Money laundering and financing of terrorism are serious threats to the financial system, economic stability, and national security. Banks and financial institutions are often used—knowingly or unknowingly—as channels for these illegal activities. Therefore, understanding the nature of risks, methods used, and banking controls is extremely important for bankers and is a core topic in JAIIB and CAIIB exams.
India addresses these risks mainly through the Prevention of Money Laundering Act (PMLA), 2002, RBI guidelines, and international standards issued by the Financial Action Task Force (FATF).
Meaning of Money Laundering
Money laundering is the process of converting illegal money into seemingly legal money so that its criminal origin is hidden. The illegal money usually comes from activities such as corruption, fraud, drug trafficking, tax evasion, smuggling, or cybercrime.
In simple words, money laundering is about “cleaning dirty money” through the financial system.
Stages of Money Laundering
Money laundering generally takes place in three stages:
Placement
This is the first stage, where illegal cash is introduced into the financial system. Criminals may deposit cash into bank accounts, buy financial instruments, or split cash into smaller amounts to avoid detection.
Layering
In this stage, multiple transactions are carried out to hide the trail of money. Funds may be transferred between accounts, across banks or countries, or converted into different financial products to make tracking difficult.
Integration
This is the final stage, where the laundered money re-enters the economy as apparently legitimate funds, such as business income, investments, or property purchases.
These stages are frequently asked in exams.
Meaning of Financing of Terrorism
Financing of terrorism refers to the act of providing funds or financial support to terrorist individuals or organisations. Unlike money laundering, terrorist financing may involve both illegal and legal funds. Even small amounts collected legally can be used for terrorist activities.
The key objective of terrorist financing is not profit, but supporting violent acts and terrorism.
Difference Between Money Laundering and Terrorist Financing
Money laundering focuses on hiding the source of illegal money, whereas terrorist financing focuses on hiding the destination and use of money. This distinction is important for CAIIB exams.
ML/FT Risks Faced by Banks
Banks face several risks if they are used for money laundering or terrorist financing.
Legal Risk
Banks may face penalties, prosecution, and regulatory action if they fail to comply with AML/CFT laws and RBI guidelines.
Reputational Risk
Association with ML/FT activities can damage a bank’s reputation, leading to loss of customer trust and business.
Operational Risk
Weak systems, poor controls, or staff negligence can expose banks to misuse of accounts and transactions.
Financial Risk
Banks may suffer direct losses due to fines, asset freezes, or loss of business.
Common Methods Used for Money Laundering in Banks
Criminals use various banking channels to launder money, such as:
- Opening accounts with fake or benami identities
- Structuring transactions to avoid reporting thresholds
- Misuse of current and cash-intensive accounts
- Use of shell companies and trusts
- Cross-border wire transfers
- Trade-based money laundering
Understanding these methods helps answer case-study questions.
Terrorist Financing Risks in Banking
Terrorist financing risks arise through:
- Use of charitable organisations or NGOs
- Small-value, frequent transactions
- Use of remittance services
- Cross-border fund transfers
- Use of digital payment platforms
Banks must monitor such activities closely.
Role of Banks in Managing ML/FT Risks
Banks are the first line of defence against money laundering and terrorist financing. They are required to implement strong AML/CFT frameworks.
Key measures include:
- Customer Due Diligence (CDD) and KYC
- Enhanced Due Diligence (EDD) for high-risk customers
- Ongoing monitoring of transactions
- Reporting of suspicious transactions (STRs)
- Cash Transaction Reports (CTR)
- Employee training and awareness
Regulatory Framework in India
In India, ML/FT risks are controlled through:
- Prevention of Money Laundering Act (PMLA), 2002
- RBI AML/CFT Master Directions
- Financial Intelligence Unit – India (FIU-IND)
- FATF recommendations
Banks must strictly comply with these regulations.