How to Detect Money Laundering: A Comprehensive Guide

Digital banks almost eliminate the in-person aspect or the face-to-face interaction between the bank’s employees and the customers, and although this has many pros, it also has some cons.

The in-person aspect makes it difficult for criminals to use fake IDs or generally hide their identities, but with digital banks, it became simpler and easier for those criminals to get around the system.

In this guide, we will discuss how you can detect money laundering but also keep your customers' journey smooth and with the least friction possible.

Key Takeaways

By the end of this guide, you will learn:

1. How to detect money laundering

2. How dirty money is tracked

3. Signs of money laundering & money laundering red flags

4. What is money laundering in banking?

How Money Laundering Works

Before discussing how to detect money laundering, let’s understand how money laundering works. This illegal process usually happens in three stages:

1. Placement

Placement is the first step, where criminals try to sneak illegal money into the financial system, where they often break up large sums into smaller, less noticeable amounts to avoid detection.

For example, instead of depositing $300,000 at once, they might make multiple deposits of $9,850 across different branches to stay below the radar.

2. Layering

In the layering stage, the criminal moves the money around through a series of financial transactions; buying assets, transferring funds overseas, or even investing in businesses. The goal of the layering stage is to hide where the money came from by making it hard to trace.

3. Integration

In the integration and final stage, the dirty money is brought back into the legitimate economy. It could be used to buy real estate, invest in businesses, or buy luxury goods.

Once the money is "cleaned" through all these transactions, it's incredibly hard to tell that it was once illegal.

Read more: Money Laundering Red Flags

Laws and Regulations: The Basics of AML Compliance

AML professionals must follow strict laws designed to stop money laundering. These rules can be different depending on where you are, but most countries follow the guidelines of international organizations like the Financial Action Task Force (FATF).

1. FATF Recommendations

FATF has 40 key recommendations that lay the groundwork for AML practices worldwide. These rules guide how financial institutions should handle customer information, track transactions, and report suspicious activity.

2. US and EU Regulations

In the United States, banks must comply with the Bank Secrecy Act (BSA), which is managed by FinCEN. There's also OFAC, which enforces sanctions. In Europe, you have the 6th Anti-Money Laundering Directive (6AMLD), which includes tough penalties and broader liability for money laundering crimes.

3. Sanctions and Watchlists

Institutions also have to check transactions against global sanctions lists. This includes lists from OFAC, the United Nations, and other groups that track criminals, and politically exposed persons (PEPs).

If a customer shows up on one of these lists and you miss it, the penalties can be steep.

How to Detect Money Laundering in Your Institution

No matter where your bank operates, whether it is in the US, KSA, UAE, or any other jurisdiction, with no exception, all banks must do their due diligence which includes following the rules of KYC to meet anti-money laundering regulations. 

These KYC checks are mandatory because, without them, it is almost impossible to spot money laundering. Think of it this way: if someone is using a fake ID to open an account, if the KYC process is weak and allows this person or entity to open the account, they will be able to use the account to launder money, but if KYC checks were done properly and by the book, this person's request to open the account will be rejected from the very beginning and in most cases will also be flagged as suspicious. 

1. Knowing Your Customer (KYC) and Customer Due Diligence (CDD)

One of the best defenses against money laundering is knowing exactly who your customers are. So, the KYC process verifies customers’ identities, knowing what they do and figuring out if there’s any risk involved.

But if you encounter a high-risk customer like a government minister, customer due diligence won’t be enough; you would need to perform Enhanced Due Diligence (EDD) because PEPs have more opportunities to engage in corruption or money laundering.

It goes without saying that you should keep your KYC records up to date, which will result in you having a clear picture of your customers and their behaviors, so if something changes like they suddenly start moving large amounts of money overseas, you’ll notice it.

2. Transaction Monitoring Systems 

Most banks use transaction monitoring systems to automatically flag suspicious activity. These systems look for patterns like big transfers, unusual withdrawals, or multiple small deposits.

For example, if a business that usually deposits small amounts starts making huge transfers to offshore accounts, an AI system would pick up on that shift in behavior and flag it for further review.

3. Predictive Analytics & Behavioral Profiling

AI can look at past behaviors to analyze abd predict future risks. It can also build a profile for each customer by analyzing their usual transactions. If something seems off, like an unusual withdrawal or an out-of-the-blue transfer to another country, it raises a red flag.

AML Red Flags: What to Watch For

Recognizing the warning signs of money laundering means keeping an eye out for behaviors or transactions that just don’t make sense.

1. Transaction Red Flags

• Odd transaction patterns: Customers who suddenly start moving large sums of money that don’t fit their usual activity.

• Smurfing: Multiple small deposits just under the reporting threshold, usually across several accounts or branches. This is also known as Structured Deposits, which is breaking up large sums into smaller deposits.

• Offshore activity: Frequent transfers to or from accounts in countries that have loose financial laws, in other words, making transactions involving high-risk countries or industries.

2. Customer Behavior Red Flags

• Reluctance to provide information: If a customer refuses to share details about their business or where their money is coming from, it’s a red flag.

• Use of third parties: If a customer always uses intermediaries to handle their transactions, especially without a clear business reason, it can be suspicious.

• PEPs and High-Risk Individuals: Transactions involving politically exposed persons, especially when they’re inconsistent with their job or usual spending, could indicate money laundering.

Real-Life Examples of Money Laundering

The following are real-life examples of money laundering:

1. Danske Bank Scandal: From 2007 to 2015, over $200 billion in suspicious transactions passed through Danske Bank’s Estonian branch. This case shows the danger of not keeping a close watch on overseas branches and highlights the importance of cross-border AML controls.

2. HSBC and Mexican Drug Cartels: HSBC was established in 1865; it operates in 60 different jurisdictions and serves millions of customers, yet, in 2012, it failed to comply because of weak KYC procedures that allowed Mexican drug cartels to launder millions of US dollars. The HSBC bank failed to report suspicious activity and had to pay $1.9 billion in fines after it got caught. 

Best Practices for Detecting Money Laundering

Many AML professionals or those who aspire to this career path ask how to detect money laundering in banks beyond the typical red flags outlined in regulatory manuals!

Despite the fact that there might be a sense of a unified approach to answer this question, the reality is that each institution tackles the question of "how money laundering is detected" differently. Some of them rely on human power solely, but others utilize a mix of technology and human intuition. 

So yes, in different situations, you find yourself wondering "how to spot money laundering" you will also find different warning signs of money laundering, and hence one of the best and most effective ways to spot money laundering is to employ an anti money laundering detection system or software.

Money laundering detection mainly relies on how strong the AML program in your bank is, and to build a strong one, you will need to follow the best practices on how to detect money laundering:

1. Build a Strong AML Program

A good AML program has four key parts:

• Governance: Clear roles for AML oversight.

• Training: Employees need to know what to look for and how to handle it.

• Technology: Invest in the best tools for transaction monitoring, AI, and blockchain analytics.

• Internal Controls: Keep your AML policies updated and review them often to make sure they’re effective.

2. Build a Culture of Compliance

Creating a culture where compliance is a priority can make all the difference. Staff should feel comfortable reporting suspicious activity, and leadership needs to set an example by making AML efforts a core part of the business.

How FOCAL Can Help in Money Laundering Detection

The FOCAL platform offers advanced solutions for money laundering detection:

• Comprehensive Analytics: FOCAL provides tools that analyze transaction data to spot anomalies.

• Real-Time Alerts: The system generates alerts for suspicious activities as they occur.

• Customizable Reports: FOCAL allows institutions to create reports tailored to their specific needs.

Conclusion

Money laundering detection requires a proactive approach, using technology, a sharp eye, and smart strategies. Financial institutions that invest in the right tools and build a culture focused on compliance will protect themselves and contribute to a safer global economy.

In order to be able to track dirty money or recognize money laundering red flags, one should look for unusual patterns because every minor transaction that might look like a normal one is part of a larger narrative, and that's why it is beneficial to not only look in the details but also the bigger picture. When you ask the right questions, you will get half of the answer, and these questions are not always the same for every situation because once the criminals know how your institution operates or how the team works, they will adapt their methods, and this is the real challenge in how to detect money laundering!

FAQs

Q1. What are the top custom rules for money laundering detection in digital banks?

Custom rules can be tailored to the specific needs of digital banks:

• High-Volume Transactions: Flagging accounts with unusually high transaction volumes.

• Frequent Cross-Border Transfers: Monitoring accounts with frequent international transactions.

• Unusual Withdrawal Patterns: Identifying accounts that make large, frequent withdrawals.
  

Q2. How do criminals exploit the anonymity of digital banking?

Digital banks rely on online tools to check identities, like asking for a photo of your ID or a selfie. Criminals can find ways around this by:

• Using stolen or fake identities: They might use someone else’s ID or even create fake ones to open accounts.

• Hiding behind digital wallets or cryptocurrency: Digital banks sometimes deal with cryptocurrencies like Bitcoin. These can offer more privacy, so seeing where the money comes from is more challenging.
  

Q3. Why is money laundering harder to detect in digital banks?

There are a few reasons it can be more difficult:

• High number of transactions: Digital banks often process a large number of small transactions, which criminals can use to hide large amounts of dirty money. They can break it up into smaller amounts (a tactic called "smurfing") so it doesn’t look suspicious.

• Cross-border operations: Since digital banks often work globally, criminals can move money between countries with different rules, making it harder to track.

• No physical branches: Without meeting customers face-to-face, it can be tricky to verify who they really are, especially when they’re opening accounts.