Going underground: accountants warned to monitor for underground banking risk

The Institute of Financial Accountants (IFA) and National Crime Agency (NCA) are warning accountants and agents to increase their vigilance for underground banking, as usage grows and the risk builds. Underground banking, which is a form of informal value transfer system (IVTS), is commonly used for transactions originating in China, Russia, and many international countries, where financial limits and sanctions, as well as some legislation, restrict large scale financial transactions overseas.

IVTS is a process for moving money from country to country, without physically moving the funds. It is done by two acting agents who agree a transaction value and then purchase property, items or services up to the agreed value, without actually transferring funds between them. This can be a straightforward exchange of value against an ongoing ledger, but more commonly includes the use of mule accounts, and even the purchase and export of goods and bribery of border officials too. While the technique pre-dates most commercial banking and postal systems, its use continues even now, and is increasingly being used for nefarious activities, including criminal money laundering for example. It is essential therefore that accountants understand the risks from this type of system and conduct appropriate client due diligence to identify the source of any funds or wealth.

Anne Davis, IFA Director of Professional Standards explains “All businesses have a responsibility to mitigate for money laundering risk and ensure robust practices and procedures to prevent it within the business, and where possible within the supply chain. Underground banking, and the use of IVTS is a significant risk, with millions and potentially billions of pounds being driven through these channels. Whilst many transactions have no criminal origin, the system enables exploitation by criminal groups, which in turn can impact legitimate businesses. We are encouraging accountants to be alert, understand and mitigate this risk with proper due diligence to ensure they and their clients are not utilising funds originating from criminal activities.”

Delving into the inner workings of this type of system, attention turns to China. The Chinese government has policies and regulations in place to limit personal foreign exchange transactions and restrict the removal of capital from China. It means that moving large values out of the country is exceedingly difficult, and there are also restrictions on how funds leaving the country can be spent. There is ordinarily a $50,000 annual limit for individuals, and additionally, since 2017, the maximum allowed value of overseas withdrawals by a private individual using a Chinese bank card is around $14,000. UK property meanwhile is proving very attractive, and $50,000 is clearly not enough to buy a UK residence, creating inbound demand for the ITVS. In the meantime, UK-based criminals seeking to transmit the proceeds of their crime out of the UK, use the ITVS to transfer money back to China. This creates the supply of ‘funds’ aka value to return money to China, balancing the ledger while providing a simple money laundering process too. In two particular cases, Santander Bank alerted the authorities to suspicious cash deposits adding up to £57m across more than 600 mule accounts set up by students, while Barclays found more than 14,000 ‘compromised’ accounts.

Red flags

As outlined in the NCA guidance, tell-tale signs of this type of transaction include:

  • cash deposits funding the account
  • transfers from multiple accounts to a single account or service
  • payment which is broken down into a large number of small amounts (known as ‘structuring’ or ‘smurfing’). These are often made at branches, in many dispersed locations.

It has also been known that in some cases, the recipients have opened multiple accounts with numerous banks into which the cash is deposited.

Due diligence is paramount

It’s easy to understand both the scale of the problem, and the severity and repercussions of this type of system. It is vitally important therefore that accountants understand the risks and work to mitigate them, particularly if funds are being transferred or received internationally for your clients. Understanding the source of funds and wealth is crucial as part of due diligence procedures, a requirement of the Money Laundering Regulations 2017 (amended in 2019).

As well as criminal consequences, there have also been issues identified through an increase in VAT reclaims. One such example was exploitation of the HM Revenue & Customs (HMRC) VAT 407 retail export scheme, which allowed VAT to be reclaimed on goods purchased in retail stores in the UK that were intended for export. In addition, some high-end stores provided a service to customers to assist in reclaiming VAT under this scheme, and shipped the goods on behalf of their customers. Despite post-Brexit regulation brought in on 1 January 2021, which saw the end of the scheme, customers were still able to lodge a claim under the scheme until 31 March 2021. Many claims are incorrectly or fraudulently lodged, including for goods purchased with criminal proceeds; forged or fabricated invoices; no proof of export; goods bought by third parties; multiple invoices submitted for the same goods and insufficient detail on invoices to verify goods and export. The list goes on.

With criminals becoming savvier and finding more ways to go ‘underground’ to launder dirty money into the UK and beyond, the sector needs to be acutely aware of the illicit methods used to get money moved internationally and immediately report any knowledge or suspicions of money laundering by their clients to the National Crime Agency. Further information on the value of suspicious activity reports and how to report is available in the NCA website https://www.nationalcrimeagency.gov.uk/what-we-do/crime-threats/money-laundering-and-illicit-finance/suspicious-activity-reports

Further information: NCA publication on Chinese Underground Banking and ‘Daigou’ and  summarised version of alerts issued by the Accountancy AML Supervisors’ Group (ASSG), produced by the National Crime Agency (NCA) in conjunction with the Joint Money Laundering Intelligence Taskforce(JMLIT).

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