Basics of Anti-Money Laundering & Know Your Customer

1. Basics of Anti-Money Laundering& Know Your Customer Compiled By : Vishal Chopra

2. What is Money Laundering? Illegally obtained money Appears to originate from legitimate source Conversion Criminal Activity Drugs / Arms Trafficking Terrorism Extortion

3. 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”

4. 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”

5. Money Laundering Money laundering generally refers to ‘washing’ of the proceeds or profits generated from: • Drug trafficking • Arms, antique, gold smuggling • Prostitution rings • Financial frauds • Corruption, or • Illegal sale of wild life products and other specified predicate offences

6. Money Laundering Process • PLACEMENT • LAYERING • INTEGRATION

7. Placement • Immersion or Soaking • The physical disposal of bulk cash proceeds derived from illegal activity

9. 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

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

12. 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

13. 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.

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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?

24. 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

25. Advantages of KYC norms • Sound KYC procedures have particular relevance to the safety and soundness of banks, in that: • 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; • They provide an essential part of sound risk management system (basis for identifying, limiting and controlling risk exposures in assets & liabilities)

26. 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

27. 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

28. Summary: Prevention of Money Laundering Observing Rules for Bankers Money Laundering Prevention Customer due Diligence Compliance with Laws Identifying Irregular / Suspicious Transactions

29. Asset Liability Management in Banks

30. Components of a Bank Balance sheet Contingent Liabilities

31. Components of Liabilities • 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.

32. Components of Liabilities 2. Reserves & Surplus Components under this head includes: I. Statutory Reserves II. Capital Reserves III. Investment Fluctuation Reserve IV. Revenue and Other Reserves V. Balance in Profit and Loss Account

33. 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

34. 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

35. Components of Liabilities 5. Other Liabilities & Provisions It 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)

36. Components of Assets • 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

37. Components of Assets 2. 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 Institutions II. Outside India a) In Current Accounts b) In Other Deposit Accounts c) Money at Call & Short Notice

38. Components of Assets 3. 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

39. Components of Assets 4. Advances The 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

40. Components of Assets 5. 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

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

42. Banks Profit & Loss Account A bank’s profit & Loss Account has the following components: • Income: This includes Interest Income and Other Income. II. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

43. Components of Income • 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

44. 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

45. Components of Expenses • INTEREST EXPENDED I. Interest on Deposits II. Interest on Reserve Bank of India / Inter-Bank borrowings III. Others

46. 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

47. ALM 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.

48. Purpose & Objective of ALM An 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

49. RBIDIRECTIVES • 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

50. SUCCESS OF ALM IN BANKS :PRE - CONDITIONS • Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams. • Method of reporting data from Branches/ other Departments. (Strong MIS). • Computerization-Full computerization, networking. • Insight into the banking operations, economic forecasting, computerization, investment, credit. 5. Linking up ALM to future Risk Management Strategies.