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Report Calls for Curbing Abuses in Diamond Trade to Combat Money Laundering

Aug 5, 2008 3:25 PM   By Jeff Miller
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RAPAPORT...  A 2008 International Narcotics Control Strategy Report, prepared by the U.S. Department of State and KPMG, found that India's status as an emerging financial center and its informal cross-border money flows have contributed to the country’s money laundering activities.

The report specifically blamed the diamond trade, illegal drugs and weapons, and wildlife smuggling as key factors on the criminal side. KPMG predicted that India's challenge going forward is to bring these activies under control.

"Historically, because of its location between the heroin-producing countries of the Golden Triangle and Golden Crescent, India continues to be a drug-transit country," the U.S. Department of State wrote in the report.

The report suggested reducing informal money transfer channels, focus upon anti-money laundering policies and procedures, and ensuring sanctions compliance.

"India should devote more law enforcement and customs resources to curb abuses in the diamond trade. It should also consider the establishment of a Trade Transparency Unit (TTU) that promotes trade transparency; in India, trade is the 'back door' to underground financial systems. The government also needs to strengthen regulations and enforcement targeting illegal transactions in informal money transfer channels," according to the report.


"...Large portions of illegal proceeds are often laundered through 'hawala' or 'hundi' networks or other informal money transfer systems. Hawala is an alternative remittance system that is popular among not only immigrant workers, but all strata of Indian society. Hawala transaction costs are less than the formal sector; hawala is perceived to be efficient and reliable; the system is based on trust and it is part of the Indian culture. According to Indian observers, funds transferred through the hawala market are equal to between 30 to 40 percent of the formal market. The Reserve Bank of India (RBI,) India’s central bank, estimates that remittances to India sent through legal, formal channels in 2006-2007 amounted to $28.2 billion. Due to the large number of expatriate Indians in North America and the Middle East, India continues to retain its position as the leading recipient of remittances in the world, followed by China and Mexico," according to the report.

The hawala system can provide the same remittance service as a bank with little or no documentation and at lower rates and provide anonymity and security for their customers. Hawala is also used to avoid currency restrictions, assists in capital flight, facilitates tax evasion, and avoids government scrutiny in financial transactions. India  neither regulates hawala dealers nor requires them to register with the government. The RBI argues that hawala dealers cannot be regulated since they operate illegally and therefore cannot be registered. Indian analysts also note that hawala operators are often protected by some politicians.

In December 2005, the RBI issued guidelines requiring financial institutions, including money changers, to follow “know your customer” guidelines and maintain transaction records for the sale and purchase of foreign currency.

Foreigners and nonresident Indians are permitted to receive cash payments up to $3,000 or its equivalent in other currencies from moneychangers. Recently, the RBI has been taking additional steps to crack down on unlicensed money transmitters and increase monitoring of nonbanking money transfer operations like currency exchange kiosks and wire transfer services. In September 2007, the RBI asked Western Union’s subsidiary, Western Union Services India, to desist from appointing any more sub-agents until further instruction. Western Union officials have explained to U.S. government officials that this is due to a new policy the Ministry of Home Affairs is formulating to require wire transfer businesses to perform due diligence on sub-agents and seek RBI and MHA approval before appointing new sub-agents.

Historically, in Indian hawala transactions, gold has been one of the most important commodities. In recent years, the growing diamond trade has been considered an important factor in providing counter-valuation; a method of “balancing the books” in external hawala transactions. Invoice manipulation is also used extensively to avoid both customs duties, taxes, and to launder illicit proceeds through trade-based money laundering, the report found.


With tax evasion a widespread problem in India, the government is gradually making changes to the tax system and now requires individuals to use a personal identification number to pay taxes, purchase foreign exchange, and apply for passports. The government also introduced a central value added tax (VAT) in April 2005 which replaced numerous complicated state sales taxes and excise taxes with one national uniform VAT rate. As a result, the incentives and opportunities for entrepreneurs and businesses to conceal their sales or income levels have been reduced. Except for Uttar Pradesh, all Indian states have implemented the national VAT mandate. Uttar Pradesh announced in late October 2007 that it would also implement the VAT.


In the aftermath of September 11, India joined the global community in addressing concerns about money laundering and terrorist finance by implementing the Prevention of Money Laundering Act (PMLA) in January 2003. The PMLA criminalized money laundering, established fines and sentences for money laundering offenses, imposed reporting and record keeping requirements on financial institutions, provided for the seizure and confiscation of criminal proceeds, and established a financial intelligence unit (FIU.) In July 2005, the PMLA’s implementing rules and regulations were promulgated. The legislation outlines predicate offenses for money laundering. Predicate offenses are listed in a schedule to the Act, but these do not include many of the predicate offenses listed as essential by the FATF recommendations, including organized crime, fraud, smuggling, and insider trading.

Penalties for offenses under the PMLA are severe and may include imprisonment for three to seven years and fines as high as $12,500.  The PMLA mandates that banks, financial institutions, and intermediaries of the securities market (such as stock market brokers) maintain records of all cash transactions (deposits/withdrawals, etc.) exceeding $25,000 and keep a record of all transactions dating back 10 years.

Economic Intelligence Council

To assist in enhancing coordination among various enforcement agencies and directorates, India  established an Economic Intelligence Council (EIC.) This provides a forum to strengthen intelligence and operational coordination, to formulate common strategies to combat economic offenses, and to discuss cases requiring interagency cooperation. In addition to the central EIC, there are eighteen regional economic committees in India. The Central Economic Intelligence Bureau (CEIB) functions as the secretariat for the EIC in the MOF. The CEIB interacts with the National Security Council, the Intelligence Bureau, and the Ministry of Home Affairs on matters concerning national security and terrorism.

Prompted by the RBI’s 2002 notice to commercial banks to adopt due diligence rules, many of these institutions have taken steps to combat money laundering. For example, most private banks and several public banks have hired anti-money laundering compliance officers to design systems and training to ensure compliance with these regulations. The Indian Bankers Association has also established a working group to develop self-regulatory anti-money laundering procedures and assist banks in adopting the mandated rules.

The RBI and SEBI have worked together to tighten regulations, strengthen supervision, and ensure compliance with "know your customer" norms. This includes, for example, provisions that banks must identify politically involved account holders who reside outside of India and identify the source of these funds before accepting deposits of more than $10,000. The RBI continues to update its due diligence guidelines based on FATF recommendations. For banks that are found noncompliant, the RBI has the power to order banks to freeze assets.

"The government should move forward expeditiously with amendments to the PMLA that explicitly criminalize terrorist financing, and expand the list of predicate offenses so as to meet FATF’s core recommendations," the report concluded. "Further steps in tax reform will also assist in negating the popularity of hawala and in reducing money laundering, fraud, and financial crimes. The government should ratify the U.N. Conventions against Transnational Organized Crime and Corruption, and it needs to promulgate and implement new regulations for nongovernment organizations including charities.

"Given the number of terrorist attacks in India and the fact that in India hawala is directly linked to terrorist financing, the government should prioritize cooperation with international initiatives that provide increased transparency in alternative remittance systems," the report concluded.

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Tags: Banks, China, Compliance, Government, India
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