KYC norms & obligation of Banks under Prevention of Money Laundering Act (PMLA 2002)

1. KYC norms &  obligation of Banks under Prevention of Money Laundering Act (PMLA 2002) PRESENTATION BY CA. P.K. AGRAWAL 28th June 2014

2. 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

3. 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,

4. 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

5. 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?

6. 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

7. Advantages of KYC • 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 likely-hood 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)

8. 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

9. 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

10. 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.

11. 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.

12. 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

13. 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.

14. 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.

15. 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 – • Non resident customers; • High net worth individuals; • Trusts, Charities, NGOs and Organizations receiving donations;

16. 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.

17. 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)

18. 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.

19. SUSPICIOUS TRANSACTIONS • Suspicious transactionmeans 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;

20. 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

21. 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

22. 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.

23. 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.

24. 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

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

26. 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”

27. (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”

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

29. Money Laundering Process • PLACEMENT • LAYERING • INTEGRATION

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

32. LAYERING - The separation of illicit proceeds from their source by creating complex layers of financial transactions - These disguise the audit trail & provide anonymity

33. 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

35. 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

36. 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.

37. 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

38. 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

39. 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

40. 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

41. 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

42. 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

43. 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

44. 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.

45. 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

46. 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

47. 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;

48. 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.

49. 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

50. 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