KYC: An effective tool to fight 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, channelising surreptitiously through legitimate business channels and integrating those to the financial system through ways like bank deposits, investments or transfer.

Financial institutions like banks, insurance companies and stock markets 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 (KYC) policy and Customer Due Diligence (CDD) guidelines across the financial sector.

The act of money laundering has been made a criminal offence in India through enactment of the Prevention of Money Laundering Act 2002 (PMLA). 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 projecting it as untainted property are guilty of the said offence of money laundering under Section 3 of the Act. 

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

To achieve the objective, Section 12 of the Act has put the obligation on banking companies and financial institutions to keep a watch on suspicious transactions and movement of tainted funds and 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 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 these norms 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 the Financial Action Task Force (FATF), the international watchdog, on anti-money laundering and guidelines issued by the Basel committee on banking supervision on customer due diligence are the basic parameters required to be adhered to by the countries. This is all for a sustained fight against its global threat. These standards have become the benchmark for framing anti-money laundering laws by the respective countries like the PMLA in India.

Regulatory authorities on the basis of these guidelines and requirements under the PMLA have issued instructions on KYC and 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. This is particularly when initiating a business relation or carrying out any occasional transaction beyond the applicable threshold limit or when there is any suspicion of money laundering or terrorist financing, or there is doubt about the veracity or adequacy of previously obtained customer identification data.

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

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

But the success of the KYC and CDD regime will be judged from how effectively the system has prevented the entry of such ill-gotten money rather than from how many cases have been detected after such instances come to the fore.

SK Panda is commissioner, customs & central excise at Delhi. He was earlier working as special  director at Enforcement Directorate, Delhi. He can be contacted at susantkumarpanda@rediffmail.com.