Negative Effects of Money Laundering on The Economy

Blog / Negative Effects of Money Laundering on The Economy

The effects of money laundering are severe and extensive. It can create global and local impacts on businesses, economies, and nations. The negative effects of money laundering on the economy are quite numerous.

What Are The Negative Effects of Money Laundering on The Economy?

Money laundering damages financial sector institutions critical for economic growth, promoting crime and corruption that slow economic growth and reducing efficiency in the real sector of the economy. Most global research focuses on two major money-laundering sectors: drug trafficking and terrorist organizations. The effect of successfully clearing drug money is obvious: more drugs, more crime, and more violence. The link between money laundering and terrorism can be a bit more complicated for an obvious example is terrorists knocking down money so that the authorities cannot monitor them and prevent their planned attacks.

Money laundering is a problem not only in the world's major financial markets and sea centers but also in emerging markets. As emerging markets open up their economies and financial sectors, they become increasingly appropriate targets for money laundering activities. It creates unpredictable changes in money demand, as well as causes large fluctuations in international capital flows and exchange rates.

Effect on Money Demand

It occurs more frequently in countries where the risk of money laundering is minimal. In economies where there are no regulations on laundering, where there is a system that stores bank or customer information, and where banking secrecy is strictly enforced, the informal economy ratio to the national economy is high. The cash inflows and outflows are easy for launderers. With the rapid and uncontrolled inflow of money into the country, consumption rates and especially luxury consumption, are increasing. However, significant increases in exports, imports, foreign payments deficit, inflation, interest, and unemployment rates may be significant. These unstable demands for money caused by black money will negatively affect monetary policy.

False signals of money laundering activities prevent taking necessary measures to solve problems such as budget deficit and high inflation, especially in developing countries, and adversely affect the economy's effective management. Through the global side of these activities, the markets' stability is affected, and financial crises in one country can reflect on other countries. The effect of central banks on monetary policies depends on whether the demand for money is predictable or not. Due to black money on money demand, failures in central banks' policies can be observed.

guide answers the most frequently asked questions and provides practical solutions to detect and prevent money laundering

Effect on Growth Rates

Real sectors can suffer significantly from financial instability in the country. As a result, foreign investors have become crucial for companies. However, it isn't easy to attract foreign investors to the country in money laundering countries. Because the price instability caused by black money in the financial system will affect the economy's credibility in the external environment, rational entrepreneurs will find it inconvenient to invest in the country because they will also consider the country's risk while investing. If the legal money escapes from entering the country, it will result in investment rates not increasing. So there will occur a long-term sustainable growth decline.

Countries with a high volume of money are considered risky places for investors. For those who want to attract international capital to their countries, fighting black money is an important message that provides investors confidence. Through the struggle's effectiveness, investors will increase, which will positively affect growth rates and the economy.

Effect on Income Distribution

Severe losses caused by black money to sources of income cause significant problems in the financial system's functioning. These problems experienced by the economy also have social consequences. The increasing enrichment of specific individuals and groups causes social degeneration. One of the most critical damages of black money to be determined is its negative effect on income distribution. Although the negative impact of the decline in income sources and the differentiation in income distribution is difficult to measure, it is also challenging to compensate for social damage. The gap between individuals in terms of income distribution increases the tendency to commit crimes and makes money attractive.

Also, since the money adversely affects competition, those operating in the registered sector are punished somewhat. Since tax evasion is common in informal economies, the tax burden of those operating in the official sector increases, and income distribution is adversely affected.

Effect on Tax Revenues

Revenue from taxes has the most significant share in public revenues. If this income is low, it will raise the possibility that public revenues will not meet the public expenditures, and if this possibility occurs, budget deficits will occur. Income generated by black money is earnings that countries do not tax. These gains will result in reductions in tax revenues.

The state with decreasing tax revenues has two choices, the first of which is borrowing. It reduces the private sector's productive investments with the effect of government crowding out, which attracts productive investors through the private sector with borrowing. Besides, as the value of bonds increases as a result of borrowing, interest rates in the market increase, creating many problems, another way to close the deficits is the emissions policy. The results of this policy are similar to others. As a result, we can say that both choices negatively affect the economy.

Money laundering activities on tax evasion are high, and regulators and governments try to prevent financial crime via taxes

Effect on Financial Institutions 

Sudden changes may occur in the assets and liabilities of financial institutions that are unknowingly used in money laundering, which will create a risk for the institutions. The news of money laundering of these financial institutions draws the attention of the public authority. In that case, the pressure on auditing for these institutions will increase, and the institution's reputation will be damaged.

The Damage of Money Laundering to The Country's Financial Sector

As shown by various economic analyzes, institutions such as banks and non-bank financial institutions are very important players in countries' economic development. Such financial institutions consist of domestic capital and foreign capital to benefit economic development. However, money laundering harms the development of these financial institutions at this point. The anti-money laundering measures applied within the relevant financial institutions show that employees carry out a relationship between money laundering and fraudulent activities, and thus, their joint work harms the institutions. If money laundering occurs at high rates, criminals use financial institutions to drain the funds they obtain, which negatively affects these institutions.

These adverse effects also undermine the trust of customers. Therefore, the trust of customers and related institutions is essential for developing financial institutions, respectively, to have a stable financial sector and develop the economy through them. The impression of fraud in relevant institutions, such as depositors, investors, and the community at large, as well as customers, is a major obstacle to trusting them. In other words, money laundering damages the image of financial institutions; as a result, the customer loses his trust in the relevant institutions.

Fighting With Money Laundering

Emerging economies may find it difficult to break the cycle of corruption even though they have fewer Anti-Money Laundering (AML) regulations. Criminals are more likely to target weaker systems. This means losing a lot of money for laundering, but the government lacks funds to prevent this. As a result, developing countries need to receive international and regional assistance to secure their economic systems. Money laundering and terrorist financing have weakened and failed many financial institutions due to non-compliance with money laundering and counter-terrorism financing programs. Some banks had to be closed after the loss of regulations resulting from AML / CFT compliance violations. Financial institutions are the backbone of the economy, but the problem begins when channels for money laundering are created. 

The United States, the European Union, and UNO have configured frameworks to protect the world financial system from money laundering and terrorist financing actions. Targeted and comprehensive sanctions are applied to persons, legal entities, and jurisdictions that violate AML/CFT regulations and face serious economic difficulties. The US Foreign Assets Control Office (OFAC) and the Financial Action Task Force (FATF) are important organizations for this purpose. As a result, financial institutions, in particular, do not have difficulty breaking the money laundering chain when they have regulations such as AML / CTF.

AML Compliance Program

The multifaceted impact of money laundering reverberates across global and local landscapes, infiltrating businesses, economies, and entire nations. To counteract the severe and extensive effects of this illicit practice, a robust and comprehensive AML compliance program becomes paramount. AML compliance program serves as a safeguard not only against financial institutions unwittingly drawn into the web of money laundering but also against the erosion of trust within the economy. As financial sectors remain critical pillars for economic growth, a dedicated program bolsters resilience, ensuring that criminal activities do not undermine prosperity. By embracing and implementing a well-structured AML compliance program, countries can secure their financial sectors, uphold income distribution integrity, and foster an environment where legitimate investments flourish while criminal networks falter. The path to economic stability and growth requires a united commitment to thwarting money laundering, guided by the principles of diligence, cooperation, and relentless vigilance inherent in a robust program.

Sanction Scanner Solution to Anti-Money Laundering

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