PRESENTATION BY

CA. P.K. AGRAWAL

28th June 2014

KYC norms &  obligation of Banks

under Prevention of Money Laundering Act (PMLA 2002)

KYC norms & obligations of Banks

• Background• June 1998 – UN call on member states to adopt

National Money Laundering legislation• Prevention of Money Laundering Act, 2002

• Objective• Prevent banks from being used by criminals for money

laundering and terrorist activities

What is KYC

• (a) Who is a Customer• a person or entity that maintains an account

and/or has a business relationship with the bank;

• one on whose behalf the account is maintained (i.e. the beneficial owner).

• -beneficiaries of transactions conducted by professional intermediaries, such as Stock Brokers, Chartered Accountants, Solicitors etc. as permitted under the law,

Who should Know

• Branch Manager, Audit Officer, Monitoring Officials,

• What you should know?

• True identity and beneficial ownership of the accounts

• Permanent address, registered & administrative address

What is a KYC

• 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?

What 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

• 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 likely-hood 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)

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

Customer Acceptance Policy (CAP)

• - Every Bank must develop a CAP• - No account is opened in fictitious of benami

name/s• -Defining risk perception about the customer:• (a) Nature of business or work carried out by

customer• (b) Location of the customer and his clients• (c) Volume of Turnover

CAP Continued

• - Social and Financial Status• - Customers requiring high monitoring (like

customers belonging to Politically exposed Persons category)

• Customers falling under PEP category may even require higher categorisation and enhanced monitoring

• Not to open or close accounts where Bank is unable to apply customer due dilligence measures.

CAP continued• - Where bank is unable to verify identity of

customer• - Non availability of documents (due to non

cooperation of the customers) to verify identity• - Non reliability of documents or information

furnished by the customer/s• Necessary checks before opening a new account to

ensure that the identity of the customer does not match with any person with known criminal background or with banned entities such as individual terrorists or terrorist organisations, etc.

Risk Categorisation

• - Preparing profile for customers based on risk perception (based on his social & financial standing, nature of business carried out by him)

• Categorising customers - Low, - Medium and - High Risk Categories

Who are Low Risk Customer- Low risk customers could be salaried employees, - people belonging to lower economic strata of the

society whose accounts show small balances and low turnover,

- Government Departments and Government owned companies, regulators and statutory bodies etc.

- In such cases, the policy may require that only the basic requirements of verifying the identity and location of the customer are to be met.

Other Risk Categories

• Medium and High Risk Customers:- Who are likely to pose a higher than average

risk to the bank are be categorised as medium or high risk depending on customer's background,

- Banks should apply enhanced due diligence measures requiring intensive ‘due diligence’ for higher risk customers, especially those for whom the sources of funds are not clear.

High Risk Customers

- Dealers in Bullion and Jewellery are categorised as High Risk Customers, in view of the risks involved in cash intensive businesses,

- Other high risk customers are –

(a) Non resident customers;

(b) High net worth individuals;

(c) Trusts, Charities, NGOs and Organizations receiving donations;

High Risk Customers- Companies having close family shareholding or beneficial

ownership; - Firms with 'sleeping partners'; - Politically exposed persons (PEPs) of foreign origin,

customers who are close relatives of PEPs and accounts of which a PEP is the ultimate beneficial owner;

- Non-face to face customers and - Those with dubious reputation as per public information

available etc. However, only NPOs/NGOs promoted by United Nations or its agencies may be classified as low risk customers.

- Such customers require enhanced due diligence.

Customer Identification Procedure (CIP)

• - Bank should approve a Policy spelling out CIP

• Customer categories:• (a) Natural Persons• (b) Legal Entities• (c) Customers acting on behalf of others

(fiduciary capacity)

Customers Identification Procedure

• Walk in Customers:

- Those who do not have banking relationship with the Bank

- Where transaction value equals or exceeds Rs. 50,000.00, (whether in a single or several transactions), customers identity is to be established.

- However, where bank is convinced that the customer is intentionally structuring a transaction into a series of transactions below the threshold of Rs.50,000/-, the bank should verify the identity and address of customer and also consider filing a suspicious transaction report (STR) to FIU-IND.

SUSPICIOUS TRANSACTIONS

• Suspicious transaction means a transaction whether or not made in cash which, to a person acting in good faith –• gives rise to a reasonable ground of suspicion that

it may involve the proceeds of crime; or• appears to be made in circumstances of unusual or

unjustified complexity; or• appears to have no economic rationale or bonafide

purpose;

Suspicious Transactions

• Providing misleading information / information not easily verifiable while opening an Account

• Large cash withdrawals from: a dormant or inactive account or account with unexpected large credit from abroad

• Sudden rise in cash deposits of an individual, with no justification

• Leading lavish lifestyles, that do not match their known income sources

Suspicious Transactions

• Large cash deposits into same account• Substantial increase in turnover in a dormant

account• Receipt or payment of large cash sums with

no obvious purpose or relationship to Account holder / his business

• Reluctance to provide normal information when opening an Account or providing minimal or fictitious or wrongful information

Risk Management

- The bank should ensure an effective KYC by establishing appropriate procedures and ensuring their effective implementation.

- It should cover proper management oversight, systems and controls, segregation of duties, training and other related matters. Responsibility should be explicitly allocated within the bank for ensuring that the bank’s policies and procedures are implemented effectively.

Risk Management- Introduction of Innovative Technologies or Products

- Banks should pay special attention to any money laundering threats that may arise from new or developing technologies including internet banking that might favour anonymity, and take measures, if needed, to prevent their use in money laundering schemes.

- Banks are issuing a variety of Electronic Cards that are used by customers for buying goods and services, drawing cash from ATMs, and can be used for electronic transfer of funds. Banks are required to ensure full compliance with all KYC/AML/CFT guidelines.

Risk Management Techniques- Summary

• Board to ensure establishing effective KYC, AML

system in place

• Role of audit and compliance mechanisms

• Quarterly review by the Board

• Cash Transaction Report

• Suspicious Transaction Report

• Screening & training of employees

•

What is Money Laundering?

Illegally obtained money

Conversion

Criminal ActivityDrugs / Arms Trafficking

Terrorism

Extortion

Appears to originate from

legitimatesource

Money Laundering

(A) '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”

(b) 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) Immoral Activities

(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

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

- These disguise the audit trail & provide anonymity

Integration

- Re-injecting laundered proceeds into economy so that they reenter financial system as normal business funds- Provides 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 practice 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 practice 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 mn.• Aug. 2005 Arab Bank US$ 24 mn• Feb. 2005 City National Bank US$750,000• Jan. 2005 Riggs Bank US$ 41 mn.• Oct. 2004 AmSouth Bank US$ 50 mn.• Sep. 2004 City Bank Japan Licence cancelled• May. 2004 Riggs Bank US$ 25 mn.

Role of cash in money laundering

• Disguise the audit trail• Provide anonymity• Concealing true ownership and origin of

money• Control over money• Changing the form of money

Cash Transactions

• All cash transactions of the value of more than Rs. Ten Lakh or its equivalent in foreign currency

• All series of cash transactions integrally connected to each other, which have been valued below Rs. Ten Lakh or its equivalent in foreign currency, where such series of transactions have taken place within a month

Cash Transaction Report

• Maintenance of records of transactions• valued below Rs. Ten Lakh or its equivalent in

foreign currency where such• series of transactions have taken place within a

month and • the aggregate value of such transactions exceeds

Rs. Ten Lakh ;• Furnishing of CTR

• individual transactions below rupees fifty thousand may not be included;

DUE DATES

• Cash Transaction Report• by 15th of the succeeding month.

• Suspicious Transaction Report• within 7 days of arriving at a conclusion that any

transaction (whether cash or non-cash transaction) is of suspicious nature.

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

Measures to deter money laundering

• Appropriate measures to ensure that ML risks are taken into account in daily operations, development of new financial products, establishing new business relationships and changes in the customer profile

• Screening of employees before hiring and of those who have access to sensitive information

• Appropriate quality training to staff• Quick and timely reporting of suspicious

transactions

Summary: Prevention of Money Laundering

Money Laundering Prevention

Observing Rules for Bankers

Compliance with Laws

Identifying Irregular / Suspicious

Transactions

Customer due Diligence

RELAXED KYC MEASURES• Customers are now allowed to submit only one documentary proof of address

(either current or permanent), while opening a bank account or while undergoing periodic up-dation.

• Where address as mentioned in the ‘proof of address’ submitted to the Bank changes, a fresh proof of address may be submitted to the branch within a period of six months.

• Where proof of address does not contain local address (where the customer is residing), the bank may take a declaration of the local address on which all correspondence will be made by the bank with the customer.

• No proof is required to be submitted for such address for correspondence/local address. This address may be verified by the bank through ‘positive confirmation’ such as acknowledgment of receipt of (i) letter, cheque books, ATM cards; (ii) telephonic conversation; (iii) visits; etc. In the event of change in this address due to relocation or any other reason, customers may intimate the new address for correspondence to the bank within two weeks of such a change

Reference of RBI Circulars

• DBOD. AML.BC. No 93 /14.01.001/2011-12 dated April 17, 2012

• DBOD. AML.BC. No 109 /14.01.001/2011-12 dated June 08, 2012

• DBOD. AML.BC. No 110 /14.01.001/2011-12 dated June 08, 2012

• DBOD.AML.BC. No. 65/14.01.001/2012-13 dated December 10, 2012

• DBOD.AML.BC. No.71/14.01.001/2012-13 dated January 18, 2013

• DBOD.AML.BC. No. 78 /14.01.001/2012-13 dated January 29, 2013

Thank You for your attention

USA PATRIOT ACT

• The official title of the USA PATRIOT Act is "Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001." 

USA PATRIOT ACT• The purpose of the USA PATRIOT Act is to deter and punish terrorist acts

in the United States and around the world, to enhance law enforcement investigatory tools, and other purposes, some of which include:

• To strengthen U.S. measures to prevent, detect and prosecute international money laundering and financing of terrorism;

• To subject to special scrutiny foreign jurisdictions, foreign financial institutions, and classes of international transactions or types of accounts that are susceptible to criminal abuse;

• To require all appropriate elements of the financial services industry to report potential money laundering;

• To strengthen measures to prevent use of the U.S. financial system for personal gain by corrupt foreign officials and facilitate repatriation of stolen assets to the citizens of countries to whom such assets belong.

USA PATRIOT ACT

• Section 311:    Special Measures for Jurisdictions, Financial Institutions, or International Transactions of Primary Money Laundering Concern

• This Section allows for identifying customers using correspondent accounts, including obtaining information comparable to information obtained on domestic customers and prohibiting or imposing conditions on the opening or maintaining in the U.S. of correspondent or payable-through accounts for a foreign banking institution.

• Section 312:    Special Due Diligence for Correspondent Accounts and Private Banking Accounts

• This Section amends the Bank Secrecy Act by imposing due diligence & enhanced due diligence requirements on U.S. financial institutions that maintain correspondent accounts for foreign financial institutions or private banking accounts for non-U.S. persons.

• Special Due Diligence Programs for Certain Foreign Accounts• Section 313:    Prohibition on U.S. Correspondent Accounts with Foreign

Shell Banks• To prevent foreign shell banks, which are generally not subject to

regulation and considered to present an unreasonable risk of involvement in money laundering or terrorist financing, from having access to the U.S. financial system. Banks and broker-dealers are prohibited from having correspondent accounts for any foreign bank that does not have a physical presence in any country. Additionally, they are required to take reasonable steps to ensure their correspondent accounts are not used to indirectly provide correspondent services to such banks.

• Section 314:    Cooperative Efforts to Deter Money Laundering

• Section 314 helps law enforcement identify, disrupt, and prevent terrorist acts and money laundering activities by encouraging further cooperation among law enforcement, regulators, and financial institutions to share information regarding those suspected of being involved in terrorism or money laundering.

• Section 319(b):    Bank Records Related to Anti-Money Laundering Programs

• To facilitate the government's ability to seize illicit funds of individuals and entities located in foreign countries by authorizing the Attorney General or the Secretary of the Treasury to issue a summons or subpoena to any foreign bank that maintains a correspondent account in the U.S. for records related to such accounts, including records outside the U.S. relating to the deposit of funds into the foreign bank. This Section also requires U.S. banks to maintain records identifying an agent for service of legal process for its correspondent accounts.

• Section 325:    Concentration Accounts at Financial Institutions• Allows the Secretary of the Treasury to issue regulations governing

maintenance of concentration accounts by financial institutions to ensure such accounts are not used to obscure the identity of the customer who is the direct or beneficial owner of the funds being moved through the account.

• Section 326:    Verification of Identification• Prescribes regulations establishing minimum standards for financial

institutions and their customers regarding the identity of a customer that shall apply with the opening of an account at the financial institution.

• Section 351:    Amendments Relating to Reporting of Suspicious Activities

• This Section expands immunity from liability for reporting suspicious activities and expands prohibition against notification to individuals of SAR filing. No officer or employee of federal, state, local, tribal, or territorial governments within the U.S., having knowledge that such report was made may disclose to any person involved in the transaction that it has been reported except as necessary to fulfill the official duties of such officer or employee.

• Section 352:    Anti-Money Laundering Programs• Requires financial institutions to establish anti-money laundering

programs, which at a minimum must include: the development of internal policies, procedures and controls; designation of a compliance officer; an ongoing employee training program; and an independent audit function to test programs.

• Section 356:    Reporting of Suspicious Activities by Securities Brokers and Dealers; Investment Company Study

• Required the Secretary to consult with the Securities Exchange Commission and the Board of Governors of the Federal Reserve to publish proposed regulations in the Federal Register before January 1, 2002, requiring brokers and dealers registered with the Securities Exchange Commission to submit suspicious activity reports under the Bank Secrecy Act.

• Section 359:    Reporting of Suspicious Activities by Underground Banking Systems. This amends the BSA definition of money transmitter to ensure that informal/underground banking systems are defined as financial institutions and are thus subject to the BSA.Section

• 362:    Establishment of Highly Secure Network requires FinCEN to establish a highly secure network to facilitate and improve communication between FinCEN and financial institutions to enable financial institutions to file BSA reports electronically and permit FinCEN to provide financial institutions with alerts.