The 3 Stages of Money Laundering Explained

In the UK alone, it is estimated that over £100 billion is laundered every year. This underscores how difficult it is for financial institutions to identify and prevent illicit funds from entering the financial system. But how is the money laundered and why is it seemingly so difficult to stop?

Generally, we can break money laundering down into three distinct stages: placement, layering, and integration. In this article, we will look at each stage of money laundering, discuss how threat actors accomplish their goals and how financial institutions can minimise the risk of unknowingly processing these illicit funds.

Stage 1 of money laundering: Placement

The first stage of money laundering is placement and it describes the process of illicit funds entering the financial system. So, for example, depositing the money made from arms dealing into a bank account. Ideally, this is the stage where Customer Due Diligence solutions would flag the transaction as suspicious and prevent it from going through.

However, threat actors have found many different ways to place their illegal funds into the financial system without triggering the alarm. 

Smurfing (structuring)

Smurfing involves breaking down large sums of illicit money into multiple smaller deposits. Since the individual deposits are quite small, this is less likely to get caught by AML systems. Smurfing can be done by:

• Utilising casinos - By just depositing and then withdrawing money in a casino. The threat actor can also make some small-stake bets to more easily pass the money off as gambling winnings. The UK Gambling Commission notes the prevalence of this method.
• Utilising different bank accounts - By breaking down their funds into small chunks and depositing them across multiple different bank accounts, threat actors avoid sticking out and raising suspicion.
• Utilising third parties - Similarly, by having a third party make the deposits, the threat actor is less likely to get caught. This is especially troubling when combined with the previous point.

Currency smuggling

Threat actors can take their illicit funds and physically drive to a different country, typically one with less robust AML/CFT structures, and deposit their money in the foreign account. Said account can then be used in later stages of money laundering to effectively legitimise these funds. This method is common in regions with lax financial oversight and high corruption levels.

Loan repayment 

Threat actors can preemptively take out large loans and then use illicit funds to repay them after the fact. While some of their funds will be lost due to credit fees, the process can legitimise their funds and even allow them to establish a financial history, making future transactions less suspicious.

Money mules 

Criminals recruit individuals, often unaware of their role in illegal activity, to deposit illicit funds into their personal accounts. Money mules may be compensated with a percentage of the funds or are recruited and manipulated through deceptive job offers or even online dating profiles. This technique helps criminals bypass identity verification measures (CIPs) while spreading transactions across multiple accounts to avoid detection.

Stage 2 of money laundering: Layering

If money laundering stopped at placement, law enforcement agencies could easily trace illicit funds back to their source. That is why layering is a crucial step in the process. This stage is designed to obscure the audit trail by moving money through complex financial transactions.

Criminals employ several layering techniques, including:

Complex transfer trails 

Funds are transferred between multiple accounts, across different banks, and even through various countries, making it more difficult to establish a clean audit trail. Furthermore, by spreading transactions across different jurisdictions, criminals take advantage of differences in financial regulations, adding to the complexity.

Shell companies

Similarly to the previous point, overseas shell companies allow criminals to move and disguise their funds. These companies exist only on paper, with no real business operations. And while domiciliary companies are by no means illegal, they can be used for criminal means. Namely, criminals can:

• List themselves as employees and issue fake salaries.
• Create fake invoices for non-existent goods or services.
• Create complex ownership structures to hide the true beneficial owner. 

For example, a legal entity can own a different legal entity that itself owns a legal entity through which illicit funds have entered the system. Tracing this back to the original beneficial owner can be both taxing and complicated.

The Panama Papers scandal revealed how criminals, politicians, and corporations have used shell companies to hide vast sums of money from authorities.

Utilising cash-intensive businesses 

Similarly, threat actors can also use their illicit funds to buy a business that relies on cash. Then they can overstate their monthly earnings and represent their illegitimate funds as regular profit. Since it’s quite complicated to prove how much a cash-intensive business actually made during a given period, this method of layering can be very difficult to prevent. Common businesses in this regard are:

• Restaurants
• Casinos
• Car washes
• Laundromats

High-value asset purchases

Threat actors can buy valuable assets or invest in items that hold their value, reselling them later at a similar price to facilitate money laundering. This is especially common in real-estate. However, similar results can also be achieved by investing into art or buying luxuries such as expensive cars or jewellery. 

Utilising the crypto market 

Cryptocurrencies present unique challenges for AML efforts due to their decentralised nature, pseudonymity, and lack of uniform global regulation. Criminals can exploit the crypto space by:

• Using privacy coins (e.g., Monero, Zcash) that obscure transaction details.
• Engaging in peer-to-peer transactions to bypass exchanges with AML controls.
• Using mixers or tumblers to blend illicit funds with legitimate transactions.
• Chain hopping, where funds are converted across multiple cryptocurrencies and blockchains to further obscure their origin.

By the time money moves through multiple wallets and exchanges, tracing its original source becomes highly challenging for financial institutions and regulators. However, measures are being put in place to better regulate the crypto market.

Stage 3 of money laundering: Integration

The final stage of money laundering, integration, encompasses the return of illicit funds into the financial system as legitimate. From the examples we’ve covered already, this means that the threat actor would:

• Deposit the illicit funds back into their account
• Withdraw the funds from their shell company or business account
• Resell their obtained real-estate assets or luxury items
• Sell their crypto assets

Generally, preventing money laundering at this stage can be incredibly difficult, especially if the layering stage was thorough. However, it is still possible, especially if one link of the chain falls under suspicion. For example, if one of the shell companies that was used gets investigated.

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How to prevent money laundering

Now that we’ve covered the different stages of money laundering, let us discuss how financial institutions can prevent financial crimes at every stage. Namely, let us discuss AML frameworks and how different KYC/KYB checks and processes directly help prevent different forms of financial crime.

1. Determining ownership structures

The reason shell companies are so useful when it comes to layering illicit funds is that it makes it difficult to determine which person is behind which legal entity. However, this issue is tackled via ownership structures.

Namely, when a legal entity, such as a shell company, tries to make a large transaction, the appropriate financial institution must check which natural person owns and/or controls the business. In the shell company example, this would mean that the bank in question would trace the ownership back to the threat actor and if they’re a known criminal or are generally considered a high risk, the bank can block the transaction before it goes through.

Beneficial ownership has even been strengthened in certain jurisdictions to cover aspects such as crypto assets, making layering even more difficult.

2. Source of wealth and source of funds checks

Source of Wealth (SoW) and Source of Funds (SoF) checks are fundamentally the bank asking “how do you have this money?” They are therefore very useful when it comes to money laundering. For example, if a money mule does fall under suspicion for whatever reason, the bank could request a SoF check before allowing them to wire money back to the original threat actor. If the sum is on the larger side, the person would likely have a hard time explaining how they suddenly have so much money.

SoW checks can also raise red flags retroactively. For example, a person tries to make a large international wire transfer. This gets picked up by the AML system of the bank and they are asked for SoW documentation. However, after looking into it, the bank realises that the SoW is illegitimate. This can then point to a longer history of financial fraud.

3. Watchlist screening

During the identification process, financial institutions must also check whether the person or the beneficial owner of the legal entity making the transaction is on any watchlists. This has a dual purpose. For one, this checks whether the person is already a known criminal or is otherwise associated with criminal groups. This is done by checking known criminal databases and performing an adverse media check.

But even if they aren’t a criminal, the financial institution must check whether they are at a higher risk of committing financial fraud. For example, performing a PEP check to see whether the person is themselves or related to a person holding a public government position. Similarly, they check whether the person or entity is under any sanctions and whether they are from a country that is considered a high risk.

All of this is done to ascertain whether the transaction should be blocked or more closely monitored. In other words, a person making an average salary in Switzerland usually won’t even be in the position to launder money. A high ranking government official from a country with a less robust AML system on the other hand can pose a legitimate risk.

4. Transaction monitoring

If a threat actor manages to open an account or uses a third party for their own benefit, transaction monitoring is essential. Namely, transaction monitoring software will ensure that all high risk transactions, such as international wire transfers or large deposits, are thoroughly investigated for signs of money laundering.

Furthermore, modern transaction monitoring systems that can utilise AI can also flag changes in user behaviour. So, for example, if a money mule suddenly starts wiring large sums of money, they will be flagged as a potential threat even though their record has been clean up to this point.

Lastly, by closely monitoring account transactions, the relevant bodies can more easily track down criminals committing money laundering after the fact. Therefore, even if threat actors manage to get through all three stages of money laundering, they can still be held responsible.

Conclusion

In conclusion, the three stages of money laundering are placement, layering and integration, which relate to the introduction of illicit funds, the obscuring of their source, and their return to the threat actor. And while the methods used to launder money are constantly evolving, the introduction of cryptocurrency for example, AML solutions are likewise becoming more advanced.

Through advanced KYC/KYB checks, automated risk-based frameworks and AI-powered monitoring software, financial institutions can still prevent money laundering before any damage has been done. And if you want to ensure that your own compliance/AML framework is up to the task, get in touch with Atfinity and set up a demo today!