How Money Laundering Works: 3 Key Stages Explained

Money laundering isn't just a financial crime; it's a global issue that siphons off an estimated $800 billion to $2 trillion annually, according to the United Nations. This staggering figure represents about 2-5% of the world's GDP, highlighting the importance of understanding how this illicit process works. But how does dirty money make its way into the legitimate financial system? It happens through a well-structured method involving three distinct stages. First, let's learn the meaning of money laundering.

What is Money Laundering?

Money laundering is an illegal act in which large amounts of money are used to conduct criminal activities in drug trafficking, terrorism, or any other corruption. It is a threat to the global financial system and a serious risk to market integrity. This article is a guide that highlights the three stages of money laundering which are placement, layering, and lastly integration.

What Are the 3 Stages of Money Laundering?

Money laundering is the act that enables criminals to camouflage money that originates from a dirty, illegal 'Source A' so that it looks like it came from a clean, legal 'Source Z'. There are three stages of money laundering. In the first stage, placement, unlawfully acquired funds are incorporated into the legal economy. The second stage, layering, entails criminals obscuring the origins of illicit funds by redistributing them through various means. The third stage, integration, occurs when the illicit funds, now disguised as legal currency, are extracted and put to use.

Both local and international organizations make an effort in by using economic and legislative means to prevent suspicious activities for money laundering and supervise related institutions. Almost every country has a national anti-money laundering (AML) compliance system according to its risks and local dynamics. In the international area, there are regional and global authorities. The Financial Action Task Force (FATF) is one of the most efficient actors in this field.

The money laundering process generally unfolds in three distinct stages aimed at legitimizing illicitly obtained funds within the legal financial system. These three phases are as follows:

1. Placement
2. Layering
3. Integration

How Does Money Laundering Work? 

Money Laundering Stage 1: Placement

Placement in money laundering is the initial stage of the money laundering process, where illegal funds are introduced into the legitimate financial system. This is achieved through a variety of methods, including deposits, wire transfers, or other means. This critical step sets the foundation for the entire laundering process and is often the most exposed to scrutiny by financial institutions.

Key Techniques Used in the Placement Stage

• Smurfing: Breaking down large amounts of cash into smaller, less suspicious transactions to avoid detection. This method often involves multiple deposits made by different individuals.
• Structuring: Making deposits just below reporting thresholds to evade regulatory scrutiny. For example, depositing $9,900 instead of $10,000 to avoid triggering suspicious activity reports.
• Cash-Intensive Businesses: Using businesses like casinos, restaurants, or convenience stores to mix illicit funds with legitimate earnings, making the origin of the money harder to trace.
• Cross-Border Transactions: Transporting cash across borders and depositing it into offshore financial institutions to complicate the tracing of the funds. This technique is often used to exploit less regulated financial systems.

Common Methods of Placement

• Cash Deposits: Criminals deposit small amounts of cash into different bank accounts and they keep the amount just below reporting thresholds. Their goal is to get away from detection. This whole process is called “smurfing” or structured deposits.
• Use of Casinos: The second method is to gamble and cash out the winnings so that it looks as if it is legitimate income. That is why casinos must be specifically targeted due to the high volume of cash circulated in this sector.
• Trade-Based Money Laundering (TBML): Another way to funnel funds is by receiving invoices for goods that are over or undervalued. This allows criminals to hide the circulation of their illicit funds by making them look as if they are part of a legitimate trading activity.

Risk Indicators of Placement

• Financial profiles or stated goals that do not align with withdrawals or cash deposits
• Frequent cashing out winnings from casinos or owning luxury goods
• Profiles involved in sudden transactions involving high-risk industries

How Can Sanction Scanner Help Detect Placement Activities?

Such unusual transactions are efficiently exposed and completely blocked by the Sanction Scanner’s Transaction Screening Tool. Whether it is flagged accounts or unusual deposits in high-risk industries, our compliance teams identify illegal attempts with high accuracy. Some of the services we offer include:

• Identifying suspicious cash activity that does not align with client profiles
• Scrutinizing transactions in high-risk sectors such as casinos, real estate, cryptocurrency
• Generating audit-ready SARs (Suspicious Activity Reports)

Money Laundering Stage 2: Layering

What is layering? Layering's meaning is the process of separating the proceeds of criminal activity from their origin through the use of layers of complex financial transactions. Layering money laundering is gradually adding legitimacy to the source of illicit money, making it difficult to detect. It is generally considered the most complex component of the money laundering process, and companies experience struggles with this process during their AML compliance steps. It intentionally involves multiple financial intermediaries and transactions to confuse AML checks. 

Key Techniques Used in the Layering Stage

• Complex Transactions: Funds are moved through a network of financial transactions, including inter-bank transfers and currency exchanges. For example, the money might be transferred between multiple accounts across various banks globally, particularly in jurisdictions with weak AML regulations.
• Investment Activity: Illicit money can be channeled through the purchase and sale of investments such as stocks, bonds, or real estate. These transactions help in distancing the funds from their original source.
• Shell Companies: Using fictitious companies to conduct transactions. These companies, often set up in offshore jurisdictions, serve to disguise the true ownership and origin of the funds.
• Cryptocurrency Tactics: Layering is prevalent in the cryptocurrency world, where criminals use techniques such as:
  • Chain-Hopping: Converting one cryptocurrency into another and moving across different blockchains to obscure the money trail.
  • Mixing or Tumbling: Blending transactions across various cryptocurrency exchanges to make it difficult to trace the original source.
  • Cycling: Making deposits of fiat currency into one bank, buying and selling cryptocurrency, and then depositing the proceeds into a different bank or account

Common Methods of Layering

• Offshore Transfers: One of the most common practices is to move funds through multiple international accounts. Countries known to be tax havens with limited jurisdictions are the locations that give criminals anonymity to conduct illegal activities.
• Crypto Mixing Services: As cryptocurrencies are used in mixing platforms, financial authorities might have difficulty in detecting the source of transactions. Criminals choose this method to obscure the sender and recipient interaction and they erase digital trails.
• Shell Companies: Another method is to form a corporation or a company through which illicit funds are funneled through seemingly legitimate transactions.

Risk Indicators of Layering

• Frequent transfers in countries known for weak anti-money laundering regulations
• Customers with normal business activities but extremely complicated transaction patterns
• Unclear business purposes or crypto-related transactions sudden spikes

How Can Sanction Scanner Help Detect Layering Activities?

Sanction Scanner’s Transaction Monitoring System offers a tool that can effectively detect unusual transactions across borders. With advanced analytics and security alerts, we offer institutions the ability to identify and flag suspicious layering activities. Sanction Scanner integrates a strong compliance infrastructure with instant alerts and coherent risk scores that will certainly reduce the risk of money laundering. Some of the services we offer include:

• Analyzing cross-border transactions, specifically locations with limited jurisdictions
• Detecting behavioral anomalies in user profiles
• Screening money exchanges, crypto-related transactions, and other suspicious digital trail

Money Laundering Stage 3: Integration

Integration, the final stage of money laundering, is where illicit funds are fully assimilated into the legitimate economy, often appearing as lawful income or investments. By this stage, the money has been thoroughly disguised through the placement and layering stages, making it extremely challenging to trace its criminal origins. The goal is to use these "cleaned" funds for everyday transactions or investments without arousing suspicion from authorities.

Key Techniques Used in the Integration Stage of Money Laundering

• Investing in Businesses: Criminals often channel laundered money into legitimate business ventures, including real estate, hospitality, or retail. This method not only generates additional income but also masks the true origin of the funds.
• Employment Schemes: Creating fake employees or shell companies allows criminals to funnel money through payroll, disguising the proceeds as legitimate business expenses. The money is then "collected" by the criminal, often in cash.
• False Loans and Dividends: Criminals may issue loans to directors or shareholders within their controlled businesses, loans that are never intended to be repaid. Alternatively, they may distribute laundered money as dividends to these same individuals, presenting it as legitimate earnings.
• High-Value Asset Purchases: Acquiring luxury items like diamonds, gold, cars, or artwork. These assets can later be sold, converting the illicit funds into seemingly legitimate proceeds.

Common Methods of Integration

• Real Estate Investments: This includes investing in high-value properties.
• Real Estate Over-Invoicing: Inflated property values are another method to disguise illicit funds.
• Cross-Border Transfers: Fake or shell companies are used to conduct international money transfers.
• Crypto Wallet Splitting: Breaking funds into smaller pieces and sending them to many different cryptocurrency wallets is another method.
• Business Ventures: Real businesses with cash-intensive nature like restaurants or construction companies are also used.
• Luxury Asset Purchases: High-value and luxury assets are used to transfer money internationally.

Risk Indicators of Integration

• High-value asset purchases that do not align with customer’s profile
• Inconsistent patterns of investment that appear unusual for the individual’s profile
• Sudden increase in wealth or unexplained financial activity that lacks a clear source of income

How Can Sanction Scanner Help Detect Integration Activities?

Money laundering schemes are becoming increasingly complicated and they evolve rapidly in response to regulatory scrutiny. Sanction Scanner’s Ongoing Monitoring Tool provides high-profile techniques and real-world implications for detecting integration activities. Our professional system consistently monitors irregular behavior patterns. Some of the services we offer include:

• Analyzing transactional data to identify red flags
• Conducting PEP screening, media monitoring and automated compliance reporting
• Monitoring of high-risk locations known for integration activities

The Global Impact of Money Laundering

• Distorts markets, fuels inflation, and creates economic imbalances, particularly in developing countries.
• Causes loss of revenue, reputational damage, and exposes businesses to multimillion-dollar fines or license suspension by regulators.
• Funds organized crime, terrorism, and corruption, weakening global security and governance.
• Slows economic growth by diverting resources from essential public services, increasing inequality, and widening the gap between the rich and the poor.
• Money laundering perpetuates corruption, further destabilizing economies and undermining the trust of foreign investors.

What Are the AML Regulations and Legal Frameworks?

AML strategies are effective if they strictly follow international and national regulatory frameworks. Here is a guide to regulatory highlights for financial institutions and their compliance obligations:

FATF Recommendations: When combating money laundering and financing terrorism, the Financial Action Task Force (FATF) arranges internationally recognized standards. Recommendation 10 (Customer Due Diligence) verifies customer identities and monitors their transactions. In addition, Recommendation 20 (Suspicious Transaction Reporting) reports any suspicious activity. FATF Recommendations are fundamental in maintaining transparency within the financial system.

EU 6AMLD: Building upon FATF Recommendations, the European Union’s 6th Anti-Money Laundering Directive (6AMLD) strengthens the legal framework. It is a directive that introduces a list of 22 offences, including cybercrime and environmental crime. EU 6AMLD will prove to be a liability for companies across EU member states.

U.S. Bank Secrecy Act (BSA): It is required by the U.S. Bank Secrecy Act (BSA) that financial institutions must implement monitoring systems for suspicious activities. Institutions must file Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs) under the supervision of FinCEN (Financial Crimes Enforcement Network).

Why Is It Important to Combat Money Laundering?

Tackling money laundering is vital for a multitude of reasons, and here's why:

• Maintains market integrity and reduces inflation risks.
• Protects institutions from fines and reputational damage.
• Disrupts financing for terrorism, drug trafficking, and human trafficking.
• Promotes accountability and reveals corrupt activities.
• Ensures a level playing field and ethical operations.
• Channels resources into public services and infrastructure.
• Builds confidence among investors and global partners.

How To Prevent Money Laundering?

• Implement strong anti-money laundering policies and procedures.
• Perform Customer Due Diligence (CDD) to verify identities and assess crime involvement before service use.
• Apply Enhanced Due Diligence (EDD) for customers deemed higher risk.
• Conduct ongoing monitoring to review transactions and detect suspicious behavior.
• Utilize transaction monitoring software to identify unusual patterns and scrutinize dubious transfers.
• Carry out independent AML audits to find and address deficiencies in your practices.

How Does the Sanction Scanner Help?

Sanction Scanner provides a comprehensive solution to combat financial crime with customer screening, customer risk assessment, transaction monitoring, and fraud detection. Our technology ensures your business remains compliant with the latest AML regulations while effectively detecting suspicious activities. Experience how Sanction Scanner can enhance your AML strategies by requesting a demo today.