How About Loans With Cash-Collateral?

Some people, including in supervisory positions, consider that loans with cash collaterals are in their essence suspicious.

Why would a person who has the necessary money take a loan and pay interest?

At first glance, such an option might raise eyebrows. Indeed, why would you choose to have extra-costs and trouble if you have the necessary money yourself?

Loans are used in the money laundering process in order to hide the origin of funds or add layers of transactions. For example, you contract a loan to buy a house and then make early reimbursements with dirty cash. In the end, the documents of the house show that it was purchased with a legitimate loan, while in reality it was purchased with dirty cash. The only difference is that the dirty cash didn’t go directly to the seller, but to the bank to reimburse the loan.

And this is the simplest example of all.

But let’s go back to our subject and I will return with a dedicated article on money laundering through loans in a different article.

Are loans with cash collateral higher risk products? Higher than regular loans?

In order to be able to answer this question professionally, we must start with the basis and that is … the Risk Assessment (FATF – Recommendation 1).

And thus, a few months ago, I asked for a list with all the loans with cash collateral that were active at that time and decided to understand them and the risks they pose from the money laundering perspective.

Aspects to be considered in an AML analysis of loans secured with cash collateral

In my analysis I focused on the loans with the highest value and the highest coverage with cash collateral.

I took into consideration the following aspects:

• The customer’s profile (occupation, source of income, source of wealth)
• The source of funds brought as cash collateral (eg. deposits already existing in the bank for a period of time, transferred from another bank, brought in cash, deposits owned by the customer or by another person, the relation with that person, etc.)
• The customer’s reason for choosing such a collateral
• The destination of the loan (credit card, house loan, personal needs loan, company working capital loan or investment loan, etc.)

My findings

To my surprise, from the sample of 20 loans, only 1 raised suspicions regarding the source of funds. I admit that I started the analysis with higher “hopes” and the Sherlock Holmes part of me was a little disappointed at the end.

I also discovered that many of the loans with cash collateral given by the bank had a real-estate or other mortgage as 1st collateral and the cash collateral was only supplementary.

However, I also noticed that in most of the cases the branches did not make all the due diligence they would normally make regarding the source of funds, just because the customer’s deposit was for a loan. It was as if the loan was giving credibility to the customer’s source of funds and the purpose and origin of the money were validating themselves automatically. In most cases, the thorough analysis of the source of funds was done post-factum during my control, although it should have been performed before granting the loan.

Another conclusion of the analysis was that the customers had legitimate reasons for choosing such a loan. Below I will provide to you the main reasons that I found for choosing such a loan. I am now talking only about the loans covered 100% with cash collateral as the reasons are obvious in the cases when the cash collateral is just supplementary.

–          The parents have the money and they don’t want to just give it to their children for a specific purpose (real-estate acquisition, investment, travelling, etc.). Thus, the children contract a loan in order to fulfill their desires and pay the monthly installments and the parents provide the collateral in the form of a deposit. A very sound approach I would add;

–          The customer has a good financial situation and “old” deposits but wants to be “compelled” to purchase what he buys with the money he currently earns and keep his deposits untouched. Thus, he contracts a loan, which he knows he must pay monthly, and uses the deposits he owns as cash collateral. He is satisfied because he is compelled to pay the monthly installment, he doesn’t have to mortgage a property (for higher value loans) and he contracts the loan faster. This is the most frequent reason I met and it materialized in all types of loans, from credit cards to personal needs loans and to real-estate loans.

–          The customer needs money for a short period of time and has a long term deposit at the bank. If he breaks the deposit, he loses the entire interest accumulated, so he decides to use the long term deposit as cash collateral for a short-term loan or card credit. He obtains the loan faster, doesn’t cancel the existing deposit and is better off with the difference between the interest earned and the interest paid than if he had lost the entire deposit interest. At the maturity of the deposit he may choose to pay off the loan.

–          In one situation, the customer wanted to be “compelled” to save and thus he contracted a loan for which he brought his apartment as collateral and used the entire amount to make a deposit. Thus, he was “compelled” to save each month by paying the monthly installment. The loan and deposit were already a few years old at the time of my analysis and did not seem to go anywhere or raise any suspicion. I am not talking about the financial gain (or its absence) from such a decision. It was the customer’s choice.

–          In the case of companies, it was usually the case of start-ups whose financial situation did not allow them to contract a loan yet, and the shareholder brought his personal deposits as the cash collateral.

Conclusions

My specific analysis did not reveal sufficient reasons to state that loans with cash collateral are by definition higher risk products. Not significantly higher than regular loans as far as money laundering is concerned.

I was surprised by this conclusion and tried to understand it. After many debates with myself I concluded that maybe it is due to the whole loan analysis process that takes into account the customer’s profile and his regular incomes for the loan reimbursement.

After all, even if it is guaranteed by a cash collateral, the customer must still be able to afford the loan and even pay it from his regular, monthly incomes in the case of loans with installments. Thus, this channel of money laundering probably remains attractive for the same group/type of people that would use normal loans for money laundering in the first place. They don’t necesarily need to use cash collateral as well.

However, considering that in most cases, the source of funds was not thoroughly documented by the branches before granting the loan and considering the vast money laundering opportunities, we decided that further attention was needed. Thus the compliance opinion became mandatory for such loans that meet certain conditions regarding the amount of the loan and the % coverage with cash collateral.

Better safe, than sorry!

In the end, let’s now share a few words about the way in which a loan with cash collateral could be used in money laundering. The classical scheme would be to bring dirty money as cash collateral, knowing that the bank is too focused on analyzing the loan itself to pay enough attention to the source of money. The loan money is used legally for personal needs, for real-estate investments or even in a company’s activity. Then, one day, the customer decides that he no longer wants to pay the installments “because it is too difficult, too stressful, too tiresome to remember, etc.” and decides to use the cash collateral to reimburse the entire loan.

And voila! A perfect method of integration. Right under the nose of the bank.

So, it is a very good idea to keep an alert eye on your loans with cash collateral. Because it may be the case that the front-office personnel is too focused on the loan and on the business target to pay enough attention to the source of funds.

By Andreea Tampu, ACAMS