KYC – A key to prevention of Money Laundering

Money laundering poses a serious threat to the health of India’s financial sector. It is the process by which criminals conceal the origin and ownership of the proceeds of crime, by legitimising illegally obtained money, by channelising surreptitiously through legitimate business channels and integrating those to financial system in a variety of ways like bank deposits, investments or through transfer from one place or person to another.

Financial institutions like banks, insurance companies, stock markets, etc are most vulnerable to such intrusion and therefore the need to protect these institutions from the debilitating effect of laundered money. This is intended to be achieved by implementation of Know Your Customers policy, and Customer Due Diligence guidelines across the financial sector.

The Act of money laundering has been criminalised in India through the enactment of the Prevention of Money Laundering Act, 2002. Persons and entities who indulge in or assist in the process or activity connected with the proceeds of scheduled crime as defined under the said Act and in projecting it as untainted property are guilty of the said offence of money laundering under Section 3 of the Act. 

Banks, insurance and stock markets are the easiest targets which most often are used for the concealment and projection of the tainted proceeds. The Act, while criminalising the act of money laundering, and prescribing a stringent punishment for the violators & the abettors, under Section 4, also prescribes legal requirements to be complied with by the Banking companies, financial institutions and intermediaries for protecting the integrity of the sector.

To achieve the objective, Section 12 of the Act, has cast obligation on the Banking companies, financial institutions to keep watch on suspicious transactions and movement of tainted funds and to bring these to the notice of Financial Intelligence Unit – IND (FIU-IND), for necessary action.

The objective of KYC and CDD guidelines is to enable the managers to examine and assess their customer’s financial dealings from anti-money laundering perspective, so as to make a proper risk assessment for preventing the tainted money from entering the institution.

Formulation of KYC and CDD Guidelines and procedures specifying the objective of KYC framework by regulators like the RBI, the SEBI and IRDA are designed for appropriate customer identification, and to monitor transactions of suspicious nature. Risk Management and Monitoring Procedures have been specifically stated for having a system at ground level to exercise caution against the transaction suspected to be involving laundered money and for its identification and reporting to the FIU-IND through periodic reports.

The recommendations of Financial Action Task Force, the international watchdog, on Anti Money Laundering, and guidelines issued by Basel committee on Banking supervision, on Customer Due Diligence, are the basic parameters, which are required to be adhered to by the countries, for a sustained fight against global threat of money laundering. These standards have become the benchmark for framing Anti Money Laundering laws by the respective countries like the PMLA, legislated and put into operation in India.

Regulatory authorities on the basis of these guidelines and requirements under PMLA have issued instructions on KYC & CDD, to give proper effect to the said law in the financial sector. As per these guidelines, financial institutions should undertake CDD measures, for establishing the identity of the customer by proper verification, particularly when initiating business relation, or carrying out occasional transaction, beyond the applicable threshold limit, or when there is a suspicion of money laundering or terrorist financing, or there is a doubt about the veracity or adequacy of previously obtained customer identification data.

Such verification, identification should be under taken for the customer and the beneficial owner by using reliable, independent source documents, data information. For legal persons, financial institutions should take appropriate measures to understand the ownership and control structure of such customer, obtaining information on the purpose and intended nature of the business relationship behind such entity.

Compliance with these standards of KYC and CDD by the financial institutions has been made mandatory through instructions issued by concerned regulators. These guidelines are essentially in the nature of filters having been introduced, and being operated at all the important entry points to the economy like bank, insurance, stock market.

But the success of the KYC and CDD regime will be judged from, how effectively the system has prevented the entry of crime money, rather than from how many cases have been detected after the entry of the laundered money.

The writer is Commissioner, Customs & Central Excise, Delhi. He was earlier Special Director at Enforcement Directorate, Delhi.
susantkumarpanda@rediffmail.com