This article is written by Diksha Trivedi, a student of Nirma University.

INTRODUCTION

Money laundering is an act of underground economy which engages in the concealing of the source or destination of the specific financial transaction. In 1995, The Interpol General Secretariat Assembly defined money laundering as: “Any act or attempted act to conceal or disguise the identity of illegally obtained proceeds, so that they appear to have originated from legitimate sources”. This unfettered investment and spending of the criminally converted income of the offenders has been an ongoing concern of law enforcement agencies.

The concept of money laundering originated in the U.S.A. In history, the first case of money laundering was when American mobster Meyer Lansky transferred funds from small casinos to overseas accounts, especially Swiss banks. The term given at that time, to this act was ‘capital flight’. However, the term money laundering was used for the first time by a British newspaper in the case of “Waterland Scam” where, illegal funds obtained for the president’s re-election were moved to Mexico and then brought back through a company to Miami.

The Basel Principles suggested the following policies in order to curb Money Laundering:

• Customer Identification –RBI introduced the ‘Know Your Customer'(KYC) compliance to make sensible pains for true identification of the client and related measures to check the bonafide information provided by customers.
• Compliance with Laws –The rules with regards to the financial transactions are to be implemented as put in the banking statutes. Banks should further not allow any financial service if there is a suspicion that the money might be used for money laundering.
• Cooperation with Law Enforcement agencies – Banks should interlinked with law enforcement authorities and regulate the laws for maintaining the privacy of its customers.

MONEY LAUNDERING IN INDIA – THE PROBLEMS AND SOLUTIONS

In India, money laundering is interlinked with drug trafficking. Money launderers ensure that money does not reach the hands of the formally regulated institution thus making sure that law enforcement in this respect does not take place. There is no legal paper work for this underground system of money as well as no room for penetration as these systems are generally family operated or gang operated.

The money laundering impact in India is substantial; the Union Revenue Department unearthed 900 bank accounts, holding a pooled cash of nearly Rs. 1,000 crore being owned by sham names in Delhi alone. As per a KPMG report, India holds around 2-3% laundered money of the whole country’s GDP. To prevent or at the least reduce money laundering in India, the Government introduced the Prevention of Money Laundering (amendment) Bill, 2008 (PMLA) in Parliament. This was a new milestone in the anti-money laundering initiatives spectrum by the Government of India.

What Is Anti-Money Laundering?

In simple terms, Anti-Money Laundering or AML are the regulations and procedures that are designed to prevent money laundering. The increasing success of Anti-Money Laundering has been helped at the grass roots level by the growth in credit cards and the increasingly cashless society we now live in. In the context of the investment industry and the hedge fund industry, Anti-Money Laundering procedures that are followed, or should be followed, are, to a great extent, based on three core requirements;

First – client verification procedures what is known as Know Your Client or KYC,

Second – identifying and knowing the source of the money that is being invested and confirming that it is bona fide;

Third – and, in my opinion, this is, perhaps, the most important procedure that needs to be followed, ensuring that the proceeds of any investment made into a hedge fund, are, when redeemed or liquidated, repaid into the original remitting bank account or, at least, into a bank account in the name of the investor, providing that account is held at a reputable bank, based in an approved and reputable jurisdiction.

The requirements at that time were to have a file containing a certified or notarised copy of each client’s passport or some other photo ID, together with some proof of residence usually provided in the form of a certified or notarised copy of a utility bill. Today, Client Verification or KYC information is very much more comprehensive than it used to be but, in essence, it is relatively simple.  The difficultly sometimes is getting that information and one of the things that the investment industry has to devote some time and effort to is, in my opinion, educating investors so that they realise they have to do this in order to invest in any respectable investment, wherever they may live or wherever that investment may be established or domiciled.

One of the basic tenets of regulation and, particularly of Anti-Money Laundering, has been to provide any steps to ensure that duplication of work does not weaken the process.  This leads to the concept of the Designated Body.  A Designated Body is, in simple terms and in the context of Anti-Money Laundering, a financial institution that is regulated by an appropriate regulator in an appropriate jurisdiction and meets certain regulatory standards regarding anti-money laundering procedures in accordance with your own local regulations.

The Reserve Bank of India is cracking Down on Money Laundering

India has a panoptic “informal economy.”Many wealthy Indian keep their money capital out of formal regulation hence store their wealth in sources which are difficult to  trace for laws application like  housing, land or precious metals,. About 85% of Indians  are paid in cash .It is estimated that  about $2 trillion of the money existing outside  the financial system as black economy of India, which  is a lot more that country’s GDP.    However, Indian government has done little with respect to that.  India, in June 2010  attended as the 34^th  member of the Financial Action Task Force (“FATF”),  an inter government body that looks after  money crime and provide suggestion to the government for crimes like terrorist financing,  money laundering and other ills of a financial system. The Reserve Bank of India (RBI) has increased its responsibility in fighting money laundering and with regards to this it issued several advisories to local financial institution in combating the same. On failing to perform the obligations strict actions will be taken by the apex bank of India. On a surprise check RBI found  438 financial institution being in violation of compliance with Anti-Money Laundering (AML) , Know Your Customer (KYC), and Combating the Financing of Terrorism (CFT) guidelines. Among those violators many were under the control of the central government and hence RBI believed government to be violators of the money laundering. RBI for the same reasons introduced various guidelines for non-complying customers but their implementation is difficult because they hold around 8100 million of deposits in the economy. One such compliance is that financial institution must have a record of the customer dealings as well as where the money is coming from and where it is going to, including address and photograph as RBI screening priorities. This compliance is made so that RBI should be aware about the locus standi of the person who is making the transaction. This is the attempt made in order to bring stability to the turmoil of Indian economy in 2015 by following the ethics and compliance suggested by RBI.

Know Your Customer and Other Guidelines

The RBI too has played an important role in curbing the menace of money laundering The RBI issued the Know-Your-Customers (KYC) Guidelines – Anti Money Laundering Standards on 16th August 2005. The Government has also established a Financial Intelligence Unit-India (FIU-IND), in rank with FATF recommendations. The FIU would be given the Suspicious Activity Reports from all FIs and would study them before passing them to the Enforcement Directorate for investigation and prosecution. The RBI has stressed that banks can successfully control and decrease their risks only if they have an understanding of the normal and practical activity of the customer so that they have the means of spotting transactions that fall outside the standard model of activity.

In the context of internet banking, there is always a danger that being extremely mobile, these transactions shall remain undetected. Thereby such banks have been asked to open accounts only after proper physical introduction and substantiation of the customer. The online banking systems are also required to keep a record of all the transactions or series of transactions taking place within a month, the character and worth of which may be set by the Central Government. This will sufficiently guard in opposition to any abuse of the Internet banking services for the intention of money laundering.

The RBI’s know your customer standards are important in the context of controlling money laundering. As per these standard, Banks must outline their KYC policies slotting in the following four key fundamentals:

• Customer Acceptance Policy;
• Customer Identification Procedures;
• Monitoring of Transactions; and
• Risk management.

Besides this, the RBI has cautioned eight other banks[1]  to put in place appropriate measures and review them from time to time to ensure strict compliance of KYC requirements in future.

“This action is based on deficiencies in regulatory compliance and is not intended to pronounce upon the validity of any transaction or agreement entered into by the bank and its customers,” it said. The penal action was based on the basis of a complaint received by the RBI from a private organisation.

A scrutiny of “fixed accounts” opened in its name in Mumbai-based branches of certain public sector banks was undertaken in July 2014.

“With more complaints and involvement of other banks coming to light, a wider thematic review was conducted and in all 12 branches of 11 public sector banks were covered,” it said.

“The scrutiny or thematic review looked into the modus operandi of the alleged frauds involving accounts of certain organisations in these banks, deficiencies or irregularities while opening Fixed Deposits (FDs) and extending Overdraft (OD) facility there against,” it said.

Besides, it said, the effectiveness of systems and processes in place pertaining to implementation of know your customer (KYC) norms or anti-money laundering (AML) standards in respect of these accounts was also looked into.

The findings revealed violation of certain regulatory guidelines issued by the RBI as also other “disquieting” actions on the part of the banks including non-adherence to the RBI’s instructions regarding funds received through Real Time Gross Settlement System (RTGS) and opening of FD accounts and granting overdrafts there against without due diligence.

Additionally, the RBI also found involvement of middlemen or intermediaries in opening of the accounts as also subsequent operations in those accounts.

Based on the findings, the RBI issued a show cause notice to 11 banks, in response to which the individual banks submitted written replies.

“After considering the facts of each case and individual bank’s reply, as also, personal submissions, information submitted and documents furnished, the RBI came to the conclusion that some of the violations of serious nature were substantiated and warranted imposition of monetary penalty on three banks, namely, BoM, Dena Bank and OBC,” it said.

DUTY OF THE FIRMS TO PREVENT MONEY LAUNDERING

All firms who are subject to the Money Laundering Regulations 2007 must put in place systems and control to prevent and detect money laundering. Many authorised firms also have an additional regulatory obligation to put in place and maintain policies and procedures to mitigate their money laundering risk. These include systems and controls to identify, assess and monitor money-laundering risk as well as customer due diligence (CDD) measures and monitoring to manage the risks identified. Firms must determine the extent of CDD measures and monitoring on a risk-sensitive basis depending on the type of customer, business relationship and product or transaction. For this purpose, The FCA is the competent authority for supervising compliance of most credit and financial institutions with the Money Laundering Regulations.

Firms must ensure that their systems and controls enable them to identify suspicious transactions. They are required under the Proceeds of Crime Act 2002 to submit any Suspicious Activity Report to the National Crime Agency where they know or suspect that a person is engaged in, or attempting, money laundering.

Firms must ensure that they are able to demonstrate the extent of their CDD measures is appropriate in view of the risks of money laundering and terrorist financing.

Additionally, all firms who are subject to the AML rules must allocate overall responsibility for anti-money laundering systems and controls to a director or senior manager. They must also appoint a Money Laundering Reporting Officer (MLRO), who should act as a focal point for the firm’s anti-money laundering activity.

With respect to mortgage brokers, general insurers and general insurance brokers who are not subject to our AML rules and the Money Laundering Regulations they are required to put in place systems and controls to prevent financial crime, which includes money laundering. Failure to have adequate systems and controls in place, for example, the absence of a process for reporting knowledge or suspicions of money laundering, put these firms and their employees at risk of committing money laundering offences. Many firms therefore choose to implement controls similar to those adopted by firms who are subject to the Money Laundering Regulations and the FSA’s AML rules.

Despite the various measures that have been undertaken it has to be understood that India’s anti-money laundering regime is still in its early stages and banks need to put in place, better systems to ensure they do not fall prey to misuse. Banks can effectively reduce the risks of banking transactions if they identify transactions that fall outside the regular pattern of consumer’s activities. Banks need to have an effective anti-money laundering technology system. These have yet to be effectively implemented in the country.

Conclusion

Money laundering is a serious threat to the global financial system and good governance. It is also boosting international crimes and terrorist activities. Governments in various countries today have come up with different legislations to deal with this menace. However more needs to be done in this regard. Black money in India, it is estimated accounts for around 40% of India’s GDP. Moreover it is the politicians in India, who are high risk customers who indulge in this activity.

In times of globalization, Indian financial institutions and banks would like to become important players in the financial setup. This could be achieved only by ensuring that proper prevention of money laundering norms are in place and have been setup effectively. In the absence of these norms it is likely that the indigenous institutions and banks shall be black listed by the foreign countries. Thereby there is a need to not only effectively implement the anti-money laundering operations, but also to ensure that there is a constant review of the anti-money laundering (AML) programme and timely up gradation as well. Also, Banks must strictly adhere to the Know Your Customer (KYC) Guidelines as setup by the RBI.

[1] Central Bank of India, Bank of India, Punjab and Sind Bank, Punjab National Bank, State Bank of Bikaner & Jaipur, UCO Bank, Union Bank of India and Vijaya Bank