutions that help them understand the true origin of the transactions passing through their systems.

Financial institutions need to pay close attention to innovative fintech companies, especially those that utilize machine learning and artificial intelligence to detect and prevent illegal activity. Machine learning can detect patterns in transactions that go unnoticed by manual checks and human analysts, making machine-learning based technology a secret weapon in the fight against online crime.

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