Money laundering is practically as old as organized crime. The term “laundering” alludes to the Mafia’s 1920s practice of moving money through laundromats, which served as fronts for their criminal businesses. It also references the process of making “dirty” money “clean.”
Today, money laundering refers to any process that obscures the source of funds. Money laundering is typically composed of three steps:
- Placement: illegally-obtained funds are directly deposited in banks, which introduces them into the financial system
- Layering: the funds are converted to other forms or moved to other institutions to separate them from their criminal source—mixing the money, so to speak
- Integration: the funds are used to purchase assets to move them into the legitimate economy
What is anti-money laundering?
Anti-money laundering—more commonly referred to by its shorthand, AML—is a system of controls to prevent, detect, and report the above money-laundering activities. AML comprises the three F’s: finding, freezing, and forfeiture of criminal assets.
The seminal anti-money-laundering rule is probably the Bank Secrecy Act, which was established in 1970 and lays out requirements to identify the source, volume, and movement of currency transported into or out of the United States or deposited in financial institutions. It also requires banks to:
- report cash transactions over $10,000
- identify people conducting these transactions
- maintain paper trails
The BSA is overseen by the Financial Crimes Enforcement Network, or FinCEN. Since the mid-80s, updates and complements to the BSA have been passed every couple of years—the most famous of which may be the Patriot Act of 2001.
In 1989, the G7 formed the Financial Action Task Force, creating an international framework of anti-money-laundering standards. FATF has developed 40 recommendations on money laundering and 9 special recommendations regarding terrorist financing. In 2000 and 2001, FATF started publicly calling out countries that were deficient in their anti-money-laundering laws.
What does AML do in practice?
In theory, anti-money-laundering laws apply only to a limited number of transactions and criminal behaviors. But in practice they touch nearly every aspect of a bank’s relationships with its customers. The onus is on the institutions themselves to detect and prevent illicit transactions, which can in turn lead to a litany of requirements on the consumer’s part.
For example, financial institutions are supposed to verify each customer’s identity, monitor his or her transactions, and report suspicious activity, like sudden, substantial increases in funds or withdrawals. It’s all part of a suite of rules termed “Know Your Customer.” Here, knowing one’s customer means not only knowing the identity of the customer, but also understanding his or her typical transactions and behavior.