The good, the bad and the ugly: how to spot money laundering’s worst offenders

Kroll’s consultants highlight the main signals that something is not right with a bank, and outline what supervisors can do about it.

As forensic investigators of fraud, corruption and money laundering, Kroll’s work takes us to fascinating jurisdictions worldwide. It allows us the privilege of working alongside some of the most committed, sophisticated and determined professionals in governments, government agencies, central banks, regulators and financial intelligence units (FIUs) working to identify and prevent such activity.

Money laundering is a global problem – not one confined to a particular market or region. We need to move away from the perception that one market is good and another is bad, and recognise that domestic challenges faced by peers overseas create money laundering risk globally. Then the focus can be on how, working together fluidly through information sharing, these challenges can be surmounted.

Regulators are trying their best, and there is no doubt that banks’ financial crime departments are full, in many cases, of well-intentioned employees, and millions are being spent on anti-money laundering (AML) detection systems.

The problem

Money laundering and money launderers operate like some of the most sophisticated, slick and tech-savvy global corporates, with intricately connected global supply chains working closely and without geographical borders.

Yet the global fight against money laundering works in precisely the opposite fashion. There are countries, those countries have regulators, those regulators regulate financial institutions, and those financial institutions review each transaction. If one happens to raise an alert, a suspicious activity report (SAR) may be filed. These SARs are queued up, in often under-resourced FIUs, that must then file requests for information around transactions with other countries, from which they have to wait for a response. All of this takes time, there are multiple stakeholders holding various pieces of the jigsaw, yet no-one is looking at the big picture. Meanwhile, the launderers can move billions of dollars around the world in millions of transactions in minutes, if not seconds.

If we accept that the global AML system is not operating effectively and that it will take some time to fix, what can be done in the short term to identify and stop large-scale abuse of the financial system in order to launder the proceeds of crime?

We could start by identifying and rooting out the worst offenders.

The good, the bad and the ugly

We have worked across developed, developing and emerging markets on behalf of central banks and other regulators, FIUs and financial institutions themselves, helping them to not only identify money laundering risk, but also investigate major systemic issues concerning financial institutions.

Admittedly, our experience is skewed, focused on the worst of the worst, situations that regulators in many western markets would find, at best, far-fetched and, at worst, incomprehensible. But, whether you sit within a developed or a developing economy, none are perfect, and money laundering risk is a common theme throughout.

The question is whether laundering is a by-product of a broader fraud and/or corruption issue that has its provenance in your jurisdiction, or whether you are a transit economy, through which the proceeds
are laundered.

Based on this experience, irrespective of jurisdiction, banks fall into one of three categories:

The good

These are banks that are, for the most part, doing the right thing in the prevention and detection of money laundering. They’re not perfect, but are proactive, have a strong governance framework and are doing their best in an imperfect world. The issue is that those that can be described as the standard-setters are few and far between.

The bad

These are the ‘transitory’ banks – those that allow the proceeds of crime to pass through their accounts. To refer to the three stages of money laundering, they perform the layering and integration functions. Broadly they fall into two categories:

• Those that might, at best, be described as inadvertent facilitators of money laundering, either due to framework and governance failures or simply not taking the issue seriously enough.
• The knowing facilitators of money laundering: banks whose primary purpose is to aid and abet wrongdoers in accessing the financial system.

The ugly

The ‘placement’ banks. “Give a man a gun, he can rob a bank; give a man a bank, he can rob a country” is a slightly adapted quote that can best be ascribed to this category. These are banks that are established or acquired with the initial intention or eventual purpose of generating cash for their owners, which can then be laundered and dissipated globally. This might sound extreme but, in our experience, it still occurs with frightening ease. There are a number of common attributes of those markets where this has occurred that heightens the risk profile. These include:

• Jurisdictions deemed at heightened risk due to their geographic location
• Markets prone to a high concentration of power
• A lack of independence or integrity in terms of legal processes
• A lack of independence or autonomy of supervisory functions.

Taking the bad and the ugly, the real point to relay here is that, in every case we have investigated, all the issues were obvious to anyone who looked – hiding in plain sight, if you like. The attributes of money laundering were prevalent internally for many years, and the interrogation of internal data would have highlighted the risks long before the issue grew to such a magnitude that significant intervention was required.

Spotting the warning signs

So, if you’re a supervisor, FIU or even investor, what are the warning signs of a bad or ugly bank?

Too good to be true

It is an age-old saying but, if a bank appears as an outlier in its performance, then it’s time to take a look. A common red flag is a rapidly inflating balance sheet, often driven by a ballooning loan portfolio; the balance sheet looks very healthy but, often, what lies beneath is far from the case. These portfolios often comprise significant loans to related parties, both declared and undeclared, and when you start to unpick their provenance, it quickly becomes apparent the majority don’t have sound commerciality behind them. At first glance, all seems sound: a trade-based loan to secure a contract for the purchase of goods by a foreign counterpart. The contractual paperwork is available and the counterparty may even check to a website. However, some brief digging below the surface reveals shell entities, fake websites and nonsensical pricing. Similarly, there may be significant increases in cash deposits, often attracted as a result of interest rates outside of market norms.

Sleight of hand

The dictionary definition of “sleight” is appropriate: “the use of dexterity or cunning, especially so as to deceive.” Although more commonly associated with the techniques used by magicians to divert their audiences, in this context we are talking of the techniques used by bad actors in the banking sector to mislead stakeholders as to the provenance of liquidity or assets within institutions. Loan recycling is the most prevalent here, in that what appear to be new, performing loans are masking years of legacy non-performance by refreshing the borrower when the loan becomes due. It is only when you look at the cashflows within the bank and how they interplay that this becomes apparent.

We have seen similar examples regarding regulator-required capital injections, post-event. On initial analysis of fund flows it is clear this ‘fresh capital’ was actually funded through loans to ‘customers’ of the bank itself, yet it is only through data analytics complemented by practical, investigative research into the viability of counterparts that this becomes apparent.

Finally, we turn to related party transactions – declared rather than undeclared. That needs to be the focus. This can only be identified by taking transactional data, not cross-border but internally, within a bank, to understand which accounts that should be unrelated are actually significantly related, due to the level of their inter-account activity.

Smoke and mirrors

To some readers, in some jurisdictions this will seem far-fetched. But to others it will be a cognisant reality. We refer to those who have successfully gained access to a banking licence, who either deliberately use this to their own advantage or receive benefit from others by providing them access to a financial institution to launder their ill-gotten gains. They can do this by deliberately misleading regulators and the market as to the reality of a situation and, as a result, true exposure is masked. We have also seen smoke and mirrors used regularly in terms of wholesale changes in the ownership of a bank or the customers of a bank. This is often achieved through nominee shareholding structures as well as the use of powers of attorney or trustee agreements.

If we accept the concept of ‘with the benefit of hindsight – everything is obvious’, then what can we learn? The real concern is that each of the aforementioned examples relates to real-life situations we have investigated, and that it was obvious, or at least became so, to the regulators or FIUs involved. However, a number of these institutions continued to be audited by firms with well-known brands and succeeded in raising funds on the capital markets. So the real question is: what were the impediments that led to action being delayed until it was too late? There are some all too common themes:

• A lack of resource, particularly in markets that represent the highest risk
• A lack of autonomy on the part of regulators to pursue required remedial actions from domestic forces that might be working against them
• A lack of co-ordination among domestic bodies to inform risk indicators and take actions
• The inability to efficiently and effectively co-operate with international counterparts to obtain strategic intelligence and insight, to inform decision-making and enforcement action.

None of these issues will be news to seasoned supervisors. Indeed, there are some initial signs of progress that move us in the right direction:

• Supervision and oversight need to be designed more around effectiveness than rules. The Financial Action Task Force has been a key proponent of this approach, and its efforts are starting to take effect
• Supervisors are beginning to take an intelligence-led approach to supervision, leveraging the technology and data available to them (such as Swift data and beneficial ownership databases)
• Cross-border collaboration: everyone wants it and agrees it is necessary, but sometimes the impediments seem too hard to surmount. Initiatives are, however, taking the industry in the right direction, perhaps not at the granular level necessary, but progress is being made.

In summary, we need to empower those doing good work on the frontline, in supervisory and intelligence unit roles, to act on the money laundering risks they identify. Treating this as a domestic issue on a jurisdiction-by-jurisdiction basis is only going to further empower the launderers, as opposed to those working within the global fight to prevent it.

Conclusion

It is globally acknowledged by all stakeholders that a lack of co-ordination and international co-operation remains a major hindrance in the fight against money laundering. Yet no single body seems equipped to address it. But what if there was a single source of information that could be analysed and shared by all parties? What if it contained most of the necessary data, was real time, and enabled macro- as well as micro-level analysis to direct supervision and enforcement?

Is Swift not the solution? When this question has been asked before, the response has always been that it wouldn’t work or couldn’t work. But why not? The current situation in Europe has forced a united response, resulting in the global financial system acting cohesively to identify and stop fund flows relating to certain banks, individuals and entities. Surely that is also possible in normal times, when the fight is less tragic, but just as globally pervasive. 

 

This feature forms part of the Central Banking focus report, Anti-money laundering and countering the financing of terrorism 2022

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