Compiled By : Vishal Chopra

Basics of

Anti-Money Laundering& Know Your Customer

•

What is Money Laundering?

Illegally obtained money

Conversion

Criminal ActivityDrugs / Arms Trafficking

Terrorism

Extortion

Appears to originate from

legitimatesource

Money Laundering

'Any act or attempted act to conceal or disguise the identity of illegally obtained proceeds so that they appear to have originated from legitimate sources'.

In other words, it is the process used by criminals through which they make “dirty” money appear “clean”

Sec.3 of PML Act, 2002 defines ‘money laundering’ as:

“whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projecting it as untainted property shall be guilty of the offence of money-laundering”

Money LaunderingMoney laundering generally refers to ‘washing’ of the

proceeds or profits generated from:

(i) Drug trafficking

(ii) Arms, antique, gold smuggling

(iii)Prostitution rings

(iv)Financial frauds

(v) Corruption, or

(vi)Illegal sale of wild life products and other specified predicate offences

Money Laundering Process

• PLACEMENT• LAYERING• INTEGRATION

Placement

• Immersion or Soaking

• The physical disposal of bulk cash proceeds derived from illegal activity

LAYERING

“Soaping / Scrubbing”

The separation of illicit proceeds from their source by creating complex layers of financial transactions

These disguise the audit trail & provide anonymity

Integration

“Repatriation / Spin Dry”Reinjecting laundered proceeds into economy so that they reenter financial system as normal business fundsProvides an apparently legitimate explanation to criminally derived wealth

Techniques employed

• Deposit structuring or smurfing• Connected Accounts• Payable Through Accounts• Loan back arrangements• Forex Money Changers• Credit/ Debit cards• Companies Trading and Business Activity• Correspondent Banking • Lawyers, Accountants & other Intermediaries• Misuse of Non-Profit Organisations

Financing of terrorism

• Money to fund terrorist activities moves through the global financial system via wire transfers and in and out of personal and business accounts

• It can sit in the accounts of illegitimate charities and be laundered through buying and selling securities and other commodities, or purchasing and cashing out insurance policies.

Legal Sources of terrorist financing

• legal or non-legal

• legal• Collection of membership dues

• Sale of publications

• Cultural of social events

• Door to door solicitation within community

• Appeal to wealthy members of the community

• Donation of a portion of personal savings

Illegal Sources

• Kidnap and extortion;

• Smuggling;

• Fraud including credit card fraud;

• Misuse of non-profit organisations and charities fraud;

• Thefts and robbery; and

• Drug trafficking

Money Laundering Risks

What are the risks to banks?

(i) Reputational risk

(ii) Legal risk

(iii) Operational risk (failed internal processes, people and systems & technology)

(iv) Concentration risk (either side of balance sheet)

All risks are inter-related and together have the potential of causing serious threat to the survival of the bank

Reputational Risk:

• The potential that adverse publicity regarding a bank’s business practices, whether accurate or not, will cause a loss of confidence in the integrity of the institution

• Reputational Risk : a major threat to banks as confidence of depositors, creditors and general market place to be maintained

• Banks vulnerable to Reputational Risk as they can easily become a vehicle for or a victim of customers’ illegal activities

Operational Risk

• The risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events

• Weaknesses in implementation of banks’ programmes, ineffective control procedures and failure to practise due diligence

Legal Risk

• The possibility that lawsuits, adverse judgements or contracts that turn out to be unenforceable can disrupt or adversely affect the operations or condition of a bank

• Banks may become subject to lawsuits resulting from the failure to observe mandatory KYC standards or from the failure to practise due diligence

• Banks can suffer fines, criminal liabilities and special penalties imposed by supervisors

Concentration Risk

• Mostly applies on the assets side of the balance sheet: Information systems to identify credit concentrations; setting prudential limits to restrict banks’ exposures to single borrowers or groups of related borrowers

• On liabilities side: Risk of early and sudden withdrawal of funds by large depositors- damages to liquidity

Penalties imposed on banks• Jan. 2006 ABM AMRO US$ 80 mio• Aug. 2005 Arab Bank US$ 24 mio• Feb. 2005 City National Bank US$750,000• Jan. 2005 Riggs Bank US$ 41 mio• Oct. 2004 AmSouth Bank US$ 50 mio• Sep. 2004 City Bank Japan Licence cancelled• May. 2004 Riggs Bank US$ 25 mio

What KYC means?• Customer?• One who maintains an account, establishes business

relationship, on who’s behalf account is maintained, beneficiary of accounts maintained by intermediaries, and one who carries potential risk through one off transaction

• Your? Who should know?• Branch manager, audit officer, monitoring officials, PO• Know? What you should know?• True identity and beneficial ownership of the accounts• Permanent address, registered & administrative address

What KYC means?

• Making reasonable efforts to determine the true identity and beneficial ownership of accounts;

• Sources of funds• Nature of customers’ business• What constitutes reasonable account activity?• Who your customer’s customer are?

KYC DOES NOT MEAN

• Denial of Service to the Common Person

• Intrusive Behaviour

• Use of information for cross selling

• Harassment of customers- threatening to close down the accounts arbitrarily

Advantages of KYC norms

• Sound KYC procedures have particular relevance to the safety and soundness of banks, in that:

1. They help to protect banks’ reputation and the integrity of banking systems by reducing the likelyhood of banks becoming a vehicle for or a victim of financial crime and suffering consequential reputational damage;

2. They provide an essential part of sound risk management system (basis for identifying, limiting and controlling risk exposures in assets & liabilities)

Core elements of KYC

• Customer Acceptance Policy• Customer Identification Procedure- Customer

Profile• Risk classification of accounts- risk based

approach• Risk Management• Ongoing monitoring of account activity• Reporting of cash and suspicious transactions

Measures to deter money laundering

• Board and management oversight of AML risks• Appointment a senior executive as principal officer

with adequate authority and resources at his command

• Systems and controls to identify, assess & manage the money laundering risks

• Make a report to the Board on the operation and effectiveness of systems and control

• Appropriate documentation of risk management policies, their application and risk profiles

Summary: Prevention of Money Laundering

Money Laundering Prevention

Observing Rules for Bankers

Compliance with Laws

Identifying Irregular / Suspicious

Transactions

Customer due Diligence

Asset Liability Management in Banks

Components of a Bank Balance sheet

Liabilities Assets

1. Capital

2. Reserve & Surplus

3. Deposits

4. Borrowings

5. Other Liabilities

1. Cash & Balances with RBI

2. Bal. With Banks & Money at Call and Short Notices

3. Investments

4. Advances

5. Fixed Assets

6. Other AssetsContingent Liabilities

Components of Liabilities

1. Capital:

Capital represents owner’s contribution/stake in the bank.

- It serves as a cushion for depositors and creditors.

- It is considered to be a long term sources for the bank.

Components of Liabilities

2. Reserves & SurplusComponents under this head includes:I. Statutory ReservesII. Capital Reserves III. Investment Fluctuation Reserve

IV. Revenue and Other ReservesV. Balance in Profit and Loss Account

Components of Liabilities

3. Deposits

This is the main source of bank’s funds. The deposits are classified as deposits payable on ‘demand’ and ‘time’. They are reflected in balance sheet as under:

I. Demand Deposits

II. Savings Bank Deposits

III. Term Deposits

Components of Liabilities

4. Borrowings

(Borrowings include Refinance / Borrowings from RBI, Inter-bank & other institutions)

I. Borrowings in India

i) Reserve Bank of India

ii) Other Banks

iii) Other Institutions & Agencies

II. Borrowings outside India

Components of Liabilities

5. Other Liabilities & ProvisionsIt is grouped as under:

I. Bills Payable II. Inter Office Adjustments (Net) III. Interest Accrued IV. Unsecured Redeemable Bonds (Subordinated Debt for Tier-II Capital) V. Others(including provisions)

Components of Assets

1. Cash & Bank Balances with RBI I. Cash in hand

(including foreign currency notes)

II. Balances with Reserve Bank of India

 

In Current Accounts

In Other Accounts

Components of Assets2. BALANCES WITH BANKS AND

MONEY AT CALL & SHORT NOTICE I. In India

i) Balances with Banks a) In Current Accounts  b) In Other Deposit Accounts

ii) Money at Call and Short Notice

a) With Banks  b) With Other InstitutionsII. Outside India a) In Current Accounts b) In Other Deposit Accounts c) Money at Call & Short Notice

Components of Assets3. Investments

A major asset item in the bank’s balance sheet. Reflected under 6 buckets as under:

I. Investments in India in : * i) Government Securities

ii) Other approved Securities

iii) Shares iv) Debentures and Bonds v) Subsidiaries and Sponsored Institutions vi) Others (UTI Shares , Commercial Papers, COD & Mutual Fund Units etc.)II. Investments outside India in **  Subsidiaries and/or Associates abroad

Components of Assets

4. AdvancesThe most important assets for a bank.A. i) Bills Purchased and Discounted

ii) Cash Credits, Overdrafts & Loans

repayable on demand

iii) Term Loans

B. Particulars of Advances :

i) Secured by tangible assets

(including advances against Book Debts)

ii) Covered by Bank/ Government Guarantees

iii) Unsecured

Components of Assets5. Fixed Asset I. Premises

II. Other Fixed Assets (Including furniture and fixtures)

6. Other Assets I. Interest accrued

  II. Tax paid in advance/tax deducted at source

(Net of Provisions)

  III. Stationery and Stamps

  IV. Non-banking assets acquired in satisfaction of claims

  V. Deferred Tax Asset (Net)

 VI. Others

Contingent Liability

Bank’s obligations under LCs, Guarantees, Acceptances on behalf of constituents and Bills accepted by the bank are reflected under this heads.

Banks Profit & Loss Account

A bank’s profit & Loss Account has the following components:

I. Income: This includes Interest Income and Other Income.

II. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

Components of Income1. INTEREST EARNED

I. Interest/Discount on Advances / Bills

 II. Income on Investments

 III. Interest on balances with Reserve Bank

of India and other inter-bank funds

 IV. Others

Components of Income 2. OTHER INCOME

I. Commission, Exchange and Brokerage

II. Profit on sale of Investments (Net)

III. Profit/(Loss) on Revaluation of Investments

IV. Profit on sale of land, buildings and other

assets (Net)

V. Profit on exchange transactions (Net)

VI. Income earned by way of dividends etc. from subsidiaries and Associates abroad/in India

VII. Miscellaneous Income

Components of Expenses

1. INTEREST EXPENDED

I. Interest on DepositsII. Interest on Reserve Bank of India / Inter-

Bank borrowingsIII. Others

Components of Expenses

2. OPERATING EXPENSES

I. Payments to and Provisions for employees II. Rent, Taxes and Lighting III. Printing and Stationery IV. Advertisement and Publicity V. Depreciation on Bank's property VI. Directors' Fees, Allowances and Expenses VII. Auditors' Fees and Expenses (including Branch Auditors) VIII. Law Charges  IX. Postages, Telegrams, Telephones etc.  X. Repairs and Maintenance  XI. Insurance XII. Other Expenditure

Assets Liability Management

It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.

Purpose & Objective of ALMAn effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ratio.

It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are:

1. Net Interest Income (NII)

2. Net Interest Margin (NIM)

3. Economic Equity Ratio

RBI DIRECTIVES• Issued draft guidelines on 10th Sept’98.

• Final guidelines issued on 10th Feb’99 for implementation of ALM w.e.f. 01.04.99.

• To begin with 60% of asset &liabilities will be covered; 100% from 01.04.2000.

• Initially Gap Analysis to be applied in the first stage of implementation.

• Disclosure to Balance Sheet on maturity pattern on Deposits, Borrowings, Investment & Advances w.e.f. 31.03.01

SUCCESS OF ALM IN BANKS :PRE - CONDITIONS

1. Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams.

2. Method of reporting data from Branches/ other Departments. (Strong MIS).

3. Computerization-Full computerization, networking.

4. Insight into the banking operations, economic forecasting, computerization, investment, credit.

5. Linking up ALM to future Risk Management Strategies.

THANK YOU