The System It is important to realize that money laundering takes place within the banking system. Big amounts of cash are spread among numerous accounts (sometimes in free economic zones, financial off shore centers, and tax havens), converted to bearer financial instruments (money orders, bonds), or placed with trusts and charities. The money is then transferred to other locations, sometimes as bogus payments for "goods and services" against fake or inflated invoices issued by holding companies owned by lawyers or accountants on behalf of unnamed beneficiaries. The transferred funds are re- assembled in their destination and often "shipped" back to the point of origin under a new identity. The laundered funds are then invested in the legitimate economy. It is a simple procedure - yet an effective one. It results in either no paper trail - or too much of it. The accounts are invariably liquidated and all traces erased.
Why is it a Problem?
Criminal and tax evading funds are idle and non-productive. Their injection, however surreptitiously, into the economy transforms them into a productive (and cheap) source of capital. Why is this negative?
Because it corrupts government officials, banks and their officers, contaminates legal sectors of the economy, crowds out legitimate and foreign capital, makes money supply unpredictable and uncontrollable, and increases cross-border capital movements, thereby enhancing the volatility of exchange rates.
A multilateral, co-ordinated, effort (exchange of information, uniform laws, extra-territorial legal powers) is required to counter the international dimensions of money laundering. Many countries opt in because money laundering has also become a domestic political and economic concern. The United Nations, the Bank for International Settlements, the OECD's FATF, the EU, the Council of Europe, the Organisation of American States, all published anti-money laundering standards. Regional groupings were formed (or are being established) in the Caribbean, Asia, Europe, southern Africa, western Africa, and Latin America.
Money Laundering in the Wake of the September 11 Attacks Regulation The least important trend is the tightening of financial regulations and the establishment or enhancement of compulsory (as opposed to industry or voluntary) regulatory and enforcement agencies.
New legislation in the US which amounts to extending the powers of the CIA domestically and of the DOJ extra-territorially, was rather xenophobically described by a DOJ official, Michael Chertoff, as intended to "make sure the American banking system does not become a haven for foreign corrupt leaders or other kinds of foreign organized criminals." Privacy and bank secrecy laws have been watered down.
Collaboration with off shore "shell" banks has been banned. Business with clients of correspondent banks was curtailed. Banks were effectively transformed into law enforcement agencies, responsible to verify both the identities of their (foreign) clients and the source and origin of their funds. Cash transactions were partly criminalized. And the securities and currency trading industry, insurance companies, and money transfer services are subjected to growing scrutiny as a conduit for "dirty cash".
Still, such legislation is highly ineffective. The American Bankers'
Association puts the cost of compliance with the laxer anti-money- laundering laws in force in 1998 at 10 billion US dollars - or more than 10 million US dollars per obtained conviction. Even when the system does work, critical alerts drown in the torrent of reports mandated by the regulations. One bank actually reported a suspicious transaction in the account of one of the September 11 hijackers - only to be ignored.
The Treasury Department established Operation Green Quest, an investigative team charged with monitoring charities, NGO's, credit card fraud, cash smuggling, counterfeiting, and the Hawala networks.
This is not without precedent. Previous teams tackled drug money, the biggest money laundering venue ever, BCCI (Bank of Credit and Commerce International), and ... Al Capone. The more veteran, New- York based, El-Dorado anti money laundering Task Force (established in 1992) will lend a hand and share information.
More than 150 countries promised to co-operate with the US in its fight against the financing of terrorism - 81 of which (including the Bahamas, Argentina, Kuwait, Indonesia, Pakistan, Switzerland, and the EU) actually froze assets of suspicious individuals, suspected charities, and dubious firms, or passed new anti money laundering laws and stricter regulations (the Philippines, the UK, Germany). A tabled EU directive would force lawyers to disclose incriminating information about their clients' money laundering activities. Pakistan initiated a "loyalty scheme", awarding expatriates who prefer official bank channels to the much maligned (but cheaper and more efficient) Hawala, with extra baggage allowance and special treatment in airports.
The magnitude of this international collaboration is unprecedented.
But this burst of solidarity may yet fade. China, for instance, refuses to chime in. As a result, the statement issued by APEC last week on measures to stem the finances of terrorism was lukewarm at best. And, protestations of close collaboration to the contrary, Saudi Arabia has done nothing to combat money laundering "Islamic charities" (of which it is proud) on its territory.
Still, a universal code is emerging, based on the work of the OECD's FATF (Financial Action Task Force) since 1989 (its famous "40 recommendations") and on the relevant UN conventions. All countries are expected by the West, on pain of possible sanctions, to adopt a uniform legal platform (including reporting on suspicious transactions and freezing assets) and to apply it to all types of financial intermediaries, not only to banks. This is likely to result in ...
The decline of off shore financial centres and tax havens By far the most important outcome of this new-fangled juridical homogeneity is the acceleration of the decline of off shore financial and banking centres and tax havens. The distinction between off-shore and on-shore will vanish. Of the FATF's "name and shame" blacklist of 19 "black holes" (poorly regulated territories, including Israel, Indonesia, and Russia) - 11 have substantially revamped their banking laws and financial regulators. Coupled with the tightening of US, UK, and EU laws and the wider interpretation of money laundering to include political corruption, bribery, and embezzlement - this would make life a lot more difficult for venal politicians and major tax evaders. The likes of Sani Abacha (late President of Nigeria), Ferdinand Marcos (late President of the Philippines), Vladimiro Montesinos (former, now standing trial, chief of the intelligence services of Peru), or Raul Salinas (the brother of Mexico's President) - would have found it impossible to loot their countries to the same disgraceful extent in today's financial environment. And Osama bin Laden would not have been able to wire funds to US accounts from the Sudanese Al Shamal Bank, the "correspondent" of 33 American banks.
Quo Vadis, Money Laundering?
Crime is resilient and fast adapting to new realities. Organized crime is in the process of establishing an alternative banking system, only tangentially connected to the West's, in the fringes, and by proxy.
This is done by purchasing defunct banks or banking licences in territories with lax regulation, cash economies, corrupt politicians, no tax collection, but reasonable infrastructure. The countries of Eastern Europe - Yugoslavia (Montenegro and Serbia), Macedonia, Ukraine, Moldova, Belarus, Albania, to mention a few - are natural targets. In some cases, organized crime is so all- pervasive and local politicians so corrupt that the distinction between criminal and politician is spurious.
Gradually, money laundering rings move their operations to these new, accommodating territories. The laundered funds are used to purchase assets in intentionally botched privatizations, real estate, existing businesses, and to finance trading operations. The wasteland that is Eastern Europe craves private capital and no questions are asked by investor and recipient alike.
The next frontier is cyberspace. Internet banking, Internet gambling, day trading, foreign exchange cyber transactions, e-cash, e-commerce, fictitious invoicing of the launderer's genuine credit cards - hold the promise of the future. Impossible to track and monitor, ex-territorial, totally digital, amenable to identity theft and fake identities - this is the ideal vehicle for money launderers.
This nascent platform is way too small to accommodate the enormous amounts of cash laundered daily - but in ten years time, it may. The problems is likely to be exacerbated by the introduction of smart cards, electronic purses, and payment-enabled mobile phones.
In its "Report on Money Laundering Typologies" (February 2001) the FATF was able to document concrete and suspected abuses of online banking, Internet casinos, and web-based financial services. It is difficult to identify a customer and to get to know it in cyberspace, was the alarming conclusion. It is equally complicated to establish jurisdiction.
Many capable professionals - stockbrokers, lawyers, accountants, traders, insurance brokers, real estate agents, sellers of high value items such as gold, diamonds, and art - are employed or co- opted by money laundering operations. Money launderers are likely to make increased use of global, around the clock, trading in foreign currencies and derivatives. These provide instantaneous transfer of funds and no audit trail. The underlying securities involved are susceptible to market manipulation and fraud. Complex insurance policies (with the "wrong" beneficiaries), and the securitization of receivables, leasing contracts, mortgages, and low grade bonds are already used in money laundering schemes. In general, money laundering goes well with risk arbitraging financial instruments.
Trust-based, globe-spanning, money transfer systems based on authentication codes and generations of commercial relationships cemented in honour and blood - are another wave of the future. The Hawala and Chinese networks in Asia, the Black Market Peso Exchange (BMPE) in Latin America, other evolving courier systems in Eastern Europe (mainly in Russia, Ukraine, and Albania) and in Western Europe (mainly in France and Spain).
In conjunction with encrypted e-mail and web anonymizers, these networks are virtually impenetrable. As emigration increases, diasporas established, and transport and telecommunications become ubiquitous, "ethnic banking" along the tradition of the Lombards and the Jews in medieval Europe may become the the preferred venue of money laundering. September 11 may have retarded world civilization in more than one way.
Hawala, or the Bank that Never Was I. OVERVIEW In the wake of the September 11 terrorist attacks on the USA, attention was drawn to the age-old, secretive, and globe-spanning banking system developed in Asia and known as "Hawala" (to change, in Arabic). It is based on a short term, discountable, negotiable, promissory note (or bill of exchange) called "Hundi". While not limited to Moslems, it has come to be identified with "Islamic Banking".
Islamic Law (Sharia'a) regulates commerce and finance in the Fiqh Al Mua'malat, (transactions amongst people). Modern Islamic banks are overseen by the Shari'a Supervisory Board of Islamic Banks and Institutions ("The Shari'a Committee").
The Shi'a "Islamic Laws according to the Fatawa of Ayatullah al Uzama Syed Ali al-Husaini Seestani" has this to say about Hawala banking: "2298. If a debtor directs his creditor to collect his debt from the third person, and the creditor accepts the arrangement, the third person will, on completion of all the conditions to be explained later, become the debtor. Thereafter, the creditor cannot demand his debt from the first debtor."
The prophet Muhammad (a cross border trader of goods and commodities by profession) encouraged the free movement of goods and the development of markets. Numerous Moslem scholars railed against hoarding and harmful speculation (market cornering and manipulation known as "Gharar"). Moslems were the first to use promissory notes and assignment, or transfer of debts via bills of exchange ("Hawala"). Among modern banking instruments, only floating and, therefore, uncertain, interest payments ("Riba" and "Jahala"), futures contracts, and forfeiting are frowned upon. But agile Moslem traders easily and often circumvent these religious restrictions by creating "synthetic Murabaha (contracts)" identical to Western forward and futures contracts. Actually, the only allowed transfer or trading of debts (as distinct from the underlying commodities or goods) is under the Hawala.
"Hawala" consists of transferring money (usually across borders and in order to avoid taxes or the need to bribe officials) without physical or electronic transfer of funds. Money changers ("Hawaladar") receive cash in one country, no questions asked.
Correspondent hawaladars in another country dispense an identical amount (minus minimal fees and commissions) to a recipient or, less often, to a bank account. E-mail, or letter ("Hundi") carrying couriers are used to convey the necessary information (the amount of money, the date it has to be paid on) between Hawaladars. The sender provides the recipient with code words (or numbers, for instance the serial numbers of currency notes), a digital encrypted message, or agreed signals (like handshakes), to be used to retrieve the money.
Big Hawaladars use a chain of middlemen in cities around the globe.
But most Hawaladars are small businesses. Their Hawala activity is a sideline or moonlighting operation. "Chits" (verbal agreements) substitute for certain written records. In bigger operations there are human "memorizers" who serve as arbiters in case of dispute. The Hawala system requires unbounded trust. Hawaladars are often members of the same family, village, clan, or ethnic group. It is a system older than the West. The ancient Chinese had their own "Hawala" - "fei qian" (or "flying money"). Arab traders used it to avoid being robbed on the Silk Road. Cheating is punished by effective ex- communication and "loss of honour" - the equivalent of an economic death sentence. Physical violence is rarer but not unheard of.
Violence sometimes also erupts between money recipients and robbers who are after the huge quantities of physical cash sloshing about the system. But these, too, are rare events, as rare as bank robberies. One result of this effective social regulation is that commodity traders in Asia shift hundreds of millions of US dollars per trade based solely on trust and the verbal commitment of their counterparts.
Hawala arrangements are used to avoid customs duties, consumption taxes, and other trade-related levies. Suppliers provide importers with lower prices on their invoices, and get paid the difference via Hawala. Legitimate transactions and tax evasion constitute the bulk of Hawala operations. Modern Hawala networks emerged in the 1960's and 1970's to circumvent official bans on gold imports in Southeast Asia and to facilitate the transfer of hard earned wages of expatriates to their families ("home remittances") and their conversion at rates more favourable (often double) than the government's.
Hawala provides a cheap (it costs c. 1% of the amount transferred), efficient, and frictionless alternative to morbid and corrupt domestic financial institutions. It is Western Union without the hi- tech gear and the exorbitant transfer fees.
Unfortunately, these networks have been hijacked and compromised by drug traffickers (mainly in Afganistan and Pakistan), corrupt officials, secret services, money launderers, organized crime, and terrorists. Pakistani Hawala networks alone move up to 5 billion US dollars annually according to estimates by Pakistan's Minister of Finance, Shaukut Aziz. In 1999, Institutional Investor Magazine identified 1100 money brokers in Pakistan and transactions that ran as high as 10 million US dollars apiece. As opposed to stereotypes, most Hawala networks are not controlled by Arabs, but by Indian and Pakistani expatriates and immigrants in the Gulf. The Hawala network in India has been brutally and ruthlessly demolished by Indira Ghandi (during the emergency regime imposed in 1975), but Indian nationals still play a big part in international Hawala networks.
Similar networks in Sri Lanka, the Philippines, and Bangladesh have also been eradicated.
The OECD's Financial Action Task Force (FATF) says that: "Hawala remains a significant method for large numbers of businesses of all sizes and individuals to repatriate funds and purchase gold.... It is favoured because it usually costs less than moving funds through the banking system, it operates 24 hours per day and every day of the year, it is virtually completely reliable, and there is minimal paperwork required."
(Organisation for Economic Co-Operation and Development (OECD), "Report on Money Laundering Typologies 1999-2000," Financial Action Task Force, FATF-XI, February 3, 2000, at http://www.oecd.org/fatf/pdf/TY2000_en.pdf ) Hawala networks closely feed into Islamic banks throughout the world and to commodity trading in South Asia. There are more than 200 Islamic banks in the USA alone and many thousands in Europe, North and South Africa, Saudi Arabia, the Gulf states (especially in the free zone of Dubai and in Bahrain), Pakistan, Malaysia, Indonesia, and other South East Asian countries. By the end of 1998, the overt (read: tip of the iceberg) liabilities of these financial institutions amounted to 148 billion US dollars. They dabbled in equipment leasing, real estate leasing and development, corporate equity, and trade/structured trade and commodities financing (usually in consortia called "Mudaraba").
While previously confined to the Arab peninsula and to south and east Asia, this mode of traditional banking became truly international in the 1970's, following the unprecedented flow of wealth to many Moslem nations due to the oil shocks and the emergence of the Asian tigers. Islamic banks joined forces with corporations, multinationals, and banks in the West to finance oil exploration and drilling, mining, and agribusiness. Many leading law firms in the West (such as Norton Rose, Freshfields, Clyde and Co.
and Clifford Chance) have "Islamic Finance" teams which are familiar with Islam-compatible commercial contracts.
II. HAWALA AND TERRORISM Recent anti-terrorist legislation in the US and the UK allows government agencies to regularly supervise and inspect businesses that are suspected of being a front for the ''Hawala'' banking system, makes it a crime to smuggle more than $10,000 in cash across USA borders, and empowers the Treasury secretary (and its Financial Crimes Enforcement Network - FinCEN) to tighten record-keeping and reporting rules for banks and financial institutions based in the USA. A new inter-agency Foreign Terrorist Asset Tracking Center (FTAT) was set up. A 1993 moribund proposed law requiring US-based Halawadar to register and to report suspicious transactions may be revived. These relatively radical measures reflect the belief that the al-Qaida network of Osama bin Laden uses the Hawala system to raise and move funds across national borders. A Hawaladar in Pakistan (Dihab Shill) was identified as the financier in the attacks on the American embassies in Kenya and Tanzania in 1998.
But the USA is not the only country to face terrorism financed by Hawala networks.
A few months ago, the Delhi police, the Indian government's Enforcement Directorate (ED), and the Military Intelligence (MI) arrested six Jammu Kashmir Islamic Front (JKIF) terrorists. The arrests led to the exposure of an enormous web of Hawala institutions in Delhi, aided and abetted, some say, by the ISI (Inter Services Intelligence, Pakistan's security services). The Hawala network was used to funnel money to terrorist groups in the disputed Kashmir Valley.
Luckily, the common perception that Hawala financing is paperless is wrong. The transfer of information regarding the funds often leaves digital (though heavily encrypted) trails. Couriers and "contract memorizers", gold dealers, commodity merchants, transporters, and moneylenders can be apprehended and interrogated. Written, physical, letters are still the favourite mode of communication among small and medium Hawaladars, who also invariably resort to extremely detailed single entry bookkeeping. And the sudden appearance and disappearance of funds in bank accounts still have to be explained.
Moreover, the sheer scale of the amounts involved entails the collaboration of off shore banks and more established financial institutions in the West. Such flows of funds affect the local money markets in Asia and are instantaneously reflected in interest rates charged to frequent borrowers, such as wholesalers. Spending and consumption patterns change discernibly after such influxes. Most of the money ends up in prime world banks behind flimsy business facades. Hackers in Germany claimed (without providing proof) to have infiltrated Hawala-related bank accounts.
The problem is that banks and financial institutions - and not only in dodgy offshore havens ("black holes" in the lingo) - clam up and refuse to divulge information about their clients. Banking is largely a matter of fragile trust between bank and customer and tight secrecy. Bankers are reluctant to undermine either. Banks use mainframe computers which can rarely be hacked through cyberspace and can be compromised only physically in close co-operation with insiders. The shadier the bank - the more formidable its digital defenses.
The use of numbered accounts (outlawed in Austria, for instance, only recently) and pseudonyms (still possible in Lichtenstein) complicates matters. Bin Laden's accounts are unlikely to bear his name. He has collaborators.
Hawala networks are often used to launder money, or to evade taxes.
Even when employed for legitimate purposes, to diversify the risk involved in the transfer of large sums, Hawaladars apply techniques borrowed from money laundering. Deposits are fragmented and wired to hundreds of banks the world over ("starburst"). Sometimes, the money ends up in the account of origin ("boomerang").
Hence the focus on payment clearing and settlement systems. Most countries have only one such system, the repository of data regarding all banking (and most non-banking) transactions in the country. Yet, even this is a partial solution. Most national systems maintain records for 6-12 months, private settlement and clearing systems for even less.
Yet, the crux of the problem is not the Hawala or the Hawaladars.
The corrupt and inept governments of Asia are to blame for not regulating their banking systems, for over-regulating everything else, for not fostering competition, for throwing public money at bad debts and at worse borrowers, for over-taxing, for robbing people of their life savings through capital controls, for tearing at the delicate fabric of trust between customer and bank (Pakistan, for instance, froze all foreign exchange accounts two years ago).
Perhaps if Asia had reasonably expedient, reasonably priced, reasonably regulated, user-friendly banks - Osama bin Laden would have found it impossible to finance his mischief so invisibly.
Straf - Corruption in Central and Eastern Europe The three policemen barked "straf", "straf" in unison. It was a Russianized version of the German word for "fine" and a euphemism for bribe. I and my fiancee were stranded in an empty ally at the heart of Moscow, physically encircled by these young bullies, an ominous propinquity. They held my passport ransom and began to drag me to a police station nearby. We paid.
To do the fashionable thing and to hold the moral high ground is rare. Yet, denouncing corruption and fighting it satisfies both conditions. Such hectoring is usually the preserve of well-heeled bureaucrats, driving utility vehicles and banging away at wireless laptops. The General Manager of the IMF makes 400,000 US dollars a year, tax-free, and perks. This is the equivalent of 2,300 (!) monthly salaries of a civil servant in Macedonia - or 7,000 monthly salaries of a teacher or a doctor in Yugoslavia, Moldova, Belarus, or Albania. He flies only first class and each one of his air tickets is worth the bi-annual income of a Macedonian factory worker. His shareholders - among them poor and developing countries - are forced to cough up these exorbitant fees and to finance the luxurious lifestyle of the likes of Kohler and Wolfensohn. And then they are made to listen to the IMF lecture them on belt tightening and how uncompetitive their economies are due to their expensive labour force. To me, such a double standard is the epitome of corruption. Organizations such as the IMF and World Bank will never be possessed of a shred of moral authority in these parts of the world unless and until they forgo their conspicuous consumption.
Yet, corruption is not a monolithic practice. Nor are its outcomes universally deplorable or damaging. One would do best to adopt a utilitarian and discerning approach to it. The advent of moral relativism has taught us that "right" and "wrong" are flexible, context dependent and culture-sensitive yardsticks.
What amounts to venality in one culture (Slovenia) is considered no more than gregariousness or hospitality in another (Macedonia).
Moreover, corruption is often "imported" by multinationals, foreign investors, and expats. It is introduced by them to all levels of governments, often in order to expedite matters or secure a beneficial outcome. To eradicate corruption, one must tackle both giver and taker.
Thus, we are better off asking "cui bono" than "is it the right thing to do". Phenomenologically, "corruption" is a common - and misleading - label for a group of behaviours. One of the following criteria must apply: (a) The withholding of a service, information, or goods that, by law, and by right, should have been provided or divulged.
To have a phone installed in Russia one must openly bribe the installer (according to a rather rigid tariff). In many of the former republics of Yugoslavia, it is impossible to obtain statistics or other data (the salaries of senior public officeholders, for instance) without resorting to kickbacks.
(b) The provision of a service, information, or goods that, by law, and by right, should not have been provided or divulged.
Tenders in the Czech Republic are often won through bribery. The botched privatizations all over the former Eastern Bloc constitute a massive transfer of wealth to select members of a nomenklatura.
Licences and concessions are often granted in Bulgaria and the rest of the Balkan as means of securing political allegiance or paying off old political "debts".
(c) That the withholding or the provision of said service, information, or goods are in the power of the withholder or the provider to withhold or to provide AND That the withholding or the provision of said service, information, or goods constitute an integral and substantial part of the authority or the function of the withholder or the provider.
The post-communist countries in transition are a dichotomous lot. On the one hand, they are intensely and stiflingly bureaucratic. On the other hand, none of the institutions functions properly or lawfully.
While these countries are LEGALISTIC - they are never LAWFUL. This fuzziness allows officials in all ranks to usurp authority, to trade favours, to forge illegal consensus and to dodge criticism and accountability. There is a direct line between lack of transparency and venality. Eran Fraenkel of Search for Common Ground in Macedonia has coined the phrase "ambient corruption" to capture this complex of features.