What Is Money Laundering?

Hand with cuffs on with the text “What Is Money Laundering?” and The Motley Fool jester cap logo

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

Much like it sounds, money laundering is the act of cleaning dirty money. In this case, dirty money refers to money gotten through illegal means, and cleaning it means making it look like it was obtained legally.

Money laundering is illegal, and it’s a serious problem in the financial systems. Global banks often devote significant resources to fighting it to ensure that they’re not enabling criminals.

In this look at money laundering, you’ll learn what it is, how it works, and why it matters.

What is money laundering?

Money laundering is the process of making illegally gotten financial assets appear as though they were obtained legally. All kinds of criminals use money laundering, including drug dealers, terrorists, arms dealers, white-collar criminals, and thieves. Laundering makes the money they use untraceable to criminal activity.

Money laundering generally involves a three-step process. Ill-gotten money is placed with a financial institution, often offshore. This is known as placement. From there, the money goes through “layering,” which refers to a complex series of transactions to obscure the source of the money and make auditing difficult. Finally, the money is integrated in the financial system to make it appear like it was obtained legally; one common way to do this is through purchasing real estate.

Why it matters

According to the United Nations Office on Drugs and Crime, money laundering schemes account for a whopping 2%-5% of global GDP, or roughly $2trn (£1.6trn). Meanwhile, according to the identity verification group, Credas, money laundering in the United Kingdom accounts for 4.3% of GDP. That’s approximately £87.9bn of illegal funds entering the UK every year1.

Banks and law enforcement agencies work together to fight money laundering through coordinated anti-money laundering systems and policies, know-your-customer practises so banks understand who they’re doing business with, and monitoring for suspicious transactions. Banks also rely on cybersecurity systems to deter fraud and reduce vulnerability to illegal activities.

Money laundering is a difficult problem to stop because there are so many different ways to do it, and there is so much banking activity to search through. Criminals are always looking for creative ways to launder their money and stay ahead of law enforcement.

What you should know about money laundering

Money laundering imposes a larger cost on society by giving criminals funds to run illegal activities. But these criminals can also prey on everyday citizens through phishing scams and other techniques that allow them to use your bank account to clean their money. Examples might include an email telling you you’ve won a prize or informing you that you have inherited money from a long-lost relative as a pretext for collecting your banking information. Sometimes, they even start on online dating websites.

If you suspect you’ve been the target of a money laundering scheme, the best thing to do is to cut off all communication with the criminal in question and report it to your financial institution and local law enforcement, especially if you’ve given the criminal your personal information.

Like most things in life, if an unsolicited email or offer sounds too good to be true, it probably is.

How money laundering works

There are a number of different ways to launder money, but here are some of the more famous examples.

In 2010, before its merger with Wells Fargo (NYSE:WFC), Wachovia Bank allowed drug cartels in Mexico to launder an estimated $380bn. The drug cartels smuggled US dollars back across the border to Mexico. From there, they converted them into pesos and deposited the currency into their personal bank accounts. Wachovia was eventually penalised by the US government with a $160m fine.

Similarly, drug cartels used HSBC Holdings (LSE:HSBA) to launder $1bn as they exploited the bank’s poor oversight. The bank was forced to pay a fine of almost $1.9bn.

Recently, UK banks have been getting the spotlight. Natwest Group (LSE:NWG) was fined £265m at the end of 2021 for failing to prevent £400m from being laundered through it. This actually marked the first criminal money laundering case from regulators against a British Bank. And it seems the Financial Conduct Authority is now probing Barclays (LSE:BARC) for evidence of money laundering as well.

Although money laundering doesn’t often get attention from investors, it is a significant drag on the global economy, and a major incidence of money laundering has the potential to crush a stock.

For banks, the consequences of not preventing money laundering can be expensive, adding another incentive to hire compliance and anti-money laundering personnel to reduce the risk. For financial stocks and other companies on the front lines in the fight against money laundering, ensuring proper prevention is key for maximising performance.

As investors look forward to the next bull market, money laundering remains one of several challenges facing the global economy. With improving technology and artificial intelligence, however, banks and law enforcement agencies may be able to turn the tide on these criminals.

Article Sources

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.  

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a "top share" is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a "top share" by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk. 

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. The Motley Fool UK has recommended Barclays Plc and HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.