Negative Effects of Money Laundering on The Economy

The effects of money laundering are severe and extensive. It can create global and local impacts for businesses, economies, and societies. The negative effects of money laundering on the economy are quite numerous.

What Are The Negative Effects of Money Laundering on The Economy?

Money laundering damages financial sector institutions that are critical for economic growth, promoting crime and corruption that slow economic growth, reducing efficiency in the real sector of the economy. The majority of global research focuses on two major money-laundering sectors: drug trafficking and terrorist organizations. The effect of successfully clearing drug money is obvious: more drugs, more crime, more violence. The link between money laundering and terrorism can be a bit more complicated, for an obvious example, terrorists are knocking down money so that the authorities cannot monitor them and prevent their planned attacks.

Money laundering is a problem not only in the world's major financial markets and sea centers but also in emerging markets. As emerging markets open up their economies and financial sectors, they are becoming increasingly appropriate targets for money laundering activities. Money laundering creates unpredictable changes in money demand, as well as causing large fluctuations in international capital flows and exchange rates.

Effect on money demand

It occurs more frequently in countries where the risk of money laundering is minimal. Economies where there are no regulations on laundering, where there is a system that stores bank or customer information, where banking secrecy is strictly enforced, the informal economy ratio to the national economy is high. The cash inflows and outflows are easy for launderers. With the rapid and uncontrolled inflow of money to the country, the consumption rates and especially luxury consumption are increase. However, there may be significant increases in exports, imports, foreign payments deficit, inflation, interest, and unemployment rates. These instabilities in demand for money caused by black money will naturally affect the monetary policy negatively.

False signals of money laundering activities prevent taking necessary measures to solve problems such as budget deficit and high inflation, especially in developing countries, and adversely affect the economy's effective management. Through the global side of these activities, the markets' stability is affected, and financial crises in one country can reflect on other countries. The effect of central banks on monetary policies depends on whether the demand for money is predictable or not. Due to black money on money demand, failures in central banks' policies can be observed.

Effect on growth rates

Real sectors can suffer significantly from financial instability in the country. As a result, foreign investors have become crucial for companies. However, it isn't easy to attract foreign investors to the country in money laundering countries. Because the price instability caused by black money in the financial system will affect the credibility of the economy in the external environment, rational entrepreneurs will find it inconvenient to invest in the country because they will also consider the country risk while investing. If the legal money escapes from entering the country, it will result in investment rates not increasing. So there will occur a long-term sustainable growth decline.

Countries with a high volume of money are considered risky places for investors. For those who want to attract international capital to their countries, fighting black money is an important message that provides investors confidence. Through the struggle's effectiveness, investors will increase, which will positively affect growth rates and the economy.

Effect on income distribution

Severe losses caused by black money to sources of income cause significant problems in the financial system's functioning. These problems experienced by the economy also have social consequences. The increasing enrichment of specific individuals and groups causes social degeneration. One of the most critical damages of black money to be determined is its negative effect on income distribution. Although the negative impact of the decline in income sources and the differentiation in income distribution is difficult to measure, it is also challenging to compensate for social damage. The gap between individuals in terms of income distribution increases the tendency to commit crimes and makes money attractive.

Also, since the money adversely affects competition, those operating in the registered sector are punished somewhat. Since tax evasion is common in informal economies, the tax burden of those operating in the official sector increases, and income distribution is adversely affected.

Effect on tax revenues

Revenue from taxes has the most significant share in public revenues. If this income is low, it will raise the possibility that public revenues will not meet the public expenditures, and if this possibility occurs, budget deficits will occur. Income generated by black money is earnings that countries do not tax. These gains will result in reductions in tax revenues.

The state with decreasing tax revenues has two choices, the first of which is borrowing. It reduces the private sector's productive investments with the effect of government crowding-out, which attracts productive investors by the private sector with borrowing. Besides, as the value of bonds increases as a result of borrowing, interest rates in the market increase, creating many problems. Another way to close the deficits is emissions policy. The results of this policy are similar to others. As a result, we can say that both choices negatively affect the economy.

Effect on financial institutions 

 Sudden changes may occur in the assets and liabilities of financial institutions that are unknowingly used in money laundering, which will create a risk for the institutions. The news of money laundering of these financial institutions draws the attention of the public authority. In that case, the pressure on auditing for these institutions will increase, and the institution's reputation will be damaged.

The Damage of Money Laundering to The Country's Financial Sector

As shown by various economic analyzes, institutions such as banks and non-bank financial institutions are very important players for countries' economic development. Such financial institutions consist of domestic capital and foreign capital for the benefit of economic development. However, money laundering harms the development of these financial institutions at this point. The anti-money laundering measures applied within the relevant financial institutions show that there is a relationship between money laundering and fraudulent activities carried out by employees, and thus their joint work harms the institutions. If money laundering occurs at high rates, criminals use financial institutions to drain the funds they obtain, which negatively affects these institutions.

These adverse effects also undermine the trust of customers. Therefore, the trust of customers and related institutions is essential for developing financial institutions, respectively, to have a stable financial sector and develop the economy through them. The impression of fraud in relevant institutions, such as depositors, investors, and society in general, as well as customers, is a major obstacle to trusting them. In other words, money laundering damages the image of financial institutions; as a result, the customer loses his trust in the relevant institutions.

What to Do to Reduce The Negative Effects of Money Laundering?

Emerging economies may find it difficult to break the cycle of corruption even though they have less anti-money laundering (AML) regulations. Criminals are more likely to target weaker systems. This means losing a lot of money for laundering, but the government lacks funds to prevent this. As a result, developing countries need to receive international and regional assistance to secure their economic systems. Money laundering and terrorist financing have weakened and failed many financial institutions due to non-compliance with money laundering and counter-terrorism financing programs. Some banks had to be closed after the loss of regulations resulting from AML / CFT compliance violations. Financial institutions are the backbone of the economy, but the problem begins when channels for money laundering are created. 

The United States, the European Union, and UNO have configured frameworks to protect the world financial system from money laundering and terrorist financing actions. Targeted and comprehensive sanctions are applied to persons, legal entities, and jurisdictions that violate AML / CFT regulations, facing serious economic difficulties. The US Foreign Assets Control Office (OFAC) and the Financial Action Task Force (FATF) are important organizations for this purpose. As a result, financial institutions, in particular, do not have difficulty breaking the money laundering chain when they have regulations such as AML / CTF.

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