For a lay man, its tricky and probably silly saying Money Laundering affects Exchange Rates, but it true it does affect the rates. To explain this we have decided to share it as it is from experts, who have broken it down to best understanding.
According to Dr. Marwan Mohammad Aboel-Majeed Abu-Orabi & Dr. Abeer F.A. Al Abbadi of the Department of Finance and Banking, Faculty of Business and Finance, The World Islamic Sciences and Education University, Jordan- Amman, “money laundering is concealing the source, the nature, the place and the disposal of funds and assets that are acquired through illegal or criminal activities such as embezzlement, drug dealing, prostitution, corruption, and large- scale criminality. It’s a process through which illicit funds, that resulted from criminal activities transferred into assets, that can’t be traced back to its illegal origins, via legitimate businesses.”
“Furthermore, money laundering can be described as the process of transferring illegal money into legal money using high-ranking officials in large corporations, to transfer the funds either through personal accounts, tax evasion, prostitution or drug dealing. One of the most used methods of money laundering is via using financial organizations and companies, which act as a front for receiving illicit money.”
“Money laundering is considered a global trend, it imposed itself in the past few years as an economical crime, where money launderers aim to conceal the illicit origin of their proceeds. Regarding, the effects of this phenomenon on Jordan, from the analysis of the responses of the sample members of this study, we can conclude the following:
1. Money laundering has a massive effect on monetary markets.
2. Money laundering has an effect on competition in the financial and monetary markets.
3. Money laundering has an effect on the government’s capability to control monetary policies.
4. Money laundering has an effect on the investment sector’s stability. 5. Money laundering has an effect on attracting foreign investments for the marketplace.
6. Money laundering has an effect on the Jordanian Dinar’s exchange rate.
The study concludes that: Money laundering has a massive effect on monetary markets, competition in the financial and monetary markets, the government’s capability to control monetary policies, the investment sector’s stability, attracting foreign investments for the marketplace, and () exchange rate.”
To buttress, Bryan Pereyo a Leader in AML Solution, explains that –
“To date, the laundering of funds greatly affects the economy of the state and on business. International Monetary Fund points out several factors: the legalization of money affects major changes in the demand for money, distrust of banks, “infecting” effect on legitimate financial transactions, the volatility of international capital flows and exchange rates due to unanticipated transfers of foreign assets. Criminals are increasingly trying to find new methods of money laundering.
She continues –
- Direct Effects: Money laundering distorts the investments and depresses the productivity. Diverting resources to less-productive activity, and by facilitating domestic corruption and crime, which in turn depress economic growth. For developing countries, the diversion of such scarce resources to less productive domestic assets or luxury imports is a serious detriment to economic growth.
2. Effect on Corporate competitiveness and Taxation: Money laundering has a bearing on taxation and small business competition. Laundered money is usually untaxed, meaning that the rest of the people ultimately have to make up the loss in tax revenue. Furthermore, legitimate small businesses cannot compete with money laundering-front businesses that can afford to sell a product cheaply because their primary purpose is to clean money, not turn profit.
3. Effect on Interest and Exchange Rates: Money Laundering has adverse consequences on the interest rates and the exchange rate volatility particularly in developing nations and dollarized nations. It complicates the government effort to manage the economic policies. It affects the income distribution, contaminated the legal transactions, and has potential to destabilize the economy by inefficient movements, which reduces the GDP growth.
4. Effect on Foreign Investment: Although developing economies cannot afford to be too selective about the sources of capital they attract, but postponing action is dangerous. There is a damping effect on foreign direct investment when a country’s commercial and financial sectors are perceived to be subject to the control and influence of organized crime. For business-friendly environment, these impedances have to be weeded out.
Effects on Financial Sector
Since financial institutions are critical to economic growth, reputation and confidence plays an important part in the developing countries.
- Customer Confidence: Reputation and integrity are valuable assets of a financial institution and the perceived risk to depositors and investors from institutional fraud and corruption is an obstacle to such trust. When customers are defrauded by the corrupt individuals within the institutions it causes loss of business for the financial institutions. Prudential risks to bank soundness, contamination effects on legal financial transactions, and increased volatility of international capital flows and exchange rates due to unanticipated cross-border asset transfers.
2. Dampening of Entrepreneurial environment: Strong financial systems are incubators of entrepreneurial growth. For developing nations, technological change is often associated with the investment and new machinery. To adopt the more productive technologies from advanced nations requires entrepreneurship. At the most fundamental level, innovation and technology thrive when property rights are clear and taxes and other drains on profits (such as corruption) are low and predictable.
3. Investment: The nations in which crime and corruption are prevalent, investors are reluctant to invest and obtain the ownership.
4. Money Laundering erodes financial institutions themselves due to vulnerability to corruption by criminal elements seeking to gain further influence over their money-laundering channels.
Bryan Pereyo also added that Money Laundering has effect on Cost of Capital in a country.
She says, “When Money Laundering takes place, the capital is reduced due to which the supply curve of capital moves towards the left. In this case due to the scarcity of the capital (credit crunch even when the central bank is infusing cash in the financial system) available the cost of capital increases.
As can be seen from the various money-laundering mechanism typologies reports, money laundered through channels other than financial institutions is often placed in what are known as “sterile” investments, or investments that do not generate additional productivity for the broader economy.
“A developing country requires vast amount of capital and accumulation of capital requires a sacrifice of current consumption over many years,” she says.
“When money laundering takes place, the capital is depleted over the time. The money which could have been used to increase the productivity of the labour is now diverted by the antisocial elements to suffice their selfish interests. The lack of capital reduces the improvement of human resources and technology.
“Developing countries are concerned with the quality of labour available. Quality of the labour can be increased by improving health and imparting skills by providing education. Money laundering indirectly affects the labour productivity by providing them low capital to improve the skills and improve the health.
“Social and political costs of money laundering, if left unchecked or dealt with ineffectively, are serious. Organised crime can infiltrate financial institutions, acquire control of large sectors of the economy through investment, or offer bribes to public officials and indeed governments.
“The economic and political influence of criminal organisations can weaken the social fabric, collective ethical standards, and ultimately the democratic institutions of society. In countries transitioning to democratic systems, this criminal influence can undermine the transition. Most fundamentally, money laundering is inextricably linked to the underlying criminal activity that generated it.
She concluded by saying “Laundering enables criminal activity to continue.”
Another analyst, Brent Railey, expands that, “Exchange rates are primarily based on supply vs. demand: Buyers compared to Sellers.
Siting an example, he says, “If a lot of euro holders want dollars and there aren’t many sellers of dollars who want euros, then the price of the dollar in terms of euros will go up. The EURUSD currency pair will increase and the USDEUR currency pair will decrease.
“Money laundering will only impact exchange rates if the money flow crosses currency boundaries, and only if they use exchanges in which there is formal bidding and asking. At that point, it really just depends on the total amount of exchanges that use laundered money. If a very small percentage of the currency exchanges are with laundered money, then the effect is marginal and hardly noticeable.
“I would assume most laundered money uses black markets to make currency exchanges to conceal the movement. In those markets, there is probably a “spread” in the exchange as compared to the public exchanges.
“If the EURUSD pair is at 1.25, then the black market exchange would be at something like $1.50 or higher. Since the money isn’t on public exchanges, it has no impact on public exchange rates.
“However in the black markets, demand for a particular currency may cause its “spread” against the public exchange rate to increase.” He concluded.
