AML has been the buzzword for the past 3 decades, but before combating money laundering, for example, going “anti,” let’s understand what money laundering is. The origin of money laundering takes us back to World Wars 1 & 2 when the illicit revenue generated by financial crimes was on an extreme rise.

Since then and even today, most choose to safeguard their money in bank deposits or mutual funds/shares. But storing cash at home in huge amounts is not a viable option for a common man or a fraudster, especially when the source is illegal. Bank is a secure option but comes with many potential risks from a fraudster’s perspective. Soon, they started businesses with low capital investment, like laundry, carwash, and small-scale casinos, where the cash transactions appeared legit.

Hence the term “laundering” simply involves proceedings of fraud or criminal activities into active financial processes. These authentic and regulated economic processes yield “legit” money at the end of the transaction pipeline.

Money Laundering involves 3 stages, Placement, Layering and Integration. Placement involves getting cash, the outcome of a financial crime, into an economic body. Now, one won’t walk with a truckload of money into the bank as large denominations would attract many.

Hence, such dirty money enters banks in small denominations as cash on bills of restaurants, hotels, bars, casinos, vending machine companies etc. This phase is usually missed by law enforcement bodies as most of the things involved appear legit.

As the second step, layering requires the fraudster to make multiple transactions involving multiple entities on various fronts. Thus, the placed and layered illegal money becomes complicated to identify as probable fraud proceedings. In the final stage of Integration, the money enters the economy as white, for example, legit. Someday this money even assimilates as an asset for the launderer himself or someone else, in any case, a success for the black hats involved. Simply put, money laundering turns “bad” money into “legitimate” money.

Here’s an example to understand the 3 most usual stages involved in money laundering:

  1. Placement: The fraudster deposits cash into a bank account and purchases property/goods.
  2. Layering: Some wire is transferred out of the country to run shell companies.
  3. Integration: Property/goods get sold, profit is wire transferred, and retained earnings of companies are wired in and reinvested into something else legal

Due to the complex nature of Wire / Transfer / ACH payment templates, it becomes a nightmare to identify transactions in the above scenario as fraudulent, as they tend to appear legitimate by default. A red flag in this scenario is missing / mismatched information provided by fraudsters at the time customer onboarding / KYC is to be done by the bank. The sole purpose of bank accounts is to act as channels to transfer funds.

Money laundering is a global issue; a unified effort is required to combat it. It poses a risk to the citizens by increasing taxes, crime rate, and monopoly in small businesses. It also comes with other moral, reputational, and financial dangers like penalties, criminal charges, etc.

Hence combating money laundering is a three-way handshake between Law Enforcement (DOJ), Regulatory Bodies like SEC (Securities and Exchange Council), and Financial Institutions like FATF (Financial Action Task Force), OFAC, and FinCEN. All of these publish content on AML regularly, which is publicly available. This content consists of case studies, possible scenarios, and Red Flags! Banks and Credit Unions are expected to have an AML compliance program and work in tandem with these regulatory institutes. These institutes use a format to record fraud: ‘SAR: Suspicious Activities Report.’

Let’s have a look at a few red flags that appeared through case studies collected over the years:

  1. A large number of small-valued transactions for example Structuring
  2. Sudden considerable activity in a dormant account
  3. Incomplete information submitted/gathered as a part of KYC
  4. Money mule schemes
  5. Trade based money laundering
  6. Shell / Shelf companies
  7. Exaggerated Donations
  8. Credit / Debit card payment fraud
  9. Gold Smuggling
  10. Money Service Businesses

Various challenges are involved in detecting fraud due to geographical limitations, currency/denomination differences, etc. A common challenge is in a transaction where sender ‘A’ sends $50,000 to receiver ‘B’ if ‘B’ is the customer of bank ‘C,’ then in transactional data records of ‘C,’ there’s no complete information available of sender ‘A.’ The same is the case the other way around. The point here is insufficient data, data accessibility, variety in sources, data asymmetry, and continuously evolving regulations and policies are the few challenges involved in detecting financial fraud.

What is Ellicium banking on to help financial institutes detect fraud?

  1. Machine Learning
  2. Rule-based algorithms
  3. KYC Scorecard
  4. Outlier Detection
  5. Red Flags Library
  6. Prerequisite for SAR
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