The concept of the shadow financial system rose to international prominence in the aftermath of the 9/11 terrorist attacks. In an interview with a Pakistani newspaper a month later, Osama bin Laden stated that Al Qaeda were as “aware of the cracks inside the Western financial system as they are aware of lines on their hands,” hinting at disparate alternative remittance systems that only occasionally interact with the conventional financial system yet are responsible for global transactions worth billions of dollars per year.
An alternative remittance system – sometimes referred to as an informal value transfer system or underground banking – can be any system, mechanism or network of people that receives money for the purpose of making funds of an equivalent value payable to a third party in another geographic location. Transfers generally take place outside of the formal banking system via entities whose primary business activity may not be the transmission of money or value.
While the primary purpose for such systems is to move legitimately earned funds from one geographic area to another, they can also be used by organized crime groups and terrorists. Examples include Chinese underground banking and the hawala system in use across large swathes of the Middle East, Africa and the Indian subcontinent.
Such systems involve one party receiving money into a pool of funds in one jurisdiction and then making an equivalent payment from a pool of funds held in another jurisdiction. This means that there is a movement of value, rather than a straight-line direct transfer of funds from one jurisdiction to another. In this way, funds are made available to a person without using the traditional banking system.
In many circumstances, citizens in countries that impose limits on moving money outside of the country may want to use such systems to transfer wealth overseas out of concern that assets may be seized if they end up on the wrong side of an authoritarian ruling regime. But such tactics may also be used for illicit purposes, such as hiding illegally accumulated funds, the evasion of international sanctions or, in the case of bin Laden, the funding of terrorist activities.
Indeed, UK law enforcement agencies have flagged that funds received in the UK via alternative remittance services often originate from criminal activity. US agencies have similarly warned that criminal organisations, including those engaged in narcotics trafficking, human trafficking, fraud and raising funds for terrorist groups, often utilise alternative remittance services to move their proceeds and avoid detection by law enforcement. Plenty of incentives are in place for such systems to service the needs of illicit transactions. Underground bankers typically will need access to a large amount of currency in destination countries, encouraging symbiosis with organized crime.
Following 9/11, the global regulatory response was to quickly bring those involved in the transmission of money within the anti-money laundering and counter-terrorist financing regulatory framework. Hawala brokers / underground bankers are acting as a money service business. Post the 9/11 changes, money service businesses are required to be licensed and, in general, it is a crime if they operate without a licence. Licensed money service businesses have the usual regulatory obligations, including record-keeping, Know Your Customer (KYC) checks and the reporting of suspicious activity.
Yet more than 20 years later, unlicensed alternative remittance systems continue to thrive, with global enforcement agencies still struggling to detect and disrupt sophisticated channels that have been in use in one form or another for thousands of years.
On the detection front, agencies have had some success via enhanced surveillance of organized crime groups, notably by following cash couriers to underground bankers. The shadow banking world will often need to intersect with the conventional global financial system; financial gatekeepers in the private sector need to be vigilant in identifying and reporting suspicious activity, providing law enforcement with potentially valuable intelligence.
Indeed, public-private partnerships between law enforcement and the private sector are increasingly common – and vital – in the AML space, given the finite resources of law enforcement agencies. Educating financial institutions about particular types of risk can be a helpful way for law enforcement to gain intelligence and to rely on private firms to take compliance steps which will stop certain transactions from happening in future.
Since the enactment of the US Anti-Money Laundering Act of 2020, the US Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) and the US Financial Intelligence Unit (FIU) have hosted the FinCEN Exchange, a “voluntary public-private information-sharing partnership between law enforcement agencies, national security agencies, financial institutions, and FinCEN to effectively and efficiently combat money laundering, terrorism financing, organized crime and other financial crimes; protect the financial system from illicit use; and promote national security”.
In the UK, law enforcement agencies have in recent years focused heavily on Chinese underground banking, given its large intersection with organized crime. Agencies have engaged in outreach to the private sector in order to disrupt this alternative remittance system by educating firms on the issue so they can identify suspicious activity and take appropriate steps.
Disruption of money mule recruitment and networks has become another priority for the UK government, which in March issued a plan setting out how various different government agencies can work together with the private sector to achieve this goal.
Similarly, US agencies have launched a private sector partnership, the Counter-Fentanyl Strike Force, to disrupt fentanyl trafficking networks. Mexican cartels often utilise alternative remittance systems to move proceeds, including through funnel accounts, exchange houses and Chinese underground banking networks. In December 2023, the Department of the Treasury began this partnership, which focuses on helping financial institutions identify risks and report suspicious activity to the government to disrupt the global flow of illicit proceeds related to fentanyl.
The US has also focused on regulating convertible virtual currency, as cryptocurrency money transmitting services have been utilised for illicit activity, including sanctions evasion, Weapons of Mass Destruction proliferation and ransomware attacks, amongst other activities. Cryptocurrency has allowed actors to move money anonymously across jurisdictions and evade reporting requirements that other forms of currency are subject to. To help address this issue, the US government proposed a regulation in October 2023 that would require domestic financial institutions and other private entities to implement record-keeping and reporting requirements for convertible virtual currency, including cryptocurrency, subject to public comments. Cryptocurrency-related enforcement action has also been a priority for the US Department of Justice, FinCEN, the Treasury Department’s Office of Foreign Assets Control (OFAC) and the US Commodity Futures Trading Commission (CFTC).
Supplementing closer collaboration with government agencies, there are three practical steps that regulated banks and financial institutions can take to disrupt the use of alternative remittance systems for criminal purposes:
- First, source of funds checks can monitor which jurisdiction funds originate from. If the funds have originated from a country that is subject to foreign exchange or capital controls, how did that money get transferred out of that state?
- Second, the installation of up-to-date transaction monitoring systems and careful training of staff can help identify suspicious patterns of cash deposits
- Third, institutions should carry out regular risk assessments of their account holders to identify those that are more likely to hold money mule accounts, such as certain categories of students.
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