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One of the most serious microeconomic effects of money laundering is felt in the private sector. Money launderers often use front companies, which co-mingle the proceeds of illicit activity with legitimate funds, to hide the ill-gotten gains. In some cases, front companies are able to offer products at prices below what it costs the manufacturer to produce. Therefore front companies have a competitive advantage over legitimate firms that draw capital funds from financial markets. This makes it difficult, if not impossible, for legitimate business to compete against front companies with subsidised funding, a situation that can result in the crowding out of private sector business by criminal organisations. The management principles of these criminal enterprises are not consistent with traditional free market principles of legitimate business, which results in further negative macroeconomic effects (McDowell, 2001).
Financial institutions that rely on the proceeds of crime have additional challenges in adequately managing their assets, liabilities and operations. For example, large sums of laundered money may arrive at a financial institution but then disappear suddenly, without notice, through wire transfers in response to non-market factors, such as law enforcement operations. This can result in liquidity problems and runs on banks. Criminal activity has been associated with a number of bank failures around the globe, including the failure of the first Internet bank, the European Union Bank (McDowell, 2001).
Banks are susceptible to risks from money launderers on several fronts.
There is today a very small step between a financial institution suspecting
that it is being used to launder money and the institution becoming criminally
involved with the activity. Banks that are discovered to be laundering
money are most certain to face costs associated with the subsequent loss
of business as well as legal costs. Banks and their directors face the
risk of criminal prosecution for money laundering whether they know the
funds are criminally derived or not (Kehoe,
1996). 
More often than not, bank directors are unaware that their institution is being used to launder money. Typically an employee colluding with a criminal will circumvent the bank's depository procedures to launder money. However, the bank is still liable for the actions of its employees. It is therefore essential that banks adopt and enforce the new legal procedures in deposit taking and keep tight controls on staff likely to be useful to money laundering.
Two conflicts of interest arise here that may dampen the enthusiasm of
banks in complying to such laws. The first is that bank officials are
under increasing pressure to bring in new business and drive up profits.
It has been argued that many western banks remain afloat due to money
laundering services. In the case of the Bank of Credit and Commerce International
(BCCI), the bank needed to earn profits so as to cover up the huge losses
from loans and trading and laundering money provided an easy way to do
so. The second conflict is that certain banks and countries have a competitive
advantage in providing private banking services, i.e. client confidentiality.
Bank secrecy laws exist in fifty nations worldwide and for such banks
these are important in attracting customers. Any moves to abolish or continually
override such laws are likely to be strongly opposed (Kehoe,
1996).
In some emerging market countries, illicit proceeds may dwarf government budgets, resulting in a loss of control of economic policy by governments. Indeed, in some cases, the sheer magnitude of the accumulated asset base of laundered proceeds can be used to corner markets or even small economies. Money laundering can also adversely affect currencies and interest rates as launderers reinvest funds where their schemes are less likely to be detected, rather than where rates of return are higher. Similarly, money laundering can increase the threat of monetary instability due to the misallocation of resources from artificial distortions in asset and commodity prices. The unpredictable nature of money laundering, coupled with the attendant loss of policy control, may make sound economic policy difficult to achieve.
Money launderers are not interested in profit generation from their investments but rather in protecting their proceeds. Therefore they invest their funds in activities that are not necessarily economically beneficial to the country where the funds are located. Furthermore, to the extent that money laundering and financial crime redirect funds from sound investments to low quality investments that hide their proceeds, economic growth can suffer. In some countries, for example, entire industries, such as construction and hotels, have been financed not because of actual demand, but because of the short-term interests of money launderers. When these industries no longer suit the money launderers, they abandon them, causing a collapse of these sectors and immense damage to these economies (McDowell, 2001).
Money laundering diminishes government tax revenue and therefore indirectly harms honest taxpayers. It also makes government tax collection more difficult. This loss of revenue generally means higher tax rates than would normally be the case if the untaxed proceeds of crime were legitimate. It also threatens the efforts of many states to introduce reforms into their economies through privatisation. Criminal organisations have the financial capacity to outbid legitimate purchasers for formerly state-owned enterprises. Furthermore, while privatisation initiatives are often economically beneficial, they can also serve as a vehicle to launder funds. In the past, criminals have been able to purchase marinas, resorts, casinos, and banks to hide their illicit proceeds and further their criminal activities.
Countries cannot afford to have their reputations and financial institutions tarnished by an association with money laundering, especially in today's global economy. Confidence in markets and in the signalling role of profits is eroded by money laundering. The negative reputation that results from these activities diminishes legitimate global opportunities and sustainable growth while attracting international criminal organisations with undesirable reputations and short-term goals. This can result in diminished development and economic growth. Furthermore, once a country's financial reputation is damaged, reviving it is very difficult and requires significant government resources to rectify a problem that could be prevented with proper anti-money-laundering controls (McDowell, 2001).
It would not be difficult to imagine the decline of a reputable financial centre were it to become synonymous with laundering criminal proceeds, given the emphasis on name and reputation in attracting and maintaining business in the financial industry. Therefore the importance of confidence and the need for transparency in the financial system cannot be understated, especially as it makes a significant contribution to certain countries' GNP (Kehoe, 1996).
There is also a risk posed to the securities markets, notably the derivatives markets. As a result of the degree of complexity of some derivative products, their liquidity and the daily volume of transactions, these markets have the ability to disguise cash flows and hence are extremely attractive to the professional money launderer. However, their activities pose huge risks to these markets. Firstly, the brokers used to execute orders on behalf of money laundering clients may be criminally liable for aiding and abetting money launderers. A worrying situation is the money launderers' skilful manipulation of the futures markets. On local futures exchanges, individuals have colluded to take correspondingly short and long positions so as to clean money debts being paid with dirty money, while profits now being clean money. Secondly, another major risk created is through the use of offshore banks who may wash money using derivative markets. As these banks are foreign, they are not required to abide by the same regulations as those of domestic investors as regards overexposure to uncovered risk, they are able to take on huge risk relative to their institutional size. Should losses result from such positions the debts may not be fully paid as the contracts purchased may be only one step in the course of a complex laundering chain that is untraceable. Thus potentially huge loses could be incurred by legitimate investors, causing damage to the derivatives markets (Kehoe, 1996).
The above effects are to some extent speculative, however, the Quirk study also conducted empirical tests on the relationship between GDP growth and money laundering in 18 industrial countries for the first time. It found evidence that significant reductions in annual GDP growth rates were associated with increases in the laundering of criminal proceeds in the period 198390 (Quirk, 1996).
Money laundering is a problem not only in the world's major financial markets and offshore centres, but also for emerging markets. Indeed, any country integrated into the international financial system is at risk. As emerging markets open their economies and financial sectors, they become increasingly viable targets for money laundering activity. Increased efforts by authorities in the major financial markets and in many offshore financial centres to combat this activity provide further incentive for launderers to shift activities to emerging markets. There is evidence, for example, of increasing cross-border cash shipments to markets with loose arrangements for detecting and recording the placement of cash in the financial system and of growing investment by organised crime groups in real estate and businesses in emerging markets. Unfortunately, the negative impacts of money laundering tend to be magnified in emerging markets.
Although the economic costs are particularly emphasised, we must also remember the social and political dimensions of crime and related money laundering, the suffering of the victims and the overall weakening of the social fabric and collective ethical standards. All of this lends urgency to anti-laundering efforts, which attack criminal activity at the most vulnerable point-where its proceeds enter the financial system. (Camdessus, 1998).