UNIT12

KNOWYOURCUSTOMER(KYC)

12.1 Objectives

12.2 InitiativesbytheRBI

12.3 Somebasicdefinitions

12.4 KYCpolicy:Origin

12.5 Customer:DefinitionundertheKYCprinciples

12.6 GuidelinesonKYC

12.7 Riskcategorization

12.8 Transactionprofile

12.9 Strategiesforriskmanagement

12.10Organisationalstructure

12.11Customerprivacy

12.12ImportantprescriptionsintheKYCframeworkoftheRBI

12.1OBJECTIVESKnowyourcustomer(KYC)processismeanttoweedoutthebadcustomers,toprotectgoodones (andthebanks). It is,therefore, importantthatbankscontinuetostayfocusedonbusiness,ongoodcustomerrelationship;gettoknowmoreaboutclientneedsandpreferences.TheKYCprocessisonlytoensurethatbankingoperationsarespotlesslyclean;tohelpclientsandbankpersonnelintheproperconductofbusiness,withcomfortandconfidence.KYCisessentialtoensurethatthereisnoslippagefromthisbasicbankingprinciple.Knowingacustomerisabasictenetinbanking.Detailedinformationtobuildupacustomerprofilehasbeencollectedtoservepurposeslike

satisfyinglegalrequirementsforthebankercustomerrelationship; toknowcustomerneeds,toextendappropriateservices,and

to know the various categoriesof customers (size,habits,typesandpreferences)toenhancebanksownbusiness.

Usingsuchdatafortrackingcustomertransactionsandtomonitortheaccountforpossibleabuseor illegaluse isalsooneof theobjectivesof theKYC.Growing incidents of banking channels beingmisused by individuals and

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organizedsyndicatesforpurposeslikemoneylaunderinghaveintroducednewdimensionsandfocustotheKYCrigour.

KYCdeficienciescanleadtovariousbusiness,operational,legalandconcentrationrisks.Evenwhenabankgetsunknowinglyusedformoneylaundering;suchinvolvement can lead to substantial risk of loss of reputation; andthroughthat,tolossofbusiness.

12.2.INITIATIVESBYTHERBITheRBIhastakenstrong,stagewisesteps.Guidelinesissuedbyitin2002havebeenrefinedcontinuously.Guidelinesrelatetoidentificationofcustomersandsystemsandproceduresthatallbanksshouldhaveinplaceforearlydetectionandpreventionoffinancialfrauds,moneylaundering,scrutinyandmonitoringoflargevaluecashtransaction,etc.,undersection35oftheBankingRegulationAct,1949.

Guidelinesweremadesharper(November29,2004)inthelightoftherecommendationsmadebytheFinancialActionTaskForce(FATF)onAntiMoneyLaundering(AML)standardsandoncombatingfinancingofterrorists(CFT).ThesestandardsaretheInternationalbenchmarksforframingAMLandCFTpoliciesbytheregulatoryauthoritiesinallcountries.

DeadlineswerestipulatedbytheRBIforallbanksinIndiatohaveclearpoliciesonAMLandCFT(February25,2005)andtobecomefullycompliant(December21,2005.)

12.3.SOMEBASICDEFINITIONSBeforegettingontotheknowyourcustomerdiscussions,letustakealookbackintothedefinitionsrelatingtothetwoplayersinthisscenariothebankerandthecustomer.

Thetermbankingisdefinedundersection5(b)oftheBankingRegulationAct.1949. Bankingmeansaccepting, forthepurposeof lendingor investment,depositsofmoneyfromthepublic,repayableondemandorotherwise,andwithdrawablebycheque,draft,orpayorder.Accordingtothedefinition,thebankerisonewhoengagesinthebusinessofacceptingdepositsfromthepublicandutilizingsuchdepositseitherforthepurposeoflendingorforthepurposeofinvestment.

Customerisgenerallyonewhoconductstransactionswithabank.Acustomercouldbeanindividual(anaturalperson),apartnershipfirm,acompany(privateorpublic),aSociety,aTrust,alocalCorporationorinstitution,oranyintermediary(likeastockbroker);itmayevenbeaGovernmentorGovernmentagency.

Bankercustomerrelationshiparisesfromanyservicerenderedbyabanktoitscustomerinanyoftheaboveforms.Therelationshipcouldbecasualorshortterm(likeastrayissueofademanddraft)orlongterm(likehavingacurrentaccountoraloanaccount).

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On account of this, the relationship assumes any one of the various legalrelationshipslikedebtorcreditor,creditordebtor,mortgagormortgagee,baileebailor,trusteebeneficiary,lessorlessee,agentprincipalandsoon.

Withthewidenedrangeofproductsandcomplexservicesextendedbybankstocustomersinrecentyears,therelationshipsalsospanalargevarietyofforms.Eachrelationshipislegal;henceanytransactionunderanyrelationshipwillneed tosatisfy the laws and processes that govern such relationship andtransaction.

Furtherasthebanksarethebackboneofanyeconomyandtheenginesofitsgrowth;theseneedtoensurethatnocustomeroftheirsandnotransactionbythemadverselyimpactsocietyatlarge.

Organizedfinancialcrimeshave,progressivelyandquietly,assumedanincreasinglydevastatingsizeandpowertothreatentheveryfabricofinternationalsocietyandthesecurityofitspeople.Theperpetratorsingenuityandtheireconomicandpoliticalinfluencehavebeenfoundtounderminefinancialandeconomicviability,collectiveethicalstandardsandultimately,societyatlarge.Itisforthisreasonthattheidentificationandotherproceduresregardingopeningofaccountsetc,whichhavebeenpractisedbybanksovertheyears,havebeenreclassifiedunderKYC.

12.4.KYCPOLICY:ORIGINThe Basel Committee1reports of 1997 and 1998 adopted a statement ofprinciplesconcerningantimoneylaundering.ThestatementcarriedthefirstinternationalmentionofKYCproceduresandencouragedbankmanagementsandtheircentralbanks,internationally,todrawguidelinesforfullidentificationofcustomers,tomaptheirtransactions.

Amongothernationalcontrollers,theFederalReserveoftheUSA initiated,almostimmediately,proposalsrelatingtothemonitoringofcustomertransactionsandthereportingofsuspicioustransactions.Itrequiredbankstodrawupcustomerandtransactionprofiles,recordsourcesoffunds,determinenormalandexpectedtransactions,identifythosewhichwereinconsistentandreport suspicious ones to a centralmonitoring authority. These are beingfollowed,religiously,byallbanksintheUSAwithquickpunishmentsbeingawardedbytheregulatorswhenseriousaberrationsareobserved.

12.5.CUSTOMER:DEFINITIONUNDERTHEKYCPRINCIPLES

5.1ForKYCpolicy,acustomerisdefinedas

apersonoranentitythatmaintainsanaccountwithabank, one on whose behalf the account is maintained(i.e.,the

beneficialowner),

beneficiariesoftransactionsconductedbyprofessionalintermediaries,likestockbrokers,solicitors,etc.,aspermittedunderlaw,and

1.AcommitteeconstitutedbyBankforInternationalSettlementinvolvingthe

centralbankauthoritiesof10developedcountries.

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anypersonorentityconnectedwithafinancialtransactionwhichcanposesignificantreputationorotherriskstothebank(e.g.,awiretransfer,or,theissueofdemanddraftofhighvalueinasingletransaction).

RBIsApproachandobjectives

TheapproachtotheKYCregimeinRBIsguidelinesis,basically,

topreventbanksfrombeingused,intentionallyorunintentionally,bycriminalelementsfortheirmoneylaunderingactivities,and,

tohelpbankstoknowtheircustomerandtheirfinancialtransactionsbetter;this,inturnwillhelpthebankstomanagetheirrisksprudently.

KYCprocessesaretobelaiddownatthecorporatelevelandshouldbefollowedbytheoperatingunits/branches.TheRBIguidelineshavecertainkeyexpectationsinthisregard.

12.6.GUIDELINESONKYC

TheRBIexpectsallbankstohavecomprehensiveKYCpolicies.Thesepoliciesshouldbeonkeyareasmentionedbelow.BankBoardswillhavetoevolverelativepoliciesandprocessesandensurethattheseareimplemented,faithfully,atalllevels.

(a)CustomerAcceptancePolicy(CAP)Explicitcriteriaforacceptanceornonacceptanceofacustomerandhis/herrelationshipwiththebank.

Broadaspectsofpolicycouldbe:

noaccountshouldbeopenedinanonymous/fictitiousorbenaminame(s);unoaccountshouldbeopened(oranexistingaccountcontinued)wherethebanksduediligenceexercisesrelatingtoidentity,andtheobtentionofevidentialdocumentsarenotfulfilledorsuccessful;whentheapplicantdoesnotcooperate;orthereliabilityofdata/informationfurnishedinthedocumentsisindoubt

ensuringthattheneworexistingcustomersidentitydoesnotmatchwiththat of apersonanongrata,i.e.,anypersonwithknowncriminalbackground,anybannedentityliketerroristorganizations,FERAviolatorsetc.

whenacustomerdesirestoactonbehalfofanotherperson,ananalysisshouldbemadeonthecircumstancesunderwhichsuchoperationisrequired,thetypeandsizeoftransactionsandthatthetransactionsdonotinfringethelawofthecountry

documentationrequirementsandotherinformationtobecollectedinrespectofdifferentcategoriesofcustomersshoulddependupontheriskperceivedandalsokeepinginmindtherequirementsofthePreventionofMoneyLaunderingAct.

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(b)CustomeridentificationprocessProcedurestobefollowedbybankpersonnel inopeninganewaccountorreviewinganexistingaccount.

ThePolicyapprovedbythebanksBoardshouldclearlyspelloutthecustomeridentificationproceduretobecarriedoutatdifferentstagesi.e.,whileestablishinganewbankingrelationship,carryingoutafinancialtransactionorwhenthebankhasdoubtontheauthenticity/veracityoradequacyofthepreviouslyobtainedcustomeridentificationdata(inthecaseofexistingaccounts).

Customer identification means identification of the customer andthe verifying of his/her identity by using reliable and independentsourcedocuments,dataorinformation.

Forcustomerswhoarenaturalpersons,banksshouldobtainsufficientidentificationdatatoverifyidentityofthecustomer,his/heraddress/location,andalsoarecentphotograph.

Forcustomersthatarelegalpersonsorentities,banksshould

(i)Verifythelegalstatusthroughproperandrelevantdocuments.(ii) Verify that any person purporting to act on behalf of the legal

person/entity is so authorized and verify the identity of thatperson.

(iii)Understandtheownershipandcontrolstructureofthecustomeranddetermine thenaturalpersonswhoultimatelycontrol theentity.

(c)Monitoringofcustomertransactions:

Thisisacriticalaspect.Thepolicyandproceduresshouldclearlyhelptheparameterisingofthetypeandsizeofnormaltransactionsinacustomersaccountandthequickidentification,forfurtherenquiry,ofanabnormaltransactionliketheonethatfallsoutsidethenormallevelandpatternofactivityrecorded.

Special attention should be placed on all complex, unusuallylargetransactionsandsuspiciouspatternswhichindicateviolationofthelawsofthecountryorthreateningitsfinancialwellbeing.

Itshouldbeensuredthatthereisnostructuring,i.e.,manipulationofthesizeoftransactionssothat,ifseenindividually,theyfallbelowthevaluesorthresholdthatneedtobereportedtotheregulators/monitoringauthority.

Transactionsthatinvolvelargeamountsofcashinconsistentwiththecustomersnormal/expectedactivityshouldreceivespecialattention.

Veryhighaccountturnover,inconsistentwiththebalancemaintainedorincomesdeclared,mayindicatewashingofillegalfunds.

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Arecordshouldbemaintainedofalltransactions,depositsorwithdrawals,involvingRs10lakhsandabove,

Banksshouldhaveaninternalmonitoringsystemtoreportsuchtransactionsasalsosuspicioustransactions.

(d)Riskmanagement

Documentation/datacollectionforcustomeridentificationshouldbeaspertheRBIguidelinesrelatingtodifferentcategoriesofcustomers.

12.7RISKCATEGORIZATION

Bankswouldneedtocategorizetheircustomersaslow,mediumandhighrisks.

(a)Lowriskcustomers:

Theseareindividuals(otherthanhighnetworthindividuals)andentitieswhoseidentitiesandsourceoffundscanbeverifiedeasily;transactionsinwhoseaccountsareinconformitywithknownCustomerandTransactionprofiles.(Salariedemployees,Govtdepts,Govtownedcompanies,regulators,regulatorybodiesetc,fallinthiscategory),Forthiscategory,itshouldbeadequateifthebasicrequirementsofverifyingtheidentityandlocationofthecustomeraremet.

(b)Medium/highriskcustomers:

Thiscategoryincludescustomerswhocarryaninherentlyhigherthanaveragerisktothebank.Thecategorizationwilldependuponthecustomersbackground,natureofactivity,location,countryoforigin,sourceoffunds,volumeandfrequency of transactions,(large and not in tune with the recorded/anticipatedlevels),etc.Diligenceinidentification/trackingwouldneedtobeofahighorderinsuchcustomers(examplesofthiscategory:NRIs,highnetworthpersons,potentates,Trusts/Charities,NGOsreceivingdonationsfromabroad,Overseas Corporate Bodies, Politically Exposed Persons (PEPs) of foreignorigin,companieshavingclosefamilyshareholdingorbeneficialownership,firmswithsleepingpartners,nonfacetofacecustomers,thosewithdubiousreputationetc.

12.8TRANSACTIONPROFILECompilationofacustomerstransactionprofileisimportantasitiscriticaltotheidentificationoffraudulent/suspicioustransactions.

Atransactionprofileisamatrixofdifferentcomponentslikesourceoffunds,levelofincome,volumeandfrequencyoftransactions,originanddestinationoffundsetc.Theprofileshouldhelpinarrivingatathresholdorbenchmarktransactionforindividualcustomertransactionsagainstwhichacomparisoncanbemade.Ifpossible,itshouldalsocarryapatternthatcanbetakenasthecustomersnormaltransactionpattern.

Itwouldbeidealtoarriveatindividualthresholdlimitsparticularlyforthehighriskcategory of customers. Banks may use software programs for such

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analysis. Itwouldhelp ifan alertpopsupora signalgets flashedon thecomputerscreenwhenthetransactioncrossesthethreshold.

Whilesophisticatedsystemsmaybeusedtodeterminethresholdlimits,broadly,25%oftheannualincomeinthecaseofindividualsandonemonthsturnoverinthecaseofbusinessenterprisesmaybeassumedasthresholdlimits.

ThepresentRBIguidelinessuggestmonitoringoftransactionsaboveRs10lakhs;thosebelowthatlevelareexemptfromscrutiny.Theseguidelinesmayberevisedatintervalsandmustbekepttrackof.

Theprofileshouldbearchivedinsuchamannerthatitcanbequicklyaccessedforverifyinganytransaction,whensuchrequirementarises.TheRBIhasbeenstipulatingcertainthresholds:theseneedtobefollowedmeticulouslyasrelatedtoKYCinscreeningaccounts,monitoring,reportingsuspicioustransactionsetc.

12.9STRATEGIESFORRISKMANAGEMENT

Banksshouldhaveknowledge,sensitivityandresponsivenesstorisksandtheirmanagement.Theirpolicies,proceduresandformatsused,thedistributionofinstructionstoallpersonnelconcerned,theirarchivingorrecordretention,accessibility,periodicreviews,trainingofpersonnel,sensitivitytoandalertnessinreportingsuspicioustransactions,organizationalstructureinthebanksforsuchtasksetc,indicatethelevelofthebanksriskmanagementcapability.Banksshouldhavestrongsystemsofcomplianceandauditfunctions.Theauditdepartmentshouldbeindependentofoperationsandbemannedbyknowledgeableandresponsibleexecutives.Theyshouldbecapableofevaluatingthebankspoliciesandtheircomplianceatoperatinglevels,efficiencyofthesoftwareused,particularlyformonitoringandreportingcompliancetoregulatoryauthorityanddetailedverificationofKYCprocessesatbranchesandsupervisoryefficiency.Anaudit isnota fault findingprocess. It isabasicorganizationaltooltoreducedeficienciesandtominimiserisks.Itshouldbesoperceivedandusedbybankmanagementsandoperatingpersonnel.

AuditreportsshouldbepresentedtotheBanksAuditCommittees,throughchannelsasmaybedeterminedbyeachbankmanagement.Whatisimportanthereisavailabilityofauditskills,integrityinauditprocess,transparencyandquicknessinreportsandtheirresolution.

Ongoingtrainingprogrammes (orseminars) forbankspersonnel,designedappropriatetotheirresponsibility(operatingstaff,compliancemonitors,auditstaff,controllersetc)shouldbeheldsothattheyarefullysensitizedtotheneedforKYC rationale, policy, process and important environmental events ofmoneylaundering,strategiesofcontainmentaspractisedglobally,softwareprogrammesetc.Trainingprogrammesshould includecurrentevents,casestudies,situationanalyses,talkbypersonswithexposureabroadetc.

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12.10ORGANIZATIONALSTRUCTUREBanksshouldpossessaneffectiveorganizationalstructuretoevolve,implement,maintainandreviewKYCpolicyandprocesses.ThebankshouldhaveaPrincipalOfficer for overall control, ensuring reporting and follow up onsuspiciousactivity,liaisonwithregulatoryauthorityetc.

12.11CUSTOMERPRIVACYBanks KYC processes should, on no account, lead to any harassment ofcustomers.KYCimplementationshouldnotleadtoanyunreasonabledenialofopeningofaccounts.

Wherebanksdesire to collect information forpurposeother thanKYC, itshouldnotbethroughaccountopeningforms(i.e.,therelativequestionsshouldnotbepartoftheform).Answeringtoqueriesshouldalsobeattheoptionofthecustomer.

ItwouldbegoodifbankscouldissueabrochuretoeducatecustomersonKYCandwhyelaboratequestionsarebeingasked.Thereiscertainlyaneedtobriefcustomersinthisarea.

Information collected shouldnotbedivulged toothersnorput touse forcommercialpurposes.Strictprivacyshouldbemaintained.Bankscould includetheseaspectsintheirKYCpolicydocument.

12.12IMPORTANTPRESCRIPTIONSINTHEKYCFRAMEWORKOFTHERBI:DetailedguidelineshavebeenprescribedbytheRBI,forvariousKYCprocesseslike:

Customerprofiles;foropening/reviewingofaccountsofvariouscategoriesofcustomers.

Identificationofhighvalue/suspicioustransactions/terrorismfinance.uMonitoring of suspicious transactions and reporting the same andreportingofcashtransactionsofRs10 lakhandabovetocontrollingoffices.

AccountabilityfornoncompliancewiththeKYCguidelines. Timeframeforimplementation

TheRBIalsorevisestheguidelinesbasedonnationalandinternationalexperience

Bankswouldneedtokeepthemselvesupdatedonanongoingbasiswithsuchchanges.