What is money laundering? Definition, examples, & prevention
Every year, criminal activity like drug trafficking, sex trafficking and arms trading generates trillions of dollars. To the proceeds of crime, those involved need to erase any trace that they obtained the money illegally — a process called money laundering. Annually, around $1.6 trillion or 2.7% of the gross domestic product (GDP) is laundered.
Though money laundering may seem like a black market tactic, it’s a financial crime many white-collar criminals employ. The challenge for modern corporations and their boards is to create policies that effectively identify and prevent money laundering. To help, this article will explain:
- What money laundering is
- Common ways people launder money
- How money laundering works
- Money laundering examples
- Anti-Money Laundering regulations and compliance
- Money laundering red flags to watch out for
- How to prevent money laundering
- Anti-money laundering best practices
- The future of anti-money laundering compliance
What is money laundering?
Money laundering definition: “Cleaning” money obtained illegally to erase its connection to criminal activity.
When people traffic drugs or commit other financially motivated crimes, they gain large sums of money. To deposit that money with a financial institution, they must create the illusion that the money came from a legitimate source, like a business they own or invested in, and not their illegal enterprise. Money laundering is the process that makes this illusion possible.
For example, a criminal organization earns large sums of cash through drug trafficking. To make this “dirty” money appear legitimate, they could buy a cash-heavy business, like a nightclub, inflate daily sales reports to include the illegal funds and deposit “clean” money into the business’s bank account. The organization can now use that money without raising suspicion.
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Register nowDoes money laundering always involve currency?
Though traditional money laundering is synonymous with cash, the proliferation of online banks and payment services has given bad actors a new outlet. Money can be laundered through peer-to-peer payments, online money transfers and more, all while using a proxy server to disguise the launderers' identities.
Criminals can also hold phony online auctions or convert their dirty money into currency for gaming and gambling before withdrawing newly cleaned money. Money laundering and other cryptocurrency-related crimes are also on the rise.
Common ways criminals launder money
People launder money in many different ways, and the advent of online banking has only added to the list. That said, some approaches are more common than others. Criminals most often launder money through:
- Banks: Many banks must report large transactions. Money launderers get around through a process called smurfing or structuring. They divide their total sum into smaller amounts that they deposit into separate bank accounts.
- Cash-intensive businesses: Criminals can also slip their dirty cash into cash-reliant businesses, like laundromats or car washes. If the car wash earns $10,000 one month, it can report the earnings as $15,000 instead and include $5,000 of dirty money in its deposit.
- Trade-based laundering: Criminals can also misreport the value of legitimate transactions to conceal dirty money, including by over- or under-invoicing for goods or services or falsifying the amount of product in a shipment.
- Real estate: Money launderers can channel their dirty money into real estate, buying property with illegitimate funds and then selling it to recoup clean cash.
- Professional services: Criminals could use lawyers, accountants or financial advisors to help move or disguise illicit funds. These professionals might create complex financial structures, set up trusts, or help transfer assets, making the original source difficult to trace.
- Virtual currencies: A bad actor can also use digital currencies like Bitcoin to transfer money anonymously across borders. Criminals may also use crypto wallets or peer-to-peer exchanges to obscure the origin and ownership of illegal funds.
- Shell companies: These are businesses that exist on paper but have no real operations. Criminals use them to hide asset ownership, make suspicious transactions appear legitimate or funnel illicit money through layers of companies to confuse investigators.
- Offshore accounts: Opening bank accounts in countries with strict privacy laws allows criminals to store money that is out of reach of domestic authorities. These jurisdictions often don’t require disclosure of account ownership, making it easier to hide illegal wealth.
How money laundering works
Money laundering is a relatively simple process. It works by finding a place to house the dirty money, leveraging performative bookkeeping to make it appear as if the money came from legitimate transactions and then returning the clean money for use in the financial system.
This involves three specific steps:
The 3 stages of money laundering
The three stages of money laundering are placement, layering and integration.
- Placement: This involves finding a place to launder the money, usually a business or other third party.
- Layering: Criminals will then use bookkeeping and other practices to make the transaction appear legitimate.
- Integration: The criminal then withdraws the clean money and deposits it with a financial institution so they can use it as they please.
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Get the guide!Examples of money laundering
Money laundering is often a covert enterprise, but many infamous examples of money laundering have made the front page. These also make excellent examples for boards that want to prevent this kind of criminal activity in their organization.
- Tobacco Industry (Multi-billion dollar industry): In the early 1990s, a major European subsidiary of a large tobacco company was investigated for a money laundering scheme with criminal groups from Russia and South America. Drug money was smuggled into Europe and then converted into euros through brokers. These euros were used to purchase large quantities of cigarettes from the tobacco company, effectively laundering the illegal drug profits.
- Global Financial Institution (One of the world’s largest banks): In 2012, a major international bank was penalized for failing to implement proper anti-money laundering controls. This lapse allowed a drug cartel from a specific region to move illicit funds through the bank’s system. The bank faced a significant financial penalty (nearly $2 billion) for these deficiencies.
- European Bank (Large financial institution): This example highlights a bank that intentionally disregarded anti-money laundering protocols. They misrepresented their safeguards to financial authorities in the United States, allowing high-risk clients from various countries to funnel an estimated hundreds of billions of dollars in suspicious funds into the US financial system through the bank's subsidiary.
Navigating the global anti-money laundering (AML) landscape
AML is anti-money laundering legislation that requires companies to verify the identity of their customers. Schemes like that of the European bank mentioned above gave way to these new requirements, as banks and other companies are also liable if their customers launder money or commit acts of terrorism.
Regulations like these can vary regionally and globally but nonetheless, heighten the need to detect and thwart money laundering and other financial crimes. That doesn’t mean compliance is easy.
Global and regional frameworks
- Financial Action Task Force (FATF) Recommendations: The FATF sets international standards to prevent money laundering and terrorist financing. Its 40 recommendations offer a global blueprint for AML compliance, due diligence and enforcement. Member countries are evaluated through mutual assessments and must show progress to avoid grey- or blacklist status.
- U.S. Bank Secrecy Act (BSA): Enacted in 1970 and historically enforced by the Financial Crimes Enforcement Network (FinCEN), the BSA is the cornerstone of U.S. AML law. Financial institutions must file suspicious activity and currency transaction reports and maintain detailed records.
- EU AML Directives: The European Union implemented six Anti-Money Laundering Directives (AMLD), each strengthening oversight. Recent updates focus on centralized beneficial ownership registries, digital assets and cross-border coordination. The proposed EU Authority for AML (AMLA) will add a layer of centralized enforcement to ramp up compliance among covered entities.
- Asia/Pacific trends: Countries like Singapore and Australia are tightening AML regulations, which align with FATF guidance. Japan and South Korea, meanwhile, are ramping up crypto surveillance to identify criminals attempting to transact anonymously. There is also a growing emphasis on public-private partnerships for financial intelligence sharing in the region.
Emerging AML legislation and enforcement trends
- Beneficial ownership transparency: Recently, a global push for identifying the true owners of companies and trusts has gained momentum. The idea is to close loopholes that criminals use for anonymous laundering. In the U.S., the Corporate Transparency Act requires many entities to report beneficial ownership to FinCEN. Canada, the UK, and countries across the EU are rolling out similar laws.
- Crypto-related AML updates: Regulators are expanding AML laws to cover virtual asset service providers (VASPs), like exchange and wallet providers. For example, FATF’s Travel Rule requires VASPs to share customer information in transactions over certain thresholds. Countries like the U.S., Switzerland, and Singapore are leading enforcement efforts against cryptocurrency and other emerging virtual asset technologies.
- FinCEN updates: FinCEN is finalizing new rules under the AML Act of 2020, including expanding whistleblower protections, tightening regulations on real estate transactions and enhancing risk-based approaches for non-bank financial institutions. FinCEN is also launching a pilot beneficial ownership database, improving access for law enforcement and financial institutions.
AML compliance
AML compliance programs are tools that financial institutions and other covered entities use to prevent money laundering. Banks, money services companies and insurance companies are among the organizations that need rigorous AML compliance efforts.
The Federal Financial Institutions Examination Council’s (FFIEC) guidance on AML compliance requires regulated businesses to:
- Implement a system of internal controls
- Perform independent audits of compliance activities
- Appoint a dedicated compliance officer to oversee day-to-day compliance efforts
- Provide comprehensive employee training
- Create a risk-based approach for identifying customers
- Establish ongoing customer due diligence
Red flags for money laundering
Money laundering has traditionally been difficult to spot. However, some clear red flags have emerged as regulators become more savvy in using common tactics and acting to prevent them. Here are situations that could signal criminal activity:
- Suspicious or secretive behavior: Customers who are unusually evasive about their identity, source of funds or business activities may be trying to conceal illicit activity. Reluctance to provide standard documentation or use of intermediaries without a clear reason is a significant warning sign.
- Large cash transactions: Regular or substantial cash deposits, especially by individuals or businesses that don’t typically handle large volumes of cash (e.g., law firms or real estate agents), may indicate an attempt to place illicit funds into the financial system.
- Owning a company with no clear purpose: Shell companies that don’t offer products or services or have unclear business models are often used to obscure the origin and movement of money. These entities may have no physical presence or operate in high-risk jurisdictions.
- Complex transactions: Layered transactions involving multiple banks, countries or currencies with no apparent economic rationale are a hallmark of the layering stage of money laundering. Watch for rapid movement of funds between unrelated accounts.
- Making multiple small transactions: Known as structuring or smurfing, this involves breaking up large amounts of money into smaller deposits to avoid triggering reporting thresholds. Repeated transactions below the legal reporting limit (e.g., $9,900) are common.
How to prevent money laundering
The FFIEC’s recommendations offer a valuable roadmap for tools that may prevent money laundering. However, an effective anti-money laundering program isn’t just about compliance but understanding and mitigating risks.
To effectively and sustainably prevent money laundering, businesses must take a risk-based approach to identifying and transacting with customers of all backgrounds. That requires:
- Identify your day-to-day business activities: Before you can create an AML program, you must understand the activities that the program will govern. Whether it’s creating bank accounts, making secure payments or issuing insurance policies, that’s what your AML policies should emphasize.
- Analyze your risk exposure: To prevent money laundering, the program you build should mitigate the most extreme risks, whether customers, employees, board members or potential other bad actors.
- Create an internal controls system: Your internal controls are where business activities and risk management meet. Wherever those activities may introduce risk, implement controls that prevent it. For example, completing due diligence before opening a customer’s bank account can ensure they are who they say they are and not a criminal with a fake or stolen identity.
- Implement risk-based due diligence: This is the companion to internal controls. While internal controls govern your organization internally, due diligence is your chance to investigate third parties for any risk they may pose. For money laundering, focus specifically on individuals, whether a potential customer or a target company’s CEO.
- Cultivate a culture of compliance: For your anti-money laundering program to be successful, your employees must buy into its importance. Offer thorough and ongoing training to help employees understand money laundering risks and recruit them to help stop it. Be sure to thoroughly explain all AML policies and procedures.
- Conduct ongoing and independent reviews: Your compliance officer should regularly review your AML program, but you should also recruit an independent auditor to do the same. The auditor will offer an unbiased view of the efficacy of your problem with feedback you can use to improve.
- Integrate technology: The above steps are critical, but they only scratch the surface of what truly effective AML compliance requires. Your program must stay one step ahead of money laundering tactics, a feat difficult to achieve amid the many other risks financial institutions face. Due diligence software can tackle much of this process, freeing you up to focus on emerging risks.
Anti-money laundering best practices
Organizations must stop checking compliance boxes to combat money laundering effectively. A well-designed AML strategy should be proactive, risk-based and embedded in your organization’s culture and operations. Here are a few best practices to reduce exposure to financial crime:
- Customize your AML program: Start with a risk-based approach and tailor it to your organization’s size, industry and financial crime exposure. The best AML programs will have documented policies and procedures, ongoing employee training, regular audits and independent testing and methods for identifying and reporting suspicious activity — all overseen by designated compliance officers.
- Link AML with broader governance and compliance frameworks: Siloing AML means risks can fall through the cracks. Instead, integrate AML into your overall compliance strategy, making it part of a broader and more robust ERM effort. This creates a unified view of risk, including money laundering, and improves board oversight.
- Vet vendors and partners: Conduct enhanced due diligence on third parties, especially those in high-risk regions or industries. Take steps to verify beneficial ownership, screen against sanctions and watchlists, review reputation and regulatory history and reassess periodically after initial onboarding in case their status changes.
- Automate alerts, draft reports and update policy with AI: Artificial intelligence can streamline and expedite AML compliance. Purpose-built AI tools can detect suspicious patterns across datasets, reduce false positives in transaction monitoring, generate suspicious activity reports and monitor regulatory changes.
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Read the guideThe future of AML compliance
AML compliance is rapidly evolving to keep up with the increasingly global and digitized financial systems. Regulators and organizations are considering how their approaches can counter new technologies, complex criminal networks and the emerging threats that come with them. The future of AML will hinge on more innovative collaboration, tighter regulation and technology-driven solutions. Here’s what to watch:
- Cross-border collaboration and data sharing: Money laundering often crosses borders, and enforcement should, too. For example, agreements like the Egmont Group of Financial Intelligence Units and the EU–U.S. Data Privacy Framework are streamlining cross-border investigations. Public-private partnerships may also play a bigger role in real-time information sharing.
- Continued rise of digital assets: Cryptocurrencies and blockchain-based financial tools continue to challenge traditional AML frameworks. In turn, regulators may expand the scope of AML laws to include decentralized finance, NFTs and crypto mixers. Compliance teams will need tools to trace this activity and verify digital asset transactions.
- Evolution of AI-assisted compliance: Artificial intelligence is the new AML compliance baseline. Machine learning models are mastering anomaly detection and reducing false positives, while natural language processing helps automate policy updates and audit documentation. Generative AI may soon be able to draft compliance reports, conduct training and summarize alerts.
- Heightened regulatory scrutiny: Regulators increasingly zero in on outcomes over compliance checklists. They want proof that AML compliance programs are effective, not just performative. FinCEN, the EU and others target high-risk sectors like real estate, luxury goods and crypto. Noncompliance penalties may also rise, and enforcement is increasingly targeting individual accountability.
Fight back against money laundering and other financial crime
Criminals launder $300 billion in the United States every year and launder billions and even trillions more around the world. As money launderers get smarter, many businesses feel helpless to stop it. However, tools like AML compliance, due diligence, internal controls, and more can all create a hostile environment for money laundering.
However, creating an effective AML program means understanding the ins and outs of financial regulations and what it means to comply. Download Diligent’s guide to financial crimes and anti-corruption regulations to learn more about how to stop money laundering in its tracks.
Frequently asked questions
What is laundered money?
Laundered money has moved through a legitimate financial institution or other company to remove any trace of its illegal origins. Criminals can then integrate their illegally obtained money into the banking system.
Is money laundering illegal?
Money laundering is illegal. It’s a federal crime to use illegitimate funds in any transaction.
Is money laundering a felony?
Money laundering is both a federal and state penalty and is punishable by 10-20 years in prison and fines that depend on the amount of funds laundered.
What are the common red flags of money laundering that GRC teams should track?
GRC teams should watch for behavioral, transactional, and structural red flags. Common indicators include:
- Unusual or secretive customer behavior, such as reluctance to provide identification or explain a source of funds.
- Large cash transactions, especially those inconsistent with a customer’s business or profile.
- Multiple small transactions (“structuring”) are designed to evade reporting thresholds.
- Complex ownership structures, shell companies, or businesses with no clear operational purpose.
- Rapid movement of funds through multiple accounts or jurisdictions without a logical business reason.
- Unusual third-party payments or transactions that don’t align with the customer’s stated activities.
Proactively monitoring these red flags using rule-based alerts and behavior analytics is essential to strengthening AML compliance.
How is AI and machine learning being used in AML programs?
AI and machine learning are transforming AML programs by making them smarter, faster, and more adaptable. Everyday use cases include:
- Transaction monitoring and anomaly detection: ML models can identify suspicious patterns and reduce false positives by learning from past flagged behaviors.
- Risk scoring and customer segmentation: AI tools help profile customers based on dynamic risk indicators instead of static rules.
- Automating repetitive tasks: AI can draft suspicious activity reports, summarize alerts and assist with policy reviews.
- Natural language processing: Natural language processing enhances screening for adverse media, sanctions and beneficial ownership data.
By embedding AI into AML workflows, institutions can improve compliance accuracy, reduce costs, and adapt quickly to evolving threats.
What industries are most vulnerable to money laundering?
Money laundering risks are highest in industries that involve large cash flows, complex transactions, or international activity. High-risk sectors include:
- Financial services: Banks, fintechs and money service businesses are prime targets due to transaction volume and global reach.
- Real estate: High-value property purchases are often used to conceal illicit funds.
- Luxury goods and art: These markets offer anonymity, subjective pricing and portability.
- Gambling and casinos: Large cash transactions and limited oversight make this industry attractive to launderers.
- Trade and import/export businesses: Trade-based money laundering leverages falsified invoices and cross-border flows.
- Cryptocurrency and digital assets: Anonymity and rapid transfer speeds present new compliance challenges.
GRC teams in these sectors should implement enhanced due diligence and regularly update AML policies to stay ahead of emerging threats.
What is placement in money laundering?
Placement is the first stage of money laundering, when criminals place their money into the banking system. Criminals may deposit cash into a bank account, buy assets for a shell company, purchase real estate or even buy currency from an online gambling website.
What is structuring in money laundering?
Structuring in money laundering is when criminals divide their cash into smaller sums to avoid unwanted attention from financial institutions, law enforcement and regulators.
What is layering in money laundering?
Layering in money laundering is a process that distances the laundered money from its source. A criminal might transfer money to a new bank account, change the currency or buy real estate to make the illegitimate cash untraceable.
What is integration in money laundering?
Integration in money laundering is when the criminal retrieves their laundered money so it appears they obtained the money legally.
