Money laundering and terror financing

The first principle

Most serious crime is committed for money, and money from crime is useless until it can be spent without revealing where it came from. Laundering is the bridge between crime and spending, so blocking it removes much of the motive for the crime. Terror financing runs the other way: it moves money, clean or dirty, towards violence and hides where it is going. In both, money leaves a trail that outlives phone calls and witnesses.

The core

How money is laundered

• Placement puts cash from crime into the financial system, for example by depositing small amounts below reporting limits (smurfing), buying gold or mixing it with a cash business's takings; banks' know your customer (KYC) checks are the first filter.
• Layering moves the money through many transactions to break the trail: shell companies, loans to oneself, resales of property, false trade invoices and tax havens.
• Integration brings the money back looking legitimate, as business profit, a property sale or foreign investment, sometimes returning to India through a tax haven (round tripping).
• Scale. The United Nations Office on Drugs and Crime (UNODC) has long estimated global laundering at 2 to 5 per cent of world gross domestic product (GDP), or roughly 800 billion to 2 trillion dollars a year.

Channels that need special attention

• Hawala is an informal transfer of value on trust: a broker in one city takes cash, a partner in another pays out the same sum, and the two settle later through trade or reverse flows, leaving no bank record. It is illegal in India as an unauthorised money transfer under the Foreign Exchange Management Act (FEMA) 1999, and its proceeds fall under the Prevention of Money Laundering Act (PMLA) 2002 when linked to crime.
• Trade based laundering hides value in the price of goods: an exporter overstates an invoice to bring money in, or an importer overstates one to send money out, and customs rarely know the true price.
• Virtual digital assets such as cryptocurrencies move across borders in minutes under pseudonyms. Since March 2023 their exchanges and custodians are reporting entities under the PMLA and must register with the Financial Intelligence Unit India (FIU-IND), which has acted against unregistered offshore exchanges.
• Money mules rent out their bank accounts so that proceeds of cyber fraud move quickly (see the cybersecurity note).

Terror financing

• Sources include state sponsors, extortion, drug trafficking, fake currency, misused charities, crowdfunding and crypto. Sums for an attack are often small, so detection means spotting networks.
• Law. Section 17 of the Unlawful Activities (Prevention) Act (UAPA) 1967 punishes raising funds for a terrorist act, and a 2012 amendment brought the production and circulation of high quality counterfeit currency within the definition of a terrorist act.

Dimensions

• Security. Insurgent and left wing extremist groups run on extortion, terror groups across the border on hawala and fake currency, and narco terror links drugs to violence; cutting money weakens all three.
• Economic. Laundered money inflates property and gold prices, lets criminal firms undercut honest ones and costs tax revenue.
• Governance. A bribe is useful only if it can be spent, so anti laundering law is anti corruption law too.
• International. A poor rating from the Financial Action Task Force (FATF) raises the cost of credit and correspondent banking for a whole country, as Pakistan found on the grey list.
• Rights. Wide powers of arrest, attachment and bail under the PMLA raise questions of liberty and due process, weighed by courts against the offence's gravity.

In practice

Institutions

• The Enforcement Directorate (ED) began as an Enforcement Unit on 1 May 1956 and sits in the Department of Revenue, Ministry of Finance, enforcing FEMA (civil), the PMLA (criminal) and the Fugitive Economic Offenders Act 2018.
• FIU-IND, set up in 2004, receives suspicious transaction reports, cash transaction reports above Rs 10 lakh and cross border wire transfer reports from reporting entities, analyses them and passes intelligence to the ED, the National Investigation Agency (NIA), the tax department and others.
• The NIA investigates terror financing under the UAPA, and the Reserve Bank of India (RBI), the Securities and Exchange Board of India and other regulators enforce KYC rules.

The law

• The PMLA 2002, in force from 1 July 2005, makes it an offence to be involved in any process or activity connected with the proceeds of crime, including concealment, possession, acquisition, use and projecting them as untainted. Proceeds of crime are property gained from a scheduled offence, an underlying crime listed in the schedule, such as corruption or drug trafficking.
• Its main tools are punishment of three to seven years, up to ten where the crime is linked to narcotics (Section 4), provisional attachment of property for 180 days, confirmed by an Adjudicating Authority (Sections 5 and 8), record keeping and reporting by reporting entities (Section 12), arrest (Section 19), a reverse burden of proof (Section 24), twin conditions for bail (Section 45) and the power to summon and record statements (Section 50).
• Amendments. The Act was widened in 2009 and 2012, and in 2018 Parliament restored the twin conditions for bail after the Supreme Court had struck them down in Nikesh Tarachand Shah (2017). A 2019 amendment made clear that laundering is a continuing offence, so it covers anyone who keeps enjoying the proceeds. Notifications in 2023 brought crypto service providers and some professionals within reporting duties.

Judgements

• Vijay Madanlal Choudhary v Union of India (27 July 2022). A three judge bench upheld the main provisions of the PMLA, holding that ED officers are not police officers, so statements recorded under Section 50 are admissible; that the Enforcement Case Information Report (ECIR) is an internal document that need not be given to the accused, though the grounds of arrest must be told; and that the twin conditions for bail are valid. It also held that laundering depends on a scheduled offence, so if the accused is finally discharged or acquitted of that offence, the laundering case cannot stand. In August 2022 the Court agreed to review two points, the supply of the ECIR and the reverse burden of proof.
• Later safeguards. In Pankaj Bansal (2023) the Court required the grounds of arrest to be given in writing, and in Tarsem Lal (2024) it held that once a special court takes cognisance of a complaint, the ED needs that court's permission to arrest the accused.
• Vineet Narain v Union of India (1997) arose from the Jain hawala diaries of 1991, which recorded hawala payments to public figures; the Court used it to shield the Central Bureau of Investigation and the ED from interference, under oversight by the Central Vigilance Commission.

FATF and India

• What the FATF is. Set up by the G7 in Paris in 1989, the FATF sets 40 Recommendations, revised in 2012 to cover terror and proliferation financing together, and checks each country through peer reviews called mutual evaluations. Countries with serious gaps go on the grey list and the worst on the black list.
• India's evaluation of 2024. India, a member since 2010, was evaluated jointly with two regional bodies; the report, adopted at the June 2024 plenary and published on 19 September 2024, placed India in regular follow up, the better of two follow up categories. India was rated compliant or largely compliant on 37 of the 40 Recommendations and partially compliant on three, including non profit organisations and domestic politically exposed persons.

Cases and their lessons

• Punjab National Bank, 2018. A fraud of more than Rs 11,000 crore ran for years through letters of undertaking sent over the interbank messaging system without entry in the bank's core accounts. The RBI stopped such letters in 2018, and the Fugitive Economic Offenders Act followed to seize assets of accused who flee abroad.
• Terror funding in Jammu and Kashmir, from 2017. NIA investigations traced hawala and cross border trade funding separatist and militant activity, and the government suspended trade across the Line of Control in April 2019 because it was misused for weapons, narcotics and fake currency.
• Pakistan on the grey list, 2018 to 2022. Under FATF pressure Pakistan prosecuted terror financiers, including leaders of banned groups, before its removal in October 2022: a financial rating changed a state's behaviour where diplomacy alone had not.

Issues and way forward

• Few convictions. The government told the Lok Sabha in August 2024 that 5,297 PMLA cases had been registered since 2014, with 40 convictions; trials are slow because the PMLA case waits on the scheduled offence. More special courts and stronger evidence in place of long custody are the remedy.
• Liberty and misuse. Strict bail and the reverse burden mean long custody before trial, and low conviction fuels claims of selective use; written reasons, time limits and judicial oversight protect liberty and credibility.
• Non profit organisations. The FATF asked India for a risk based approach that protects charities from abuse without a blanket burden on all.
• Gaps in the non financial sector. Dealers in gold and jewels, real estate agents and crypto providers are supervised less well than banks, and limits on cash dealing need enforcement.
• Mule accounts. Banks, telecom operators and police must share data in real time; the RBI's MuleHunter.AI, which uses machine learning to flag mule accounts, is a start.
• Beneficial ownership and hawala. A verified register of companies' real owners would expose shells, and cheaper formal remittances would shrink hawala more than raids.

Common confusions

• Money laundering and terror financing. Laundering hides where dirty money came from; terror financing hides where money, possibly clean, is going.
• PMLA and FEMA. The PMLA is a criminal law on proceeds of crime; FEMA is a civil law on foreign exchange, enforced mainly through penalties.
• ED and FIU-IND. FIU-IND analyses financial intelligence but does not investigate; the ED investigates, attaches and prosecutes.
• ECIR and FIR. The ECIR is the ED's internal record that opens a PMLA case; a first information report is the police record under criminal procedure law.
• Grey list and black list. The grey list means increased monitoring while a country fixes agreed gaps; the black list calls for counter measures.

For the exam

• Keyword bank: placement, layering, integration, proceeds of crime, scheduled offence, hawala, trade based laundering, money mule, PMLA 2002, twin conditions, Enforcement Directorate, FIU-IND, FATF regular follow up, grey list, Vijay Madanlal Choudhary (2022).
• Previous year questions: Practise the previous year questions on this topic →
• Use in an answer:
  • Introduction with data: The FATF's mutual evaluation of 2024 rated India compliant or largely compliant on 37 of its 40 Recommendations and placed it in regular follow up, while flagging delays in prosecution.
  • Introduction with a judgement: In Vijay Madanlal Choudhary (2022) the Supreme Court upheld the PMLA's wide powers of summons, arrest, attachment and strict bail, treating laundering as a grave offence with effects across borders.
  • Conclusion: Laws and ratings are in place; India now needs convictions, through faster trials, better evidence and supervision beyond the banks.
  • Conclusion: Following the money is the surest way to reach the organiser behind a crime or an attack, so financial intelligence belongs at the centre of internal security.