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Underground Banking and National Security
Money laundering networks have and continue to provide avenues to siphon money between individuals, groups, and nations across national borders and across the world for legitimate and illegitimate purposes. Less is known of underground banking in law enforcement circles and government regulatory agencies than any other form of money laundering or cash movement. The lack of understanding is largely due to lack of understanding of the cultures in which the systems operate. The presence of underground banking does not necessarily mean money laundering is also present. However, underground banking has historically proven itself to be one of the safest methods for money launderers to transfer large sums of money without a trace.
This Spring the CBI filed chargesheets against the breakaway Congress leader, Mr. Arjun Singh; the BJP President, Mr. L.K. Advani; Mr. Yashwant Sinha; and others, including senior cabinet ministers of the ruling Congress(I) party. At present, the Indian Government is continuing to investigate the source of Rs. 65 crores, which Mr. S.K. Jain and Mr. J.K. Jain paid to politicians and bureaucrats as bribes or political donation through the hawala route. Participants in the hawala scandal refused to cooperate with the authorities, notwithstanding the overwhelming evidence against them. Adding another dimension to the case, Mr. Ameer (brother-in law of the currently jailed Ameer) who arranged Jain's hawala operations in West Asia, Europe and also Australia, allegedly laundered over Rs. 150 crores out of India.
This brings into question the issue of hawala, and underground banking in general, as an imperilment to national security. How easily may vast sums of money be moved from point to point without a trace or trail? If funds are being transferred in this way to bribe politicians, for what other nefarious purposes are underground banking methods used? What is underground banking? Where did it originate? What implications does it have to governments seeking to track illicit funds, halt narcotics money laundering and to control financial support to subversive and international terrorist organizations?
Historical Perspective: A Chinese Model
First, let's examine how banking and its mirror image, underground banking came to be. Hawala is an Arabic word, which is used in non-Arabic Muslim countries with the spelling hawallah, meaning the transfer of money or information between two persons using a third person. The system dates to the Arabic traders as a means of avoiding robbery. It predates western banking by several centuries. During the T'ang dynasty in China, the growing tea trade between the south and the imperial capital underscored the necessity for a more convenient method of exchange. In response to the need, a medium of transfer poetically named "flying money", or fei-ch'ien, evolved. Provincial governors maintained "memorial-offering courts" at the capital. Southern merchants paid the money they made from the sale of goods at the capital to these courts, which then used it to pay tax quotas due from the Southern Provinces to the central government. In return, the courts issued a certificate to the merchants. When the merchant returned home, he presented this certificate to the provincial government and was paid an equivalent sum of money. In this way, both the merchant and the government avoided the risk and inconvenience of carrying quantities of copper and silk.
Whether the underground banking is done by Indians, Pakistanis or some other nation, its roots are inevitably found in the culture which originated the practice out of necessity. As an example of how underground banking originated, let's examine its genesis in China. Historically, in China, if you had a quantity of raw opium and I wished to purchase the opium, I would give you a quantity of silver. The silver would become a medium of exchange with which I obtained a commodity. If there was an unsatisfied debt and I had the ability to pay in raw opium, that opium would be a means of payment and a form of money. I accepted the opium from you at the rate of one kilo for each one hundred taels of silver you owed me. I stockpiled silver in anticipation of future purchases, and you did the same with your opium. Suppose I wish to purchase 500 kilos of opium from you. You live in Burma, I live in China. I do not want to transport 50,000 taels of silver, so I tell my cousin in Burma to pay you and I promise to settle with him later. You deliver 250 kilos, but you receive 50,000 taels of silver. I now have a 50,000 tael liability on my cousin's books, a 25,000 tael asset on your books and a commodity worth 25,000 taels on my books. I sell my opium for double its unit cost and have 50,000 taels of silver in my possession. My cousin tells me to pay a 50,000 tael debt he owes in China and thus settle my debt with him in Burma. I have caused the transportation of 250 kilos of opium from Burma to China without moving my silver and have 25,000 taels in Burma which the Chinese authorities will never see.
During the course of this transaction my "money" has taken the form of raw opium; silver taels; notes between my cousin, myself and a third party; and has been alternately (various) mediums of exchange, including a means of payment, a standard of value and a store of value. Those transactions have been both domestic and international in character. The preceding example provides the fundamental concept in Chinese and Indian underground banking. The practice has not changed since its inception.
What Police Inspectors in Hong Kong noticed was this:
"The record keeping procedures of the underground banking system are nearly non-existent, with coded messages, chits and simple telephone calls used to transfer money from one country to another. One Hong Kong police official stated that he once seized a piece of paper with the picture of an elephant on it that represented the collection receipt for US$3 million at a Hong Kong gold shop. The system, nonetheless, has the ability to transfer funds from one country to another in a matter of hours, provide complete anonymity for the customer, provide total security, convert gold or other items into currency, and convert one currency into another of another's choice."
In February 1988, the U.S. Department of Justice reported, "Large amounts of money...move internationally in an underground banking system that operated on tradition and trust. Chinese (and Indians) sometimes carry and exchange encoded chits that substitute for monetary instruments. For example, a chit encoded in New York can be exchanged for an agreed-upon amount of cash, gold, heroin or other commodity in Hong Kong. Shops that specialize in gold and precious stones, money exchangers, and import/export businesses form a network that moves cash and commodities with little or no documentation. This system originated hundreds of years ago as a means of avoiding robberies and repressive tax measures by the Ching dynasty. Today, the chit system offers an invisible means of moving hard currency internationally."
The system is swift and efficient. Guarantees of payment are assured by relationships between the bankers and their clients. Failure to meet obligations has reportedly led to reprisals on the families of bankers. As a result, payments are generally handled with care and dispatch.
Origins of the Chit System
The chit system did not originate with overseas Chinese remittances nor with so-called native banks. Chits are a British colonial invention. The word "chit" itself is the derivative of "chitty", a word of Anglo-Indian origin borrowed from the Hindi chitthi, meaning a mark. From the late seventeenth century, the word crept into the English usage as meaning a note, pass or certificate given to a servant. The chitty came to China in the nineteenth century by way of British custom. Foreign residents in the treaty ports found handling strings of Chinese cash or silver ingots a major inconvenience. A system was devised to eliminate this inconvenience.
Harvard University economist Frank King describes this system: "The salary of foreign employees was paid by check drawn on the Chinese compradore, who then held the funds against which the employee wrote 'chits'...memoranda acknowledging debts for retail transactions. These were accepted by the shopkeeper and passed for collection to the firm's compradore." The Chinese underground banking network is active in China, Taiwan, and throughout Southeast Asia.
In August 1984, Lt. General James A. Williams, then Director of the U.S. Defense Intelligence Agency (DIA), reported to the U.S. Senate, "Some sources have stated their suspicions that this system is being used by criminal elements in Vietnam as a way of transferring funds generated in Vietnam through black market activities to a safe haven outside Vietnam for unspecified future use. In the opinion of our DIA analysts, such a system may also be used by Soviet Republic of Vietnam (SRV) intelligence and security agencies, possibly in association with criminal elements. This system would result in availability of operational funds for the use of SRV personnel or others, both in the United States and elsewhere.
Such a barter system is not unique to Vietnam. It is quite probable [you have] noted the barter system in use in other countries around the world which have strict prohibitions regarding foreign currency transactions." Money Laundering: Hawala and India In 1994, the U.S. State Department reported that India is increasing in significance from a money laundering perspective. Raids conducted in August 1992 against a Colombian money launderer working for the Cali and Medellin cocaine cartels revealed that drug money was being deposited in an account in Punjab. A multilateral effort was recently initiated in the United States to target a well known Colombian cocaine kingpin, who has used at least one bank account in India to facilitate the transfer of funds from the U.S. Although there have been no arrests/prosecutions for money laundering, investigation of a major stock market scandal in Bombay in 1993 and 1994 developed leads indicating possible ties to narcotics-related activities.
In general, India is meeting the goals and objectives of the UN Convention with respect to adopting money laundering legislation, but enforcement measures needs improvement. Money laundering is a crime. Indian banks are required to maintain records on large currency transactions that are over 20,000 rupees (approximately US$800) and to report them to the Central Bank. However, reliance on manual bookkeeping for some 60,000 branches and loose accounting practices have created abundant opportunities for fraud. The Central Bank created a separate bank supervising board in March 1993 to address the widespread perception that bank supervision is weak and ineffective. The major difficulty law enforcement agencies face in the successful pursuit of financial investigations is that the Indian asset seizure law is a criminal statute requiring a criminal conviction to effect asset forfeiture.
The law contains so many loopholes and requires so many years to prosecute as a criminal matter that U.S. officials consider it ineffective. In March 1992, duties on imports were reduced, and a variety of currency and foreign exchange requirements were liberalied. Restrictions on gold and silver imports were also relaxed. In September 1992, the Indian Government announced that foreign institutions would be allowed to invest directly in all stock market instruments, operate foreign currency accounts, and convert funds to rupees at market rates. Hawala, the Indian form of an underground banking system traditional throughout the Middle East and Asia, has links to drug trafficking. With the easing of foreign exchange controls and the unified exchange rate, Hawala activity has apparently slowed.
There has been a 40 percent increase in remittances by nonresident Indians through banking channels. Indian Customs reports a recent increase in large currency importations. Indian law requires declarations for imported currency exceeding US$10,000. However, records are maintained by hand and investigations rarely follow. While the long-term effects of India's liberalization measures remain to be seen, the Hawala system will continue to be used by persons involved in such illicit activities as tax evasion, drug trafficking, money laundering, political corruption and arms smuggling. Invoice manipulation is pervasive and is used extensively to launder illicit proceeds.
Money Laundering: Hundi and Pakistan
Even as the Islamic Republic of Pakistan was formed from India, the Hundi System was an offshoot of the Hawala System of Money Laundering which was originally brought to India by Arab traders. As with all institutions, and underground banking being no exception, evolution of the process and system of the Hundi was strongly affected by political events in Afghanistan in 1970 with the establishment of a Communist Government in Kabul. Prior to 1970, the center of underground banking in the region was Peshawer, where Afghans cornered much of the market. Before 1970, the main outside contact point was Kabul. This axis did about 60 of the total business, even for European destinations. The reason was the narcotics trafficking through Landi Kotal and later Bara. When the Afghan Transit Trade (as was and is the euphemism for smuggling) fell after the Russians invited themselves into Afghanistan, drug smuggling, often in exchange for arms, supplied a need for the Hundi trade. There was also a new and generous supply of US$ to trade.
This replaced many of the indigenous dealers in Lahore, Rawalpindi and eventually Karachi. They also took over or developed their own counterparts in Dubai and the Middle East. Pakistan is a significant money laundering concern, primarily due to its prominence in the production and trafficking of heroin and hashish. Pakistan does not yet meet the goals and objectives of the UN Convention. While Pakistan is making understandable efforts to channel funds from underground currency movement systems into mainstream banking, its relaxation of currency controls and other steps, which can be exploited by drug traffickers, combined with its failure to update its narcotics control legislation and practices, heightens the potential for money laundering.
Undercover investigations into Pakistani drug traffickers and money launderers have revealed the international scope of their operations. Pakistani heroin networks have laundered their profits through banks throughout the United States and Middle Eastern nations. Strict hard currency laws inhibit the outward flow of cash, but Pakistanis use the worldwide underground networks, known as Hundi in Pakistan, to overcome outgoing currency exchange restrictions, evade taxes, or move their illicit proceeds. One official estimates as much as US$2 billion a year flows through Pakistan's Hundi system, and a significant part of this money may be derived from drug trafficking. Gold smuggling is also a means of laundering money.
The Hundi system is a major target of recent foreign exchange reforms, which are designed to bring the money flowing through the black market and the Hundi system into the formal economy. During the last five years, The Government of Pakistan liberalized foreign currency restrictions and gold import policies, and launched various bond schemes. Pakistanis may now negotiate foreign currency transactions and remit offshore profits made with foreign exchange outside of Pakistan. In addition, Pakistani banks offer foreign currency accounts that guarantee complete secrecy.
The Government is encouraging its banks with offices in the Middle East to establish money changing operations in countries with large Pakistani populations, who might otherwise use the Hundi system. An estimated US$1 billion has flowed into Pakistan since the foreign exchange controls were liberalized. In March 1992, attempting to attract foreign capital, Prime Minister Sharif announced the issuance of interest bearing bonds, denominated in US dollars. The bonds were advertised, "No questions asked about Source of Funds." Nor was the identification of the purchaser required. The Government admitted the bond scheme was an effort to make "black" money "white." Under pressure from the international community, the Pakistani Government withdrew the bond issue five days after the advertisements appeared.
Money laundering is not a criminal offense, and there have been no arrests or prosecutions for money laundering. Under 1991 regulations, banks are no longer required to maintain records of large currency transactions, nor to report the identity of customers engaging in large cash transactions. And, controls on the amount of currency moving in or out of Pakistan were removed. Foreign exchange assets in the Pakistani banking system have increased significantly since the new foreign exchange regime came into being. According to some sources, these assets may have grown by as much as 400 percent.
Government officials have recognized the money laundering potential of these regulations and have begun to consider ways of remedying this defect, but no plans exist at present. "Prudential banking regulations" exist, but do not adequately address the problem. The law provides for forfeiture of drug-related assets, but requires a life sentence before being invoked. An amendment under review would lower the minimum sentence triggering forfeiture from life to two years, whether the conviction is handed down in Pakistani or foreign courts. United Arab Emirates' Influence. The United Arab Emirates (UAE), particularly Dubai, is a widely-used repository for Pakistani drug proceeds. In Pakistan, invoice manipulation can benefit drug traffickers, as it allows them to defraud the government, which offers export incentives. Hundi transactions and invoice manipulation have been used to launder money through Dubai.
Recognizing Underground Banking
From a practical point of view, law enforcement officials do not consider underground banking when attempting to account for large transfers of cash from accounts in the U.S., to Hong Kong, Taipei, Islamabad, New Delhi or Singapore. In 1994, a multi-agency task force in the United States which was involved in the investigation of organized crime activity in the Asian communities of Orange and Los Angeles Counties, California serediptiously discovered a case of international underground banking. U.S. Customs and the Internal Revenue Service spent many man hours investigating what they believed to be a massive narcotics network as evidenced by a seemingly organized group of small shop owners, all of whom were either Chinese or ethnic Chinese of Vietnamese nationality. The problem was that none of the agents could determine the source of the tens of millions of dollars to be seemingly attributed to an illegal enterprise such as alien smuggling or narcotics.
The answer to the puzzle came with the arrest of Asians involved in gang activity by the Orange County District Attorney's Office Gang Unit. The gang investigator presented a large volume of potential evidentiary material to the organized crime unit supervisor. The gang unit had seized ledgers and apparent financial documents, but didn't know what they represented. As it turned out, the suspects in the gang investigation were a component of the group suspected of money laundering by the Orange County District Attorney's Office undercover operation. Examination of the books and records showed those arrested to have been a component of an Asian underground bank. Further examination showed the Catholic Church was using the underground bank to transmit $250,000 to Vietnam as part of an effort to fight the communist government of Vietnam. The bank was also used by Vietnamese people living in the U.S. to send money to relatives living in hamlets and small villages in Vietnam. No evidence of narcotics money laundering was found in that investigation.
New Avenues on the Information Superhighway
The past and present is represented in payment by chits, faxes, and telephone calls authorizing credit and payments between underground bankers, but where is it headed? What are the trends? Lately, the Internet, and more particularly the World Wide Web has become a focus for concern in the field of money laundering and underground banking. The terms cyberspace banking and cyberspace money laundering have now crept into the financial lexicon of the first cyberbanks. First Virtual Holdings of Cheyenne, Wyoming, U.S. opened for business in October 1994, and was followed by First Bank of Internet in March 1995.
On-line gambling, which relies on cyberbanking, followed soon after in May and June 1995, and more on-line gambling has appeared since then. Dr. Stanley Morris, Director of U.S. Treasury FINCEN, (The U.S. Government agency which has the primary responsibility for detecting and combating money laundering) targeted cyberbanking as one of his agency's highest priorities. Given its home outside present regulatory reach of the U.S. and most other countries, his concerns are not misplaced. From an American perspective, cyberspace banks operate differently from commercial banks in the following fundamental aspects:
A. They do not accept deposits as those transactions are understood in the US.
B. They do not have bank charters from federal or state governments.
C. They do not have federal deposit insurance protecting the accounts.
D. They are not subject to federal or state regulation.
Cyberspace banking can provide payments for purchases over the Internet and other such services, a process that is growing rapidly. Cyberspace banks act as intermediaries in transactions involving the sales of goods, computer software, and presumably financial information and services. Their potential roles in transactions extend as far as the imagination.
The following innovations are underway on the Internet:
* Digital cash allows consumers to pay for purchases with funds stored on plastic smart cards. Visa, Citibank, Microsoft, Digicash and CyberCash, Inc., are all developing electronic money schemes for use on Internet or in smart card form.
* Electronic Share Information, Ltd., is seeking a license from Britain's Securities and Investments board to start the first British stock exchange on the Internet.
* Debit card transactions will permit person-to-person cash payments on the Internet.
* All of the transactions listed above operate in an environment where identities are often concealed. National borders do not exist and transactions are instantaneous and potentially untraceable.
Infant Cyberspace banks are often affiliated with bank holding companies or chartered banks such as Wells Fargo, or with consortia of banks or clearing houses, such as Visa International. As intermediary service providers, cyberbanks obtain and hold buyer's authorizations to charge designated credit cards or to charge actual bank accounts. They also process transfers of money through smart card technology and offer additional security to the participants in the underlying financial services than is otherwise available to Internet users.
Cyberspace banking will attract money launderers because of its potential to aid them in three classical areas of money laundering:
A. Placement.
They want to introduce their proceeds into legitimate repositories, such as banks, or in securities or real estate, with as little trace of the course and beneficial ownership as possible. Presently, U.S. based cyberspace banks do not accept conventional deposits. Without innovative action by bank regulators, this constraint on the placement of illicit proceeds will be short lived. Cyberbanks should be organized to take custodial- like forms, including holding, reconciling and transferring rights to assets held in different forms around the world. It seems likely that money launderers will create their own systems, shadowing traditional commercial banks in order to accept deposits, perhaps as warehouses for cash or other commodities in bulk. Thus, cyberspace banks have the potential to offer highly secure, uncommonly private "placement" vehicles for money launderers.
B. Layering.
They want to move assets through a series of transactions to mask their source, ownership and location. At this stage, the money launderers' crucial needs are for reliable intermediaries and swift and safe processing of multiple transactions. The greater the number of layers through which the assets pass, the harder it is to determine beneficial ownership and source. Electronic mail messages, aided by encryption and cyberspace banking transfers, will enable launderers to transfer assets around the world several times in a day. These technologies also offer the chance to profit from assets held outside the U.S. Cyber technologies will reduce the need for physical movement of assets.
C. Integration.
Launderers want to inject laundered monies into the mainstream economy with no hint of tainted sources. Once layered, other cyberspace banking technologies may facilitate integration in two ways. If cyberbanking permits person-to-person cash like transfers with no involvement of cash, existing U.S. currency reporting regulations technically will not apply. Using super smart card technologies, some of which are in use here and abroad, cash can be moved around the world in Automated Teller Machine (ATM) transactions, such as those that VISA International and First Bank of Internet offer. These smart cards promise easy retrieval of the account balance by using an ATM card, according to First Bank of Internet. It is probable that cyberspace banking will become an important communication device for launderers to transfer assets or to give payment instructions outside the funds-transfer structure used by commercial banks.
Ramping onto the New Electronic Age
Modern technology has had an impact on the evolution of Asian Underground banking. The following information will explain the workings of the new system of communication which is being relied upon with greater frequency. The first requirement is equipment. The banker or banking agent obtains a notebook computer with a modem. With the modem he/she accesses the Internet directly through either an Internet Service Provider (ISP) or his own Internet server in any (other) country. Through the use of a modem and notebook computer, access can be made from any telephone jack, anywhere in the world. Through the use of a pre-paid calling card, no telephone toll is generated. Electronic mail is transmitted in an Rivest-Shamir- Adleman (RSA) public key cryptosystem.
The system provides that only those intended to receive a message can read it. The system authenticates messages which appear to be from a person will only have originated from that person. RSA differs from Data Encryption Standard (DES) in that DES uses a single key for encryption and decryption. The single key is transmitted via secure channels. RSA uses two keys. RSA users have a "public key" and a "private key". Each key unlocks the code the other key makes. Knowing the public key does not enable deduction of the private key. The public key may be openly distributed by the originator to the recipient. Secure channels are unnecessary. The recipient uses the public key to encrypt a message to the originator. The originator uses his private key to decrypt the message. Only the private key can decrypt. Not even the person who encrypted the message can decrypt it. Message authentication is also provided. The originator may use a private key to encrypt, subsuming a digital "signature" generally consisting of a 128 bit cryptographically strong one- way hash. The digital signature may then be checked by using the public key. Forgery of the digital signature is not feasible.
RSA based software employs a 1024 bit, military grade key size with 17 bits in the encryption exponent. It generates keys through the measurement of the interval between keystrokes as the user types sample text at the keyboard. As a practical matter, it is unbreakable. As a further precaution, cryptographic layering and one-time-pads are used in especially sensitive transactions or messages.
The sophisticated techniques above have not yet been adopted by the Indian or Pakistani Underground bankers for the most part, but they are expected to make the transition to newer technology early in the 21st Century as a result of available technology and a rising generation which is more "tech friendly." As a practical matter, investigation of underground cyber banking is extremely difficult and requires expertise not only in the culture creating the system, but sophisticated techniques in computer investigation and cryptography. In order to secure its borders, all nations need to be aware of underground banking practices, not only as they existed in the past, and as they exist today, but where things are headed.
Author: Larry B. Lambert (The author is a California based specialist on Asian affairs and a consutant on International Money Laundering issues.)
Date: March 1996
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