Keeping Clean: How Islamic Banks Fight Money Laundering?

By: Hany Abou-El-Fotouh Money laundering is not a new trend. It is a process that takes illegal or dirty money generated from illegal activities and puts it through a cycle of transactions, so that it comes out at the end as apparently legal or clean money. The process is driven by criminal activities and conceals the true source, ownership, or use of funds. No one can deny that money launderers may use Islamic banks as a place to clean their dirty money through the use of various financial instruments. In fact it is important to ensure that Islamic banks are well protected from being unwittingly used by money launderers. Additionally, the public at large should continue to maintain confidence on the credibility of the Islamic financial system.

When did Money Laundering Start

In medieval times when the Catholic Church banned usury as not only a crime but also a mortal sin, merchants and moneylenders intent on collecting interest on loans engaged in a wide variety of hiding, moving and washing criminal money. The main objective was to make interest charges either disappear or disguise their nature. This trick could be made in many ways. When merchants negotiated payments over long distances, they would artificially increase the exchange rates sufficiently to cover interest payments as well. They would claim that interest payments were a special premium to compensate for risk. They would make interest appear to be a penalty for late payment, with lender and borrower agreeing in advance that such a delay would take place. They would pretend that interest payments were really profits by using something similar to todays "shell companies" (companies that have no real operational role). Capital would be lent to the company and then taken back again, allegedly in the form of profits rather than of interest on the loan, even though no profits had really been made. All of these tricks to deceive the Church authorities have their rough equivalents today in the techniques used to launder criminal money.

The Size of the Problem

Today money laundering represents an estimated 25% of the worlds gross domestic product. According to International Monetary Fund, it is one of the most serious issues facing the international financial community. Worldwide money laundering estimates US$ 800 Billion US$1.6 Trillion where 47% of the dirty money use banks to clan the dirty money.

Three Stages of Money Laundering

Money laundering process comprises of three main stages. "Placement" is the first stage in the money laundering process. Physical currency is made to enter into the financial system during this stage. The illegal profits may derive from drug trafficking, prostitution rings, smuggling, illegal arms sale, kidnapping for ransom, bribery, computer-fraud schemes and smuggling of human beings and organs. It is here that the illegal proceeds are most vulnerable to detection. The second stage is layering. It is the separation of the money from its illegal source by conducting a complex series of transactions. At each layer, the money looks more and more like legitimate funds. Launderers try to make any tracing back to the dirty source impossible. Examples include bank-to-bank transfers, wire transfers between different accounts in different names in different countries, often using shell companies and purchasing high-value items (boats, houses, cars, diamonds, and securities) to change the form of the money. The last

stage is "Integration" i.e. to integrate the illegal proceeds back into the economy as legitimate funds through legitimate transactions such as business ventures, luxury assets, lending, financing and investing. This stage provides money a launderer with an apparently legitimate explanation for his/her

Is Terrorist Financing Similar to Money Laundering?

Terrorist financing is the process of reverse laundering but tend to use smaller amounts than is the case with money laundering. This process uses funds raised from legitimate sources, e.g. personal donations and profits from businesses and charitable organizations, as well as from criminal sources. Terrorists use same money laundering techniques to evade authorities' attention and protect the identity of their sponsors and the ultimate beneficiaries of the funds. They use conventional and Islamic banks, informal value-transfer systems, Hawala and physical transportation of cash, gold and other valuables through smuggling routes.

Money Laundering from Islamic Perspective

Islam forbids involvement in economic activities which are not in line with the teaching of Islam such as money laundering activities. Allah says in al-Quran surah al-Baqarah verse 188: And do not eat up your property among yourselves unjustly and do not use it as bribe for the judges, with intent that you may eat up wrongfully and knowingly (even) a little of other peoples property. The word unjustly here means property acquired through unlawful ways such as deceiving, stealing, smuggling, etc. Money laundering involves proceeds of unlawful activities and Islam does not allow any property derived from such sources. Islamic banks are required to combat money laundering and terrorist financing by laws and regulations and the ruling of Islam. Therefore, Islam obliges Muslims to do good things and forbids criminal activities. This duty rests with individuals and corporate entities as Allah says in al-Quran surah al-Imran verse 104:- Let there arise from you a group of people inviting to all that is good, bringing together what is right and forbidding what is wrong, they are the ones to reach ultimate felicity. Accordingly, Islamic banks are responsible to prevent or to combat money laundering activities which are clearly not in line with the teachings of Islam.

Are Islamic Banks More Vulnerable To Money Laundering?

Conventional and Islamic banks and other financial institutions are vulnerable to money laundering. Money launderers may target them because of the fast, safe services offered with the possibility of transferring enormous amounts of money electronically around the globe using their products and services. Sadly, Islamic banks and financial institutions are seen as the weak link in the Wes. The wrong perception is about inadequate anti-money laundering (AML) and internal controls. Moreover, in Islamic institutions, the heavy reliance of the industry on cash transactions and on trust within the business communities of Muslim countries have been key areas of concern for Western regulators and institutions. The reality is in the majority of cases AML standards are the same in Islamic financial institutions as in their Western counterparts, However, Islamic finance is a new industry, and with all new industries there is always a room for improvement.

The 5 Common Myths about Islamic Banks

Myth 1: Many Muslims send their Zakat (alms giving) through Islamic banks. No assurance they have funded a legitimate charity vice a terrorist group.

Reality: Islamic banks oversee payment of Zakat to worthy charities and apply same adequate due diligence on about no payments are made to doubtful charities Myth2 Islamic banking system operates under loose regulatory oversight. No proper accounting/auditing standards Reality: Islamic banks are well regulated and follow defined standards e.g. Sharia Council, home regulators, International Islamic Rating Agency, Accounting and Auditing Organization for Islamic Financial Institutions, International Financial Services Board Myth 3 : Terrorist groups more likely to find willing collaborators within the Islamic banking system Reality: Sharia principals do not conflict with international anti-money laundering and counter terrorist financing standards. Islamic banks are subject to the same laws and regulations as their conventional counterparts. Myth 4: Assets and commodities used as degrees of separation in purely financial dealings, resembling "layering" methods of criminal financiers. Reality: Criminal activities are not in line with Sharia. Islamic banks cannot undertake activities which are harmful to society and its moral values e.g. gambling, casinos, liquor trade etc. Myth5: Islamic banks operate in countries known of weak banking regulations Reality: Conventional international banks with Islamic windows: Citigroup, HSBC, UBS, Standard Chartered Bank. National regulators are also involved e.g. FSA (UK) & FED (NYK)

How Islamic Banks Combat Money Laundering?

Almost all countries in which Islamic banks operate have taken serious efforts in combating money laundering by introducing anti-money laundering (AML) laws and guidelines on Know Your Customer. Islamic banks are obliged to report suspicious transactions to Financial Intelligence Units. Furthermore, they should have AML policy approved by the board, a competent compliance officer, rules on record keeping and know your customer guidelines. Indeed, Islamic banks have further duty to combat money laundering activities as mandated by religion of Islam. From Shariah's perspective, statutory duty under AML laws is commendable and in line with the spirit of Islam. About The Author: Hany Abou-El-Fotouh is Chief of Staff & Group Board Secretary, CI Capital Holding - the investment banking arm of Commercial International Bank which is the largest private bank in Egypt . He provides advice and direction to the Board and management with respect to corporate governance practices and formulates corporate policies. Hany is a leading expert on money laundering and terrorist financing controls in the MENA region. Founder of the Middle East Compliance Officers' Forum (MECOF), he has been honored for his work in promoting compliance culture and awareness in the MENA region. He was also voted as Corporate Governance Officer of the Year (2011). Hany writes articles to different newspapers and journals on a variety of subjects. He is a public speaker and professional trainer. Previously, he worked in various senior positions in leading banks in Egypt and GCC countries like HSBC, Oman International Bank, Banque Saudi Fransi among others.

Hany is a certified member of the Association of Certified Anti-Money Laundering Specialists (ACAMS) and Certified Director by Egyptian Institute of Directors. http://www.linkedin.com/in/ hanyfotouh hanyfotouh@yahoo.com Islamic banks, money laundering, terrorist financing, banks, banking