CHAPTER -02

KYC & AML GUIDELINES (PART –I)

INTRODUCTION
There is an interesting case related to a remittance scam in the whole Bank of Baroda - the
amount of money that is said to have gone out of the country (Rs .6,000 crore) is bigger than
the illegal money which the Government has claimed to have recovered from foreign soil
during the 90-day black money compliance window (Rs 4,147 crore). According to investigators,
Fraudsters transferred large amount of funds abroad by splitting into small sums through
several thousand transactions using names of non-existent entities to avoid taxmen. Fraudsters
have been using the country’s banking channels for transactions on trades that never happened
over a period of time and one wouldn’t know how many more banks have been subjected to
similar frauds. It is quite possible that more skeletons would tumble out of the closet as the
investigations progress. Until now, in most cases, unaccounted cash or black money has
changed hands through hawala channels. But, rampant use of formal banking channels in this
scale is unheard of in the recent past. It indeed raises serious concerns.

MODUS OPERANDI
The modus operandi in the BoB case is interesting. The perpetrators opened some 59 accounts
in BoB’s Ashok Vihar branch under the names of various companies and initiated multiple
remittance transactions in these accounts. Finally, the bank was asked to transfer this amount
to certain companies abroad as advance remittance for imports.

Since several accounts were opened and the funds were split into small units, the transactions
probably didn’t come to the notice of the Reserve Bank of India (RBI) or agencies like the
Financial Intelligence Unit (FIU), which typically filters large transactions. According to the
investigators, no transaction exceeded $1 lakh to avoid automatic detection tools.

Investigators have found that many company addresses used to open accounts that didn’t
actually exist. According to ED, transactions were initiated for fake imports and exports,
meaning no real movement of goods happened.

In the BoB case, the bank’s auditors themselves had found out the fraud and reported to CBI
and Enforcement Directorate. But, the question is why it took so long for BoB to detect the
chain of transactions. Also, going by the findings of investigators, the bank has clearly failed to
do its KYC due diligence with respect to both end of its customers in this particular series of
transactions — importers and the foreign exporters.

Following will be discussed in this Chapter.

KYC meaning Know Your Customer guidelines are formulated to safeguard the Bank’s interest
from the hands of fraudsters and to understand their customers’ and their financial
requirements cautiously and also to eliminate Money Laundering or money reaching the hands
of Terrorists. Money Laundering It refers to the process of concealing the source of illegal
money. Money Laundering is a process through which the origin of money obtained
fraudulently is suppressed.

Possibly this money can be through either an illegal business or income obtained through
irregular means. AML guidelines are brought in place to avoid money laundering activity.

(1)When money enters illegally in to the banking system, there are different methods through
which the same can happen. Customer may deposit cash in small denominations to avoid
finding out of the fraudulence by banks, since such transactions would be for small amounts,
and may not be routed through the same account and will be diverted through different
accounts across. The modus operandi adopted here is – first cash is deposited in the account
which subsequently is transferred to a normal running account.

(2)Customers while doing complex transactions, ensure to hide illegal source from which the
amount is received. Ex: Transferring Rs. 25,000 daily from 5 different accounts to a single
account. Transferring frequently from one account to another etc., are the normal transactions
observed. If such transactions are done through multiple accounts and more so through
different banks, it would be difficult to find out the transaction details

Hence there arises a need to define as to who a customer is?

A person with a due business relationship or through maintaining an account with a bank,
becomes its Customer. Also, if the customer does not have an account, at least a business
relationship established through a financial transaction makes him a customer of the bank.

Ex: Sundar who is having a saving account with a bank becomes its direct customer. If sundar
obtains a draft favouring Babu and if Babu does not have an account with the bank, he
becomes an indirect customer of the bank.

The four principle guidelines prescribed by RBI are as under:

1. Customer Identification:
This will confirm the identity of the customer through comparison with the original document
submitted by the customer. Bank Officer is responsible for correctly obtaining the documents.
Following form a part of such document.
The banker customer relationship is the most essential thing to be understood here which has
something related to the customer’s transactions. That means the following are the essentials:

a. The exact service to be rendered to the customer

b. The exact quantum of each of such transaction

c. The character pertaining to the operation ie, whether large cash or cheque transactions etc.,

This is mainly meant to keep track of the transactions made and to ensure that any variation in
its nature is avoided. KYC documents will differ for different customer types. If Mr.Ramgopal
Verma, comes to the branch and wants to open a current account in the name of his company
M/s Ram Systems which is a proprietorship firm and Mr. Ramgopal Verma is its proprietor,
please note that since the account is to be opened in the name of the firm, the actual existence
of the firm should be verified. Also, along with the AOF, documents like PAN Card, Address
proof, Registration Certificate, IT returns etc., are to be obtained and the originals have to be
verified.

There are other people, with whom the bank has to be extra cautious. They can be
categorized as:

1) Politically exposed persons

2) Non face to face customers

3) Walk in customers.

2. Risk Management
Politically exposed Persons:

These are the persons who hold high political positions locally or abroad. These can either be
Government Personnel, or holding offices in Army or military or hold high Posts in the in the
political circle. These accounts are normally opened after obtaining sanction from higher
authorities. The following chart shows the comparison as to the dos and dont’s in respect of
procedures to be followed while opening an account of a PEP. Permission from higher
authorities is required while entering such customers.
Non Face to Face customers:

a. Increasingly accounts are being opened over internet or through phone banking.

b. This has avoided frequent visits of the customer to the branch

c. In such cases, more precaution is required to be exercised and all relevant documents duly
certified should be obtained at the time of Account Opening.

d. Certification is a process, through which the verification and approval processes are duly
taken care.

The process can be more clearly understood through the following example explained herein.
The documents submitted by Mr. Prasad can be verified at multiple places like –the bank
verifies authenticity of the PAN card through the website of Income Tax

Department www.incometaxindiafilling.gov.in/portal The address of the customer is verified

through a personal visit. After due verification and approval, the account is duly opened.

Internet is accessed by users for doing various types of transactions. The statistics of
transactions done through different modes, on comparison reads as under:

WALK IN CUSTOMER:

A WALK IN CUSTOMER is one who holds no bank account. He visits a branch either to get a DD
or a Credit Card, for which maintenance of a bank account is not compulsory.

3. CUSTOMER ACCEPTANCE
Important points to be noted here are:

1. No Benami accounts should be opened by banks. For example a customer may reveal only his
first name and does not reveal the other parts of his name. This is not acceptable. A person
named Narayan Rao Hanumanth Rao Deshpande, reveals his name only as Narayan Rao is not
acceptable.

2. Verification of original documents is compulsory which can be waived in exceptional cases.

Ex: Premraj Thankur mentions his name as Premraj, in some of the documents, can be accepted
since Premraj is known to the bank, and has an account with the bank and visits the branch
regularly.
3. More Care should be taken on third party operated accounts. Examples, accounts operated
through Mandate Holder and Power of Attorney which may end up in frauds.

4. Matching the identity of the customer is very essential. The name should not match with
names of any terrorist organization. Ex: Al Umer Mujahideen is aname which matches with a
Terrorist group and hence cannot be accepted.

Let apart, there are also guidelines from RBI to be strictly adhered to viz., In terms of RBI
guidelines, customers should be categorized as:
Note: Check points in a low risk account are:

1. Identity proof

2. Address Proof

3. Verification of high value transaction if any made through the account.

Example: Level II: Let us take the details of Mr. Rajat Bhatia’s account, we can understand
better.

a. Name: Mr. Rajat Bhatia,

b. Occupation: Own business

c. Organization: Real estate business;

d. Turnover INR 2 crores per annum.

e. Profile details: Mr. Bhatia is running a real estate business, and most of his transactions are
done through cash only. We should now understand as to why we should classify him as a Level
2 customer.

Note: Thus the account is categorized as level 2 at the time of its opening.

In a level II risk related accounts, following are to be taken care:

1. Verify identity through documents as well as personal discussion.

2. Personally verify the residential/business address

3. Newly opened accounts are placed under scanner for initial 6 months.

4. Ensure to check if there is multiple cash withdrawal and if so are they genuine?

5. Customers may resort to multiple deposit of cash to escape threshold limit.

6. Multiple deposits are done to avoid threshold crossing Rs. 50,000/- (for PAN)

Here Mr. Bhatia is doing business through cash and remits to the bank.

Some part of it relates to white money and other parts to black money which the bank is unable
to identify. Hence we classify the account under Level 2.

Here is an example where there arises suspicion:

Example of Level III

Level 3 customers can more be explained as under:

- It is those where the origin of funds are not exactly known

- The bank officials are required to be vigilant and exercise more caution on these accounts

- Many of the Level 3 accounts come under Non Resident categories or Politically Exposed
Persons and also Trusts and Charitable Institutions.

- The due diligence is strictly applied in the case of Level 3 customers which shall be apart from
the general guidelines followed for other accounts.

- To make it clear, let us say that Mr. Sitaram Nigam is a High net worth individual and wishes to
open an account with Novel Bank. The due diligence measure followed are:

 Background and past history to be established

 Details of customer’s other bank accounts and its conduct to be checked
 Country of origin of funds and its beneficiaries to be checked.

Thus the guidelines provide that

 Customer profile has to be maintained based on their risk category

 Higher the risk higher level of care and monitoring is required
 These details are highly confidential and should not be divulged to anyone.
 Officer should keep a record of the periodic account categorization done.
4. TRANSACTIONS MONITORING
Effectively the account can be easily monitored, through:

a. Understanding the transaction flow in an account

b. Monitor the transactions in the account on the basis of their risk portfolios.

c. Big malls and Electronic Galleries are pruned to high risk and hence monitoring of such
accounts is essential.

Test your understanding

1) Categorize the following in to Direct and Indirect Customers.

2) Define the four principles of KYC guidelines as prescribed by RBI.

3) Classify the following in to different risk categories (Level I, II and III in terms of
RBI guidelines):
i) Pritam Associates an NGO working for the welfare of physically handicapped
ii) Ram Motors dealers for motor cars
iii) Mr. Rajinder Sehwag, vice president at Business Institute
4) Ram Mishra works in Gujjal Finance Limited
Every month a salary of INR 1 lakh is credited to his account since last 1 month
Otherwise there is no big credit found in the account suddenly a credit of INR 20 lakhs is
received in his account which Mr. Mishra says is a loan availed for renovation of his
house. How will you categorize this account? (Low, medium or high risk).

5) Match the following: