UPSC MAINS 2019: Money-laundering



Topic: Money-laundering

Topic in Syllabus: GS Paper 3: Indian Economy



  • The primary function of money is to serve as a medium of exchange, and as such it is accepted without question in final discharge of debts or payment of goods or services.
  • Money is the root cause of many evils like corruption, black marketing, smuggling, drug trafficking, tax evasion, and the buck does not stop here it goes to the extent of sex tourism and human trafficking (a human selling another human in the era of human rights).
  • As per OECD, “Money laundering is the process of concealing illicit gains that were generated from criminal activity”. Prevention of Money-Laundering Act, 2002 defines the offence of ‘Money Laundering’ as, “Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projecting it as untainted property shall be guilty of offence of money-laundering”.
  • In simple terms, Money laundering is the process of taking money earned from illicit activities, such as drug trafficking or tax evasion, and making the money appeared to be earnings from legal business activity.


Money laundering:

  • Money laundering is the process of transforming the profits of crime and corruption into ostensibly “legitimate” assets
  • Money laundering is the process by which large amounts of illegally received money is given the appearance of having originated from a legitimate source.
  • money laundering has criminal dimensions related to black
  • It is the way to convert the black money into white money.
  • Money laundering must involve a predicate crime such as the violation of Indian Penal Code, IPC, Narcotics, Prevention of Corruption Act and Human Trafficking.
  • In India, stashing Black money a civil crime, while money laundering has criminal dimensions related to black money.


Various Techniques Used for Money Laundering:

  • Structuring Deposits: This is a method of placement whereby cash is broken into smaller deposits of money which is then exchanged by many individuals (known as “smurfs”) to avoid anti-money laundering reporting requirements. This is also known as smurfing because many individuals (the “smurfs”) are involved.
  • Shell companies: These are companies without active business operations. They take in dirty money as “payment” for supposed goods or services but actually provide no goods or services; they simply create the appearance of legitimate transactions through fake invoices and balance sheets.
  • Third-Party Cheques: Counter cheques or banker’s drafts drawn on different institutions are utilized and cleared via various third-party accounts. Since these are negotiable in many countries, the nexus with the source money is difficult to establish.
  • Bulk cash smuggling: This involves physically smuggling cash to another jurisdiction and depositing it in a financial institution, such as an offshore bank, with greater bank secrecy or less rigorous money laundering enforcement.
  • Credit Cards: Clearing credit and charge card balances at the counters of different banks. Such cards have a number of uses and can be used across international borders. For example, to purchase assets, for payment of services or goods received or in a global network of cash-dispensing machines.
  • Hawala: Hawala is an alternative or parallel remittance system. It exists and operates outside of, or parallel to ‘traditional’ banking or financial channels. It was developed in India, before the introduction of western banking practices, and is currently a major remittance system used around the world. In hawala networks the money is not moved physically.


Causes of Increase in Money Laundering and Inability to Control:

There are various causes for increase in Money Laundering and the few of them can be enlisted as follows which is popularly known as ‘Features of an Ideal Financial Haven’:

  • No deals for sharing tax information with other countries –
  • Availability of instant corporations
  • Corporate Secrecy Laws – as the corporate law of certain countries enables launderers to hide behind shell companies.
  • Excellent Electronic Communication
  • Tight Bank Secrecy Laws
  • A Government that is Relatively Invulnerable to Outside Pressures
  • A high degree of Economic Dependence on the Financial Services Sector
  • A Geographical Location that Facilitates Business Travel to and from rich neighbors.
  • Increase in sophistication and employment of professional people for doing the task.


Impact of Money Laundering on Nation:


Social Impact: It damages social institutions by following ways:

  • Transfers the economic power from the right people to the wrong
  • Increases income inequality
  • Loss of morality and ethical standards leading to weakening of social institutions
  • Increased unemployment as legitimate business companies fail to compete with operators operating through illegal money
  • Increased crime and corruption which slows down human development and thus affecting societal progress


Microeconomic impacts of money laundering are as following:

  • Potential damage to reputation of financial institutions and market
  • Destabilises economy of the country causing financial crisis
  • Give impetus to criminal activities
  • Policy distortion occurs because of measurement error
  • Legitimate businesses lose when competing, as there is no fair competition involved
  • Organised crime at local level can flourish.
  • It also leads to higher cost of doing business.


Macroeconomic impacts of money laundering are as following:

  • These include volatility in exchange rates and interest rates due to unanticipated transfers of funds
  • Fall in asset price due to the disposition of laundered funds.
  • Misallocation of resources in relative asset commodity prices arising from money laundering activities
  • Loss of confidence in markets caused by insider trading, fraud and embezzlement.
  • Discourages foreign investors
  • Other indirect economic effects are higher insurance premiums for those who do not make fraudulent claims and higher costs to businesses therefore generating fewer profits which make it difficult to break even.
  • Due to such negative impact, policy makers have to face difficulty to devise effective responses to monetary threats and it causes difficulties in the government efforts to manage economic strategy.


Political Impact:

  • Affects the Government’s capability to spend on development schemes thereby affecting a large section of populations who could have benefitted from such spending
  • Legislative bodies find it difficult to quantify the negative economic effects of money laundering on economic development and its linkages with other crimes – trafficking, terrorism etc. becomes.


Indian Mechanisms to Combat Money Laundering:


Prevention of Money Laundering Act, 2002 (PMLA):

  • It is a comprehensive law enacted by the Parliament of India to prevent money-laundering and to provide for confiscation of property derived from money laundering.
  • The Act and Rules notified thereunder impose obligation on banking companies, financial institutions and intermediaries to verify identity of clients, maintain records and furnish information in prescribed form to Financial Intelligence Unit – India (FIU-IND).
  • It seeks to bring certain financial institutions like Full Fledged Money Changers, Money Transfer Service and Master Card within the reporting regime of the Act.
  • It adds a number of crimes under various legislations in Part A and Part B of the Schedule to the Act for the purpose of money-laundering.
  • In cases of cross-border money-laundering the Act enables the Central Government to return the confiscated property to the requesting country in order to implement the provisions of the UN Convention against Corruption.
  • The Act prescribes for formation of a three-member Adjudicating Authority for dealing with matters relating to attachment and confiscation of property under the Act.


Financial Intelligence Unit – India (FIU-IND):

  • Financial Intelligence Unit – India (FIU-IND) was set by the Government of India as the central national agency responsible for receiving, processing, analyzing and disseminating information relating to suspect financial transactions.
  • FIU-IND is also responsible for coordinating and strengthening efforts of national and international intelligence, investigation and enforcement agencies in pursuing the global efforts against money laundering and related crimes.
  • FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the Finance Minister.


Enforcement Directorate:

  • It is a government agency responsible for enforcement of the Foreign Exchange Management Act, 1999 (FEMA) and certain provisions under the Prevention of Money Laundering Act (PML).
  • The Directorate is under the administrative control of Department of Revenue for operational purposes; the policy aspects of the FEMA, its legislation and its amendments are within the purview of the Department of Economic Affairs.


Global mechanisms to Combat Money Laundering:


Vienna convention;

  • It was the first major initiative in the prevention of money laundering held in December 1988.
  • This convention laid down the groundwork for efforts to combat money laundering by obliging the member states to criminalize the laundering of money from drug trafficking.
  • It promotes international cooperation in investigations and makes extradition between member states applicable to money laundering.


The Council of Europe Convention:

  • This convention held in 1990 establishes a common policy on money laundering to facilitate international cooperation as regards investigative assistance, search, seizure and confiscation of the proceeds of all types of criminality, particularly serious crimes such as drug offences, arms dealing, terrorist offences etc. and other offences which generate large profits.
  • It sets out a common definition of money laundering and common measures for dealing with it.


Basel Committee’s Statement of Principles:

  • In December 1988, the Basel Committee on Banking Regulations and Supervisory Practices issued a statement of principles which aims at encouraging the banking sector to adopt common position in order to ensure that banks are not used to hide or launder funds acquired through criminal activities.


The Financial Action Task Force (FATF):

  • The FATF is an inter-governmental body established at the G7 summit at Paris in 1989 with the objective to set standards and promote effective implementation of legal, regulatory and operational measures to combat money laundering and terrorist financing and other related threats to the integrity of the international financial system.


United Nations Global Programme against Money Laundering (GPML):

  • GPML was established in 1997 with a view to increase effectiveness of international action again money laundering through comprehensive technical cooperation services offered to Governments.
  • The programme encompasses following 3 areas of activities, providing various means to states and institutions in their efforts to effectively combat money laundering.


Challenges in Prevention of Money Laundering:

  • Fast pace of change in technology including cyber technologies creates problems of tracking money launderers. The enforcement agencies have failed to match such a high rate of growth.
  • Lack of awareness about the seriousness of Money Laundering in common people due to which they continue to use Hawala system offering fewer complexities and formalities
  • Failure of Banks to effectively implement KYC norms as stipulated by the RBI
  • A number of black market channels sell imported smuggled goods and they deal in cash transactions and avoid custom duties thus generating black money.
  • Multiplicity of agencies dealing with money laundering, cybercrimes, terrorist crimes, economic offences etc. Such agencies lack convergence among themselves which is required to tackle multi-facet and global nature of money laundering
  • Many Tax Haven countries exist which allows the creation of anonymous accounts with strict financial secrecy laws prohibiting the disclosure of financial information to foreign tax authorities.
  • The provision of financial confidentiality in other countries which are unwilling in compromising with this confidentiality.


 Sample Question:

Money laundering poses a serious threat to country’s economic sovereignty. What is its significance for India and what steps are required to be taken to control this menace?

Money-laundering Infographic