Defining Underground Banking
A commercial activity involving the transfer of money across national borders through a
non-bank institution or organisation subject to the below exceptions:
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- There may not always be commercial activity underlying the transaction
- ‘Money’ may not always be the underlying asset (could include commodities)
- The transaction may be international or domestic and it may be conducted by institutions or individuals.
Background of Chinese Underground Banking
Although it was the 1983 discovery of the utilization of the Chinese Underground Banking (CUBS) in heroin-related transactions within Asia that first brought the system under global scrutiny, the system itself has been in existence for many centuries, predating even the formal banking system. Its origins can be traced as far back as the T’ang Dynasty (618-906 AD) when Chinese tax collectors devised this system called ‘fei ch’ien’ (literally translating to “flying money”).
As with any underground banking network, accounts are settled with little to no physical movement of actual money as long as transactions and payments are conducted in both directions in similar amounts.
Modus Operandi of Chinese Underground Banking in the UK
The detailed modus operandi of the system has been refined over the years to one that is now tough to uncover. The required amount is paid to a local bank account controlled by a Chinese Informal Value Transfer System (IVTS) provider who arranges the reciprocal payment to be deposited into the UK bank account specified by the remitter.
To avoid suspicion in the deposit, several tactics are deployed. Often, the amounts are ‘smurfed’ or broken down into smaller portions and deposited at different branches or into numerous accounts with multiple banks. Else, the payment is received from one or more bank accounts of Chinese citizens into which money had previously been smurfed.
Access to Bank Accounts
The first crucial prerequisite for a seamless transfer process is the IVTS provider’s access to multiple bank accounts. In the UK, these ‘mule accounts’ typically belong to Chinese students enrolled at UK institutions. Such students are specially recruited for this purpose, typically under the social guise that their accounts are being used for money transmission services for other students or unbanked Chinese citizens working in the UK.
Apart from the naively generous few, the attractive financial compensation is what lures most of these recruits into setting up multiple bank accounts with different banks and handing over control of these, either during their time of study or upon their return to China.
Alternatively, the cash is paid into accounts of persons carrying out ‘daigou’, a form of retail
commerce involving goods in demand in China purchased in the UK by the Chinese citizens and exported to China for sale there, sometimes contravening Chinese customs controls.
Liquidity Maintenance
The second prerequisite is the UK IVTS provider’s maintenance of unusually large liquidity to immediately settle inward remittances. This need for large sums of money is perfectly countered by the need of UK crime groups (drug traffickers, cigarette smugglers, organized crime groups, and human traffickers) to dispose illegally generated cash while recovering that value elsewhere. Such synergy fuels the abuse of the CUBS by money laundering groups.
Evolution of Chinese Underground Banking
What is ironic is the stark contrast between fei ch’ien’s original and evolved purposes. Devised by tax collectors, fei ch’ien was intended to be the Chinese state’s strategy to ensure that tax money owed by merchants was not compromised during the merchant’s thievery-exposed journey.+
However, the modern day has seen fei ch’ien evolve to defeat its very purpose with it now predominantly being used to evade tax and other regulations imposed by the Communist state of China.
Nonetheless, fei ch’ien was and continues to be the Chinese method of sealing any possible leak of earnings, regardless of whether the leak is caused by lawful (state regulation) or unlawful (thievery) forces of society.
The rich history of this system serves only as sufficient precedence for its present and future scope although, as with any other survival tactic, it is an adaptation that secures CUBS’ relevance in the 21st-century marketplace. With the increased globalisation of the world came the need for the overseas Chinese labour force to remit their earnings in a fast, cheap, and efficient manner.
The fei ch’ien system allows these (sometimes illiterate and illegal immigrant) labourers to anonymously remit money through its highly accessible, rapid, and versatile system that is resilient to economic, political, and social change, thereby ensuring no leak of their little remittances to fluctuating exchange rates.
However, the other end of its spectrum of users are of quite the opposite nature – those acquiring huge wealth through sometimes unlawful means and those looking to evade tax or bypass China’s strict policies on cash outflows such as the USD 50,000 annual limit on outward transfers.
Such austere Chinese currency laws alongside the existence of a convenient modus operandi have contributed to the prosperity of the CUBS. In fact, the system has prospered to the extent that even the formal banking sector has tried its luck, with the Bank of China being recently investigated for offering underground banking services to wealthy clients looking to stash money abroad.
With the identicalness of this underground banking system to just about any formal banking system (except the convenient replacement of the bureaucracy and red tape with faster service and more lucrative rates), it is unsurprising that this system remains so sought after.
The apparent concern with the use of the CUBS in highly sensitive matters is that incorporating the element of illegality translates to the lack of legal recourse in the event of a dispute. But, trust, or rather, ‘guanxi’, the social system of rules governing relationships and social behaviour, forms the very cornerstone of the CUBS.
In fact, it is the same element of illegality that can even ensure their safety; it opens the window to infinite illegal recourses powered by dangerously influential individuals/ institutions, arguably a more effective regulator of the system.
Use of Chinese Under Ground Banking in Money Laundering
It is a variant of this same principle of guanxi that Ballard proposes to rule out the possibility that this lesser regulated banking network could be appealing to transnational criminals looking to launder their money. Ballard claims that the fear of provoking social and commercial ostracism by engaging in money laundering activities in the underground network could act as a natural regulator.
However, there has since been significant empirical evidence postulating that the CUBS is a common choice for money laundering activities, exceptionally so within the Chinese population in the UK.
Such evidence is drawn from the successful money laundering prosecutions in the UK as well as the discovery of Scottish and Northern Ireland banknotes in cash seized from Chinese cash collectors, quintessential evidence of money derived from criminal activity. In light of this, the National Crime Agency of the UK warned their solicitors that the CUBS is ‘the most prevalent money laundering threat faced across the Western world’ and that the cash used by wealthy Chinese nationals in the UK could often have criminal roots.
Chinese Underground Banking is Route to UK Property Market
The Chinese diaspora in this English island has further played a significant role in the rising popularity of the CUBS as the system also serves as a convenient route for those of them seeking to invest their wealth in the UK property market, a practice currently prohibited under Chinese law.
Apart from the annual limit on outward transfers that has long propelled the prosperity of the CUBS in the Western world, it is the Chinese law prohibiting overseas property investment that specifically fuels its thriving network in the UK.
Chinese citizens are allowed to invest in property abroad only if they have emigrated, do so from a capital account, and are willing to submit proof of cancellation of Chinese residence.
Parallel to this legal system, however, runs the illegal underground banking system- a fast and easy mechanism for the untraceable outward transfer of unlimited sums of money.
Global Trade Impact
The CUBS also has the impact of severely distorting international trade in a multitude of ways. CUBS is an important tool in Trade fraud. It includes manipulated reports of import and export prices, arbitraging through advanced or delayed payments, and the use of false trade contracts. It contributes to the convolution of the reality of the global trade market.
The CUBS typically balances the books through over or under-invoicing, sometimes called ‘counter valuation’.
Further, in daigou, the luxury British goods being sold to China are often misdescribed or undervalued to contravene customs, import duties, and taxes imposed by China.
The undervalued portion is then often recovered by the daigou business owner through the CUBS from bank accounts controlled by Chinese money laundering groups.
Apart from luxury goods, an unusual trade that is heavily stimulated by the CUBS is that of British infant formula milk. Post the 2004-2008 scandals involving the death of many babies in China as a result of being fed tainted, locally produced formula milk, the business of Chinese nationals in the UK selling British infant formula milk in China boomed.
Although this itself is perfectly legal, China’s limits on outward transfers would mean that their proceeds and in turn their funding would remain locked in China, if not for the convenient CUBS.
Lastly, given the popularity of the UK as an investment haven for Chinese nationals and the prohibition on overseas investments, the CUBS also undoubtedly contributes to a consequential portion of activity in the British real estate market.
The 12 months through September 2019 alone saw a 32% rise in tier-1 investor visa applications from high-net-worth Chinese individuals. This “golden visa” offered by the British effectively trades a £2 million investment in the island for a 40-month residency permit.
It even teases a potential 2-year extension and a permanent settlement in return for a couple more million invested. Combining this enticing offer with the fall in the value of the Sterling pound and the increased stringency of the US visa applications amidst the trade war, Chinese buyers flock to the UK housing market.
Role of Chinese Underground Banking in Terror Funding
An area of alarming concern is the tendency of terror organizations to take advantage of the opacity offered by any underground banking network. Information that part of the money used to fund 9/11 had been moved through underground banking systems vilified them in the Western world, particularly in the United States. Yet, it is this same system that often illiterate, uneducated immigrants find refuge into remit money back to feed their families in their home countries.
Although much of the $575 billion in global remittances in 2016 went towards the legitimate support of livelihoods, it would be ill-advised to ignore their evident vulnerability to exploitation by terrorist organizations. Several opportunity-seeking hawaldars (operators of hawala, the predominantly Middle East and South Asian version of fei ch’ien) have been known to cooperate with ISIS particularly in Iraq and Syria among other terror organisations, resulting in a much higher proportion of attention hawala receives in comparison to its Chinese counterpart.
Such terrorism-linked evidence remains to date close to none for fei ch’ien. Whether this is a result of the actual inexistence of such links to terrorism or the lack of sufficient investigation remains unclear.
Conclusion
What is clear is this – under the Chinese legal framework that effectively illegalised transfer of significant money overseas, informal banking systems such as fei ch’ien remain the most convenient and accessible method to sustain numerous livelihoods of family and friends. It is such ‘legitimate’ uses of the system that act as a hurdle for law enforcement bodies who often synonymize ‘underground banking’ with ‘criminal activity’. In a post-Brexit Britain could significantly benefit from Chinese investment, criminalizing the CUBS also comes with a huge potential backfire.
Such juxtaposition is both blamed for the ambiguity around regulation of the CUBS as well as hailed by its users for guaranteeing its continued existence.
However, in the face of the potentially weakening yuan and strong capital outflow pressures, it is imperative for China that they find a way to crack down on the value transfer system that went rogue.
