Definition and Origins

Money laundering is the conversion of criminal incomes into assets that cannot be traced back to the underlying crime (Reuter & Truman, 2004, p. 1). Other authors may use a slightly different wording, but generally they stress two basic elements: the first is the illicit source of the funds, while the other is the process to make them appear as legal. The illicit source refers to a predicate offense, which can be either a typical “blue-collar” crime, such as various forms of theft (e.g., robbery or burglary), drug trafficking, pandering, or other less violent, “white-collar” crimes, like tax evasion, corruption, and embezzlement.

In contrast with this economic approach, the legal point of view focuses on four distinct groups of activities: the conversion or transfer of property knowing its illicit source; the concealment or disguise of its unlawful origin; the acquisition, possession, or use of such property; and any kind of participation in the illegal activities (UNODC, 1988). This became a standard definition for many international organizations, and numerous countries adapted it in their national legal systems (EU, 2015; Levi & Soudijn, 2020, p. 7).

Although it lacks evidence, it is a widespread belief that the term comes from the notorious Prohibition-era gangster Al Capone, who allegedly used laundries as cover firms to hide his illegal revenues. However, the first well-documented use of the phrase can be dated back to the Watergate scandal, around 1973, as the Oxford English Dictionary states. While preparing this article, another earlier example emerged from the Life magazine as well (Oulahan & Lambert, 1967). Whichever is true, both illustrate the mechanism of the process. A gangster can illegally sell alcoholic beverages and then put the money into the cash register of a laundry, claiming falsely that the money is coming from a legal activity. In the Watergate scandal large amount of cash was deposited in Mexican banks, which was later transferred back to the United States, thus hiding the origin of the money and the identity of the donors funding the Republican campaign (Rosenbaum, 1974).

Bulk Cash Smuggling

Before the process of money laundering, several organized crime groups need to transport their revenues back to their native countries. As bulk cash smuggling increases the risk of being caught, many authors consider this stage as a preliminary phase, which precedes money laundering itself. To mention a well-known example, Latin American drug cartels typically generate their income in European or North American states and use a specialized network to smuggle their illegal revenue back to their country of origin (USDT, 2018, pp. 20–23). In the absence of significant economic ties between these countries, which could cover up the illicit flows, they usually contact a money broker to organize the smuggling. These brokers have connections in the target countries, known as coordinators, whose role is to find cash couriers and other complicit individuals (Soudijn & Reuter, 2016, pp. 273, 279).

The criminal income is typically in smaller denomination banknotes, which needs to be changed into the highest denomination available to make the smuggled amount physically the most compact as possible (Riccardi & Levi, 2018, pp. 141–142). It is the task of the coordinator to find high denomination banknote suppliers, who usually work at banks, post or exchange offices. While in the United States it is not uncommon to pay with a $100 bill, in the Eurozone the €500 bill is frequently called the “Bin Laden banknote,” as it is mostly used in questionable transactions (Sands, 2016, p. 12). According to a European Central Bank report, on average, 81% of the respondents have not had either a €200 or a €500 note in their possession for a year (Esselink & Hernández, 2017, p. 44). To a limited extent, the 1,000 Swiss franc bill plays a similar role (FATF, 2015b, p. 54).

Soudijn and Reuter (2016, p. 278) found that the caught cash couriers carried on average €300,000, which only weighs approximately 0.7 kilograms and has a volume of 3 litres in €500 banknotes (Sands, 2016). These cash couriers often volunteer from the ethnic group of the offenders, and they retain a certain percentage for their services along with getting a free flight ticket. There are specialists to modify suitcases, transport couriers to the airport, and ensure check-in, while others collect the smuggled money if the couriers can eventually circumvent the border control. Soudijn and Reuter (2016) estimated that the total cost of the smuggling can be above 10% of the total value.

Authorities report various methods to conceal banknotes. Besides suitcases fitted with a concealed compartment, cash couriers can hide the money among their clothes or on themselves. There were cases when transporting vehicles had secret compartments filled with cash, but customs officers of several countries caught large amount of money bundles in different types of cargo as well. The quickly growing e-commerce also offers criminals an opportunity to send money in mail parcels with less suspicion. Others may try to circumvent cash declaration rules by either underreporting or willfully neglecting declaration (FATF, 2015b).

Process of Money Laundering

Money Laundering in the Information Age

By the first years of the 21st century internet has become a commonplace in the Western world, and a couple of years later the developing world also followed this trend. Mobile phone usage is now self-evident in Asia and Africa as well, and in a few years smartphones and online banking will have a similar penetration. Criminals have to adapt to the new environment, and they definitely will, just as they switched from horse theft to car theft, and evidently nowadays more smartphones are stolen than car radios. This adaptability skill is essential in crime, and money laundering is no exemption.

The relevant feature of this technological development is the introduction of monetary transactions on the internet. Electronic commerce and banking have a growing share in the economy, and new forms of crime have developed to exploit the new vulnerabilities. Classic confidence tricks are now done online (e.g., Nigerian Prince scam, romance scam), and new ones, like ransomware, have been developed to extract money from victims. A common element of these frauds is that, except for a few cases, they do not involve cash, hence the placement stage is mostly skipped. Criminals either trick or coerce victims to wire transfer the demanded money to their account, thus they can directly start with the layering phase (Levi & Soudijn, 2020, p. 4). The advent of digital marketplaces also reshaped illicit trade. Illegal drugs, firearms, child sexual abuse images, animal products are widely sold at specialized sites on the darknet, and many professional money launderers advertise their services on such pages (FATF, 2018, p. 11). On multiple occasions criminals tried to launder their illicit revenues using gift cards of a leading technology company (BBC News, 2020; FATF, 2020, pp. 23–24), while the ease of opening bank accounts online and having pre-paid cards pose a significant laundering risk.

In 2009 bitcoin was launched, the first cryptocurrency to become widely used. This type of digital currency enables quick, cheap, secure, and fully anonymous transactions in the virtual space. Although payments by means of bitcoins in the real world have not yet become prevalent, it is possible to exchange them and other similar cryptocurrencies into conventional money. This possibility is widely used in cybercrime, especially malevolent, black hat hackers extort ransom in form of cryptocurrencies although current evidence shows that, at least for the time being, it has only gained limited popularity in offline crime. There are various possible explanations, among them the volatile exchange rate, the limited convertibility to real products and services, security concerns, and the unfamiliarity with the new technology. Another threat from the money laundering perspective is the presence of cryptocurrency tumblers or bitcoin mixers. Originally these platforms aimed to increase anonymity by obscuring the origin of the mixed amount, since cryptocurrencies record each transaction in the given unit itself utilizing the blockchain technology. Nevertheless, this has soon become a common tool of cybercriminals to hide their traces in monetary transactions. Both cryptocurrency exchanges and mixers retain a certain transaction fee for their services, which is higher when the money is known to be unlawful, but still lower than the costs of cash smuggling. During the layering stage money mules are used in a similar way as in the case of conventional money (Kruisbergen et al., 2019, pp. 574–578).

Many sectors getting digital are jeopardized by criminal activity, and the quick growth of online gambling was expected to pose a threat to the fight against money laundering. Betting and gaming have been for long used by criminals to launder money. Even if there are no fixed matches, marked decks, rigged slot machines and roulettes, offenders can still obtain winning lottery or horse racing tickets at a premium to cover up the source of their wealth (Reuter & Truman, 2004, pp. 28–29). Yet there are risks that need to be addressed in online gambling. A concern arises when sites are registered in countries with lax regulation, but should that occur, countries may decide to block access to them. Winnings and unused money may be transferred back to a different account than from which the bet was made, which is a way to move funds across borders. There are other risks associated to front gamers acting on behalf of others such as game fixing to incur deliberate losses and payments from banks in less regulated countries. Yet all of them apply to gambling in person, and there are considerably more ways on the internet to collect data and monitor activity, not to mention the better traceability of payments. Proper customer identification, betting limits, sanctions for unfair playing, and statistical profiling of gamers can prevent abusing legal providers, and they are frequently easier to implement in the virtual space than in the real world. Limited evidence also suggests that online gambling does not mean a bigger risk than its traditional counterpart (Levi, 2013).

Social and Economic Impact

It is difficult to see the direct effect of money laundering on people’s everyday life (Unger, 2013, p. 20). Usually classic criminal offenses, such as violent crime, substance abuse, corruption, or internet fraud, raise more concern in society. In this sense money laundering is a secondary crime, a side product of various predicate offenses. However, if money laundering conceals the evidence and prevents corrupt politicians and officials to be indicted and removed from power, it can lead to unfair competition in elections, which eventually results in democratic backsliding. Terrorist financing, which is closely related to money laundering, can also facilitate democratically elected governments to be overthrown with all its consequences (Jojarth, 2013, pp. 23–24).

The economic effect is similarly less clear cut. In the long term, infiltrated companies using laundered money have an unlawful advantage compared to those ones adhering to the law. If money laundering is not restricted to a minimal level, not the most profitable projects are realized, but the ones with the lowest risk of detection, which can ruin in the end certain economic sectors without state intervention (Jojarth, 2013, p. 23). Evidence shows that the presence of organized crime harms economic growth (Pinotti, 2015), and public procurement contracts awarded to politically connected firms suffer from lower performance both from a cost and a quality perspective (Schoenherr, 2019). Evidently, both organized crime and grand corruption are resorted to money laundering.

Several attempts have been made to quantify the extent of money laundering, although these estimates should be treated with much caution (Levi & Reuter, 2006, p. 327; Reuter, 2013). A classic method of estimating criminal revenues is to compare the gross domestic product calculated from the production and the consumption side. Theoretically, they should match, any difference is due to measurement or methodological errors and crime, even though it is extremely difficult to tell the two apart. This estimate has to be further elaborated by taking into account the profit and its share that is eventually laundered (Walker & Unger, 2009). To name a few other approaches, one may similarly analyze the errors and omissions in the balance of payments or compare the printed amount of currency with the quantity that is actually circulating (UNODC, 2011).

International Legislation

Besides money laundering, another term was popularized during the presidency of Richard Nixon, namely the war on drugs. In connection with the Comprehensive Drug Abuse Prevention and Control Act of 1970, substance abuse was declared a public enemy. Almost all current national and international money laundering regulations are the result of the struggle in those years to counter illegal drug trafficking, because the main part of money laundering activity in the United States was related to the market of illicit substances. Since the origins of these revenues needed to be disguised, serious efforts were made to fight against it, which promoted international cooperation leading to the first worldwide agreements.

Financial Crimes Enforcement Network lists the timeline of the most important laws related to money laundering in the United States. The Bank Secrecy Act of 1970 required financial institutions to report large cash transactions. A second important step was the Money Laundering Control Act of 1986, which established money laundering as a federal crime, and listed drug and human trafficking, smuggling, bribery, fraud, and murder among others as predicate offenses. A completely new era began, when the September 11 attacks destroyed the World Trade Center in New York. Despite the main objective of the USA PATRIOT Act of 2001 to combat terrorism, as a side effect it introduced measures against terrorism financing which improved reporting standards and enhanced customer identification procedures as well. More recently, the 2020 coronavirus pandemic contributed to the efforts to fight illegal trade of animal products (FATF, 2020).

The United Nations also created three major treaties against illegal substances, and the Vienna Convention in 1988 raised the attention on money laundering too (United Nations, 1988). The G7 summit of Paris in 1989 was a milestone on a supranational level, which established the Financial Action Task Force (FATF) on money laundering. FATF released 40 recommendations that required the member states to pass laws in order to criminalize money laundering, enable confiscation of assets coming from this activity, introduce customer due diligence, report suspicious transactions, and cooperate with other countries (Levi, 2001). In the subsequent years on multiple occasions these recommendations were amended or new ones were added to them (FATF, 2019).

As of 2020, the European Union has passed five directives about money laundering and set up a FATF-like monitoring body, Moneyval, which reports to the Council of Europe. The first directive, 91/308/EEC referred to the 1988 UN treaty. In addition, it aimed to include terrorism and revenues from various forms of organized crime other than drug trafficking. The second, 2001/97/EC extended the scope regarding both the covered institutions and types of crime. The 2003 revision of FATF recommendations included terrorism financing, which were added in the third directive (2005/60/EC). The fourth directive (2015/849) implemented the 2012 FATF revision, reduced the reporting threshold, added letting agents, gambling service providers, and art dealers to the obliged entities, required central beneficial ownership registers to be created, and gave a more precise definition of politically exposed persons (PEP) among others. The fifth directive, (EU) 2018/843, formally amending the fourth one, made the beneficial ownership registers public, increased the transparency of trusts, addressed the issue of virtual currencies, and required the disclosure of pre-paid card owners above a certain threshold.

Since 2000 the FATF publishes the list of non-cooperative countries or territories, which are the jurisdictions that do not implement the recommendations on a satisfactory level. The methodology of this blacklist was later revised many times, and different categories were introduced to better reflect the level of cooperation. In spite of a serious, worldwide level improvement in money laundering regulation, many people criticized FATF for adding or omitting certain countries (Jojarth, 2013, pp. 25–26). As of February 2020, only North Korea and Iran were among the high-risk jurisdictions.¹ The grey list, referred to as jurisdictions under increased monitoring, included mostly developing countries with high rate of poverty (e.g., Albania, Yemen, and Zimbabwe) and only two more familiar countries were present (The Bahamas and Panama).

Numerous authors argued that the biggest offshore centers, which made money laundering remarkably easy through their high secrecy and low customer due diligence, operated in highly developed countries. Delaware, Wyoming and Nevada in the United States are states notorious for facilitating the creation of secretive shell companies (Tax Justice Network, 2020, pp. 5–7; van Duyne et al., 2018, p. 236). The United Kingdom is known for the high secrecy in its overseas territories and crown dependencies, like Bermuda, British Virgin Islands, Cayman Islands, Jersey, and Guernsey (Garcia-Bernardo et al., 2017). These territories offer both offshore services and no need to disclose beneficial ownership, which, on the one hand, enable unethical, yet formally legal tax-base erosion and profit shifting, but also serves as a haven for layering transactions of outright illegal tax evaders, corrupt politicians, and organized crime groups.

But not only remote islands are prone to regulation deficiencies. Several countries have recently improved their anti-money laundering regimes after a scandal causing international outrage. In 2007 and 2009 data on tax evading clients was leaked from leading Swiss banks, which contributed to the fact that Switzerland joined the Agreement on the Automatic Exchange of Information and has been sharing taxation data since 2018 (Swissinfo, 2019). Cyprus had a significant offshore banking sector, which attracted many Russian investors, including a few criminals. However, the 2012–2013 financial crisis in the country totally reshaped the banking sector, which puts now a far greater emphasis on fighting money laundering according to the 2019 Moneyval assessment. Following the murder in 2017 of Maltese investigative journalist, Daphne Caruana Galizia, who reported in detail about corruption and money laundering, Moneyval and the International Monetary Fund sharply criticized the inefficient Maltese regulation and incompetent authorities, and demanded swift changes (Borg, 2020). The 2017–2018 Danske Bank scandal demonstrated how fragile the system was, as approximately €200 billion could have been laundered through Danske Bank’s Estonian subsidiary. Investigative journalists connected the transactions with high-ranking corrupt Russian and Azerbaijani politicians (Milne & Binham, 2018). The Financial Crimes Enforcement Network of the United States Department of the Treasury (FinCEN, 2018) named the Latvian ABLV Bank an institution of primary money laundering concern cooperating with the North Korean regime, which eventually led to the bank’s voluntary liquidation. Although Cyprus, Estonia, Latvia, and Malta are full members of the European Union, they all failed to implement a sound monitoring system.

Anti-Money Laundering in Practice

International treaties and their national counterparts significantly changed the way how the financial system operates now. By reorganizing and reinforcing previously existing institutions, financial intelligence units (FIU) were set up in the participating countries. Various government organizations can supervise these units, but in all cases a strong cooperation is needed among the different government departments, the central bank, the tax authority, the police, and the judiciary. It is the role of these institutions to adapt and implement the recommendations to the national legal system and to enforce them.

The relationship of these measures and the private sector is ambiguous because financial institutions lose the income generated by their criminal clients, while reporting and compliance entail a substantial cost. The financial sector typically passes on these costs to their clients, who sometimes cannot even afford a bank account (Jojarth, 2013, pp. 27–28). Consequently, lower social classes and poor countries may maintain high cash usage, which provides an ideal environment for money laundering. To prevent this, the European Union introduced affordable payment accounts with basic features through the directive 2014/92/EU, although in many countries no similar solutions are available for marginalized citizens, and instead various informal value transfer systems are used.

Financial intermediaries must perform numerous tasks to comply with the regulations and mitigate money laundering risks. The first step is to thoroughly identify new customers and then track any further changes (know your customer—KYC). All cash transactions above a certain threshold (currency transaction report—CTR), wire transfers from FATF blacklisted countries, various suspicious transactions (suspicious activity report—SAR), activities of PEP have to be reported. If these reports are not well-designed, and obliged entities are excessively punished for not informing government agencies of certain activities, it can have an undesirable effect of over-reporting. This poses a serious challenge to authorities that may not be able to select the important ones when flooded with irrelevant cases (Takáts, 2011).

In order to efficiently allocate resources both at financial institutions and supervisory agencies, the 2012 update of the FATF recommendations transitioned to a risk-based approach. Besides banks, now insurance companies, money and value transfer providers, different brokerage firms, and legal counsellors must use this method as well. The supervised institutions need to identify and mitigate risks related to customers, geographic area, and type of service. For example, a foreign cash-intensive business from a country infamous for corruption executing remote transactions should deserve more attention than a local pensioner, who may execute high-value cash transactions but has enough savings and does not receive any money, except for the monthly pension.

Even so, these systems can utterly fail if the only goal is to tick all the boxes. In 2014 a Hungarian newspaper reported on a former drug addict who applied for a job at a construction company. His employment was never reported, and his only task was to withdraw cash from the bank account of the firm. He withdrew approximately €6 million equivalent, which he handed over in bags to his employers in cars or cafés. It turned out that the manager and one of the owners were foreign nationals, one having a travel visa, while the other entered the country illegally. During the investigation the manager vanished, and the owners claimed that they had been victims of identity theft and did not know anything about the company, which was registered in an unfinished building. Despite all, the tax authority, which coincides with the local financial intelligence unit, debited a €4 million fine to the account of the straw man, and the real tax fraudsters were never caught, as the statute of limitations expired. This case illustrates the necessity of awareness, good communication and sound procedures both from the bank and the authority side (Halmos, 2014).

Review of the Literature and Primary Sources

Crime literature is usually more concerned with the laundered money of criminal organizations. Levi (2015) has listed various research projects in American and European countries, where illegal funds were coming from human and drug trafficking. Crime infiltration in legal economy is another current topic, where firms are used as vehicles to disguise the illicit origins of money (Mirenda et al., 2019). As money laundering has close ties with terrorism financing, after the September 11 attacks both legislature and research had more focus on it (Verhage, 2011, p. 39). A different example that has lately gained wide attention is the laundering of revenues from oil and antiquities smuggling in the Islamic State (FATF, 2015a).

Economists are more interested in analyzing the “white-collar” part, such as the relationship of tax enforcement and misuse of corporate funds (Desai et al., 2007), and the effect of tax evasion on firm value (Mironov, 2013). In 2016 a worldwide scandal erupted, when millions of documents were leaked from a Panamanian corporate service provider, containing detailed information about corrupt politicians and tax evaders. Since data is usually scarce on money laundering, the Panama Papers fostered research in this topic (O’Donovan et al., 2019). The effect of cryptocurrencies on usury and the money laundering risks of initial coin offerings were simulated Barone and Masciandaro (2019), and more research is expected in the field of this technology.