Money Laundering in relation to KYC norms

MONEY LAUNDERING IN RELATION TO KYC				themselves updated and this is possible with the help
				of advanced Anti Money Laundering (AML) software.
Money laundering, in a layman’s term means to				A few AML softwares available in the market are
clean dirty money. Literally it means concealing or				Complinet from Mantas Softwares, Omni Enterprises
disguising illicit income in order to make it appear				from Infrasoftech, Searchspace AML, AML2 from
legitimate. According to Black’s Lexicon, the				ECONWARE, AMLOCK and Bank Alert from 3i
term Laundering is referred to describe investment or				InfoTech. All banks, asset management companies
other transfer of money flowing from racketeering,				and securities agencies are the target markets. The
drug transactions and other illegal sources into				Indian AML software market is pegged at more than
legitimate channels so that its original source cannot				Rs.200 crores. It is still in its early stages. AML
be traced. Section 3 of the Prevention of Money				vendors need to upgrade beyond KYC requirements.
Laundering Act 2002, defines it as “Whosoever				Some banks that have adopted the AML Softwares
directly or indirectly attempts to indulge or knowingly				are IndusInd, ING Vysya, Bank of Baroda, UTI,
assists or knowingly is a party or is actually involved				Karnataka Bank etc. Some major companies involved
in any process or activity connected with the				in the production of AML software are TCS, Infosys,
proceeds of crime and projecting it as untainted				3i InfoTech, Logica CMG, Wipro, Misys and SAS India.
property shall be guilty of offence of money
�				The Reserve Bank of
The term money				India introduced KYC i.e., Know Your Customer
laundering is said to originate from the Mafia				norms on 16th August, 2002 owing to the
ownerships of Laundromats in the United States.				recommendations made by the Financial Action Task
Gangsters there were earning huge sums of money				Force (FATF) on AML standards. The standards
from prostitution, extortion, gambling and bootlegging.				provided by FATF have become mandatory for
They needed to show a legitimate source of these				maintaining cordial international financial relationships. In
monies. The original sighting was in newspapers				addition to the FATF, a paper on customer due
reporting the Watergate scandal in United States in				diligence presented by the Basel Committee on
1973. The expression first appeared in a judicial or				Banking Supervision has been cardinal to the
legal context in 1982 in America in the case US vs.				formulation of the KYC and AML measures. The main
$4,255,625.39(1982) 551 F Supp. 314. More recently,				purpose of the KYC was to restrict money
“Operation Green Ice (1992)” showed the				laundering and terrorist financing.
essentially transnational nature of modern money				The KYC guidelines have
laundering.				been issued under section 35A of the Banking
Money Laundering				Regulation Act, 1949 and attract stringent penal
deprives Governments of tax revenues thereby				measures for any contravention or non-compliance
raising the relative burden of honest citizens. Because				under the same act. The guidelines issued in 2002
of rapid movements of large amounts of money				were:
there occurs destabilization of financial institutions				1. Know Your Customer standards: It puts forth the
which in turn jeopardizes funds of innocent citizens.				objective of KYC which is to prevent banks from
The estimated magnitude of the Money Laundering				being misused by criminal elements and also to enable
menace totals more than an astounding $500 billion to				banks to understand the customers and manage their
$1.5 trillion billion a year of which the Asia Pacific alone				risks efficiently.
accounts for around 30 percent.				2. Customer Acceptance Policy: Banks are required
The core of money				to lay down explicit criteria for acceptance of
laundering in India is undoubtedly the parallel				customers and are to ensure that:-
remittance system of Hawala which operates				3. No anonymous or fictitious accounts are opened.
independent of the traditional banking or financial				4. Categorisation of customers into three levels
channels. It has now spread its tentacles around the				according to their monetary requirements.
world. The popularity of Hawala can be attributed to				5. Documentation information requirements of
its cost effectiveness, efficiency and reliability. Some				different categories of customers to be collected
ancillary reasons are the lack of bureaucracy, lack of				keeping in mind the requirements of the Prevention
paper trail and tax evasion. Moreover, the minimal use				of Money Laundering Act, 2002.
of negotiable instruments further motivates the				6. No opening or closing of existing accounts due to
hawaladars as the possibility of being exposed is				customer non-cooperation or unreliability of
reduced considerably. Hawala is discernable from				information furnished.
other remittance systems due to the extensive use				7. Guidelines as to the circumstances in which a
of family and regional affiliations. Another unique				customer is permitted to act on behalf of another
aspect of Hawala is the importance of trust between				person or entity should be clearly enunciated in
the parties involved. It is worth noting that one of				conformity with the statutory law.
the meanings attached to the word Hawala is trust!				Customer Identification Procedure: Customer
Even though Hawala is illegal from a regulatory				Identification procedure means identifying the
standpoint, hawaladars widely advertise their services				customer and verifying his/her identity by using
in ethnic newspapers as well as on the internet. The				reliable, independent source documents, data or
term ‘white Hawala’ refers to legitimate				information. Banks need to obtain sufficient
transactions whereas ‘Black Hawala’				information necessary to establish to their
connotes illegitimate transactions. Black Hawala				satisfaction, the identity of each new customer
transactions are always associated with some serious				whether regular or occasional and the purpose of the
offence like narcotics trafficking and fraud which is				intended nature of banking relationship. For natural
illegal in most jurisdictions. Another remittance system				persons, banks should obtain sufficient identification
is ‘chop’, ‘chit’ or ‘flying				data to verify the identity of the customer, his
money’ indigenous to China and also used around				address and also his recent photograph. For legal
the world.				entities, banks must verify their legal status and
With the passage of time and technological				understand the ownership and control of the
developments, Money laundering has evolved into				customer. Banks, may however frame their own
more complex and advanced forms like				internal guidelines.
Smurfing- It is another term used for Placement in				Monitoring of Transactions: Banks must understand
Money Laundering. .In the US, for instance, launderers				the normal and reasonable activity of the customer
had sent troops around the country's banks to				so that they have the means of identifying
purchase cashier's checks, drafts and similar				transactions that fall outside the regular pattern of
instruments for amounts less than $10,000. In India				activity. Banks should also pay attention to all
too, smurfing is quite common. Since most bank				complex and unusually large transactions. Transactions
branches do not issue cashier's cheques, drafts etc				that involve large amounts of cash inconsistent with
against cash deposit beyond Rs 10,000 to Rs 15,000				the normal and expected activity of the customer
launderers use different names and different bank				should particularly attract the attention of the bank.
branches for such transactions Currency notes worth				Indications of funds being washed such as the
Rs. 1.8 crores seized by the Enforcement Directorate				country of origin, sources of funds, the type of
from a money-laundering group in Delhi in 1997.				transactions involved and other risk factors must be
Bank Complicity, Money Services and Currency				identified by the bank. Section 12 of the PML Act
Exchanges, Asset Purchases with bulk cash,				2002 requires the bank to maintain records of
Electronic Funds Transfer, Postal Money Orders,				transactions. Banks should also ensure that its
Credit Cards, Casinos, Legitimate business/				branches continue to maintain proper record of all
Co-mingling of funds, Value tampering.				transactions (deposits and withdrawal) of Rs. 10 lakh
The most perilous				and above.
repercussion of money laundering has been Terrorist				Risk Management: Banks may in consultation with
Financing, the reverse procedure of Money				their boards, devise procedures for creating Risk
Laundering. In Terrorist Financing white money is				Profiles of their existing and new customers. Banks
converted into dirty money. Here the money earned				internal audit and compliance functions have an
through legitimate sources is used for illegitimate				important role in evaluating and ensuring adherence to
activities.				the KYC procedures and policies. The compliance
The endemic of money				function should provide an independent evaluation of
laundering is similar to that of terrorism. As no				the bank’s policies and procedures including legal
country is immune from the malady of terrorism,				and regulatory requirements.
likewise no nation is impervious to the vicious threat				Customer Education: Banks need to prepare specific
of money laundering. This is corroborated by the				literature/pamphlets etc. so as to educate the
various legislations enacted by different countries to				customer of the objectives of the KYC programme.
tackle it. Strategies used by these countries include				Introduction of New Technologies- Credit cards/debit
effective legal framework and tax systems, sound				cards/smart cards/gift cards: Banks should ensure
financial institutions, efficient tracking and monitoring				that proper KYC procedures are duly applied before
systems to identify irregular financial transactions. A				issuing the cards to the customers. It is also desirable
few of the key laws relating to money laundering in				that agents are subjected to KYC measures.
some major countries are enumerated below:-				Appointment of Principal Officers: Banks may appoint
USA				a senior management officer to be designated as
Patriot Act 2001; Money Laundering and Financial				Principal Officer. He /she shall be located at the head
Crimes Strategy Act 1998; Annunzio-Wylie				corporate office of the bank and shall be responsible
Anti-Money Laundering Act, 1992; Money Laundering				monitoring and reporting of all transactions and
Control Act, 1986; Bank Secrecy Act, 1970.				sharing of information as required under the law.

The Acts establish requirements for record keeping				On May 17th 2004, US firm Goldman Sachs stock
by individuals, banks and other financial institutions,				market saga played out bringing forth the lacuna in
establish money laundering as a federal crime;				the KYC norms for foreign institutional investors
introduce civil and criminal forfeitures for the Bank				(FIIs). Capital market watchdog SEBI had proceeded
Secrecy Act violations, criminalize the financing of				against Goldman Sachs, as it had found evidence that
terrorism, prohibit financial institutions from engaging				the US firm had conducted some trades which had
in business with foreign shell banks, require financial				resulted in the market crash that day. The regulator
institutions to have due diligence procedures, provide				wanted to give detailed information about the clients,
the Secretary of Treasury with the authority to				which the latter did not provide. The contention of
impose “special measures” on jurisdictions or				the firm was that the interpretation of KYC which
transactions that are of “primary money				SEBI had sought to apply would result in FII being
laundering concern”.				required to know to know ultimate client level
				information and details of reasons for client trades.
UK
Money Laundering Regulations 2007; Proceeds of				Owing to these interpretation barriers, the Reserve
Crime Act 2002; and Terrorism Act of 2000.				Bank of India in 2004 came up with more specific
				guidelines regarding KYC. These were divided into
The Acts criminalize both actions relating to criminally				four parts:-
acquired property and the failure to disclose				Customer Acceptance Policy
suspicious transactions that may indicate money				Customer Identification Procedures
laundering. The Regulations create a regime of Due				Monitoring of Transactions
Diligence, record keeping and reporting that the				Risk Management
institutions are required to comply with and also				The RBI also directed all banks to make a policy for
establish penalties ((both civil and criminal) for				implementing ‘Know Your Customer’ and
non-compliance.				Anti-Money Laundering measures and remain fully
				compliant with given guidelines before December 31,
Germany				2005. But there have been instances of lapses in the
Section 261 of the Criminal Code, 1998; Money				implementation of these guidelines by several banks.
Laundering Act of 25 October 1993.				The culmination of these failures and the mother of
				all scams was undoubtedly the IPO scam. Here, one
The Acts penalises any person who hides an object				Roopalben Panchal applied for shares in her own
derived from a specified unlawful act, makes its				name, in a single application, but failed to get an
obligatory for institutions or casino to report any				allotment. Undeterred, she ensured herself 9.47 lakh
financial transaction that serves the purpose of				shares by applying through a staggering 6,315 demat
money laundering.				accounts! Most of these accounts were with
				depository participant Karvy and had almost identical
Australia				addresses. The Securities and Exchange Board of
The Anti Money Laundering and Counter Terrorism				India unearthed this demat racket involving entities
Financing Act, 2006.				that opened these thousands of demat accounts to
				ensure higher allotments in the retail offering. The
The Act covers the financial sector, gambling sector				Board advised the two depositories in the country,
and bullion dealing and any other professionals or				NSDL and CDSL, to step up their surveillance
business that provides particular ‘designated				systems and referred Bharat Overseas Bank and
services’. The Act imposes a number of				Vijaya Bank to the Reserve Bank of India to
obligations on businesses when they provide these				examine their roles in opening bank accounts of
designated services such as customer Due Diligence,				Benami entities and funding their initial public offer
reporting and recordkeeping.				applications. Moreover, SEBI instructed NSDL to
				thoroughly inspect the systems and procedures put
Malaysia				in place by the depository participant Karvy as
Anti Money Laundering Act 2001				regards “know your client” norms. Thirteen
				entities were barred from dealing in Yes Bank shares
The Act criminalises money laundering stating that				and in ensuing IPO’s.
any person who engages in a transaction that				Moreover, in the infamous Abdul Karim Telgi case,
involves proceeds of any specified unlawful activity				the machines used to print the fake stamps were
commits an offence. It also provides for an				acquired by way of money laundering by one Manoj
investigation, freezing, seizure and forfeiture of the				Ramesh Sharma, Telgi’s accomplice.
proceeds of money laundering and terrorist financing				PROBLEMS WITH KYC
offences, suspicious transactions reporting, record				- Banks say the biggest problem with KYC is the non
keeping and the establishment and functions of the				existence of a unique identification number for every
Financial Intelligence Unit.				individual in the country.
				- There are also no ways to verify whether
India				documents submitted by customers are not fake.
The Prevention of Money Laundering Act 2002:-				According to KYC norms, banks and financial
Whoever commits the offence of money-laundering				institutions need to verify a customer’s identity
shall be punishable with rigorous imprisonment for a				and address by asking for documents at the time of
term which shall not be less than three years but				opening an account. The Indian Banks’
which may extend to seven years and shall also be				Association (IBA) on behalf of banks is seeking help
liable to fine which may extend to five lakh rupees:				of the I-T department to solve the problem.
Provided that where the proceeds of crime involved				SOME POSITIVES FOR A BETTER FUTURE
in money-laundering relates to any offence specified				The Income Tax department is now working hand in
under paragraph 2 of Part A of the Schedule, the				hand with the banks and is sharing its database with
provisions of this section shall have effect as if for				them. This has enabled banks to authenticate the
the words "which may extend to seven years", the				identification proof submitted by customers at the
words "which may extend to ten years" had been				time of opening accounts. Moreover, every bank has
substituted."				been given a unique identification with which they can
				verify the PAN (Permanent Account Number) card
It also attracts offences under The Arms Act, 1959;				details of a customer.
The Wildlife (Protection) Act, 1972; The Immoral
Traffic (Prevention) Act 1956; The Prevention of				CONCLUSION
Corruption Act, 1988; Smugglers and Foreign				Although India has not seen any money laundering
Exchange and Prevention of Smuggling Activities Act				scams for funding of anti national activities after the
1974; The Benami Transactions (Prohibition) Act,				introduction of KYC norms, it sure has failed to
1988; The Prevention of Illicit Traffic in Narcotics				prevent innocent customers from being fraught
Drugs and Psychotropic Substances Act 1988.				unnecessarily. This is because it has failed to curb
				offences like fraud, cheating etc. involving money
The Parliamentary Standing Committee on Finance				laundering. Another huge threat that India still faces is
examined the Prevention of money Laundering Bill				Narcotics. It is mostly owing to this business that
2008 and suggested recommendations of which a				money laundering is used. Hence India has a long way
few are enlisted below:-				to go before it actually sees the success of KYC
- The Committee believes that enacting the PML bill is				norms and is able to nip the menace of money
an essential step to strengthen the country’s				laundering in its bud.
legal framework from preventing money laundering
and counter financing of terrorism.
- Apart from plugging other avenues generating illegal
funds such as Hawala, etc, international guidelines
should be taken into account for effective				BIBLIOGRAPHY:-
enforcement of anti money laundering law.				1) Prevention of Money Laundering Act
- The government should consider expanding the				2002.
ambit of law to cover the FATF recommended				2) Financial Intelligence Unit -India, Ministry
DNFB’s such as gold or gem dealers, real estate				of Finance.
agents etc.				3) Reserve Bank of India notifications from
- MoU’s for mutual cooperation should be				16th August 2002- 18th February 2008.
concluded with other countries.				4) The Financial Express (June 4 2009).
- Enforcement Agencies should strengthen their				5) Indian Banks Association (Briefing on
machinery to keep abreast of emerging trends of				Compliance to ‘KYC Norms and AML
money laundering and terror funding. This includes				Measures’ June 2
having proper software especially with regard to				2006).
suspicious transactions; strong reporting equipments				5) The Web page of the Financial
to monitor transactions, quarterly audit to verify				Action Task Force.
know Your Customer information etc.				6) The Web page of the BIS.
				7) Money Laundering: A New
As a consequence of the emerging trends in money				International Law Enforcement Model book, by
laundering, enforcement agencies must keep				Stessens Guy.

AirTravel

Money Laundering in relation to KYC norms

Articles