It is important, in these days of drugs smuggling, terrorism, financial fraud, money laundering and arms dealing that banks know who their customers are. Banks must be comfortable with the honesty and the integrity of their customers. The need increases as external people like general selling agents introduce a number of customers. In order to develop a long- term relationship, it is very crucial that the banker should know as much as possible about his customer.
KYC means that a banker should know his customers. He should know about their business and as far as possible the nature of their earnings and their moral standing. Because of this reason it is recommended that persons known to the bank recommend prospective customers. Even though the introducers cannot be sued or held responsible, the introducers have a moral responsibility.
A banker will lose the statutory protection available under section 131 of the Negotiable Instruments Act if it is proved that he was negligent while opening an account. This is also reinforced by the concept of relationship banking. The basic concept behind KYC is that:
“How can you offer your client excellent service if you do not know what he requires? You need to be capable to anticipate his requirements. You can do this only if you know your customer well.”
The second reason is on borrowing customers. It would be very short sighted and foolishness to lend to someone whom you does not know. Although there was some negligence regarding the enforcement of the Know Your Customer (KYC) imperative, recent happenings such as terrorism, money laundering, drug smuggling, etc. has brought the need of KYC to everyone’s focus. Headquarters of banks, government and central banks are insisting on KYC policies being strictly followed.
RBI guidelines on KYC
The Reserve Bank of India has been issuing guidelines for the banks on KYC regularly. Some of the more important instructions are stated below.
RBI was instructed :
The applicants for demand drafts, traveler’s cheques and money transfers should attach their Permanent Account Number (PAN) on the application for transactions of Rs. 10,000 and above.
It was declared that cash should not be accepted for retirement of import bills. It was also mentioned that there must be a reasonable time between the time an introducer opens his account and introduces a potential account holder. Introduction of an account should facilitate the proper identification of the person opening the account so that the person can be traced if the account is misused.
Banks were instructed that demand drafts, travelers cheques, mail transfers and telegraphic transfers for Rs. 50,000 and above should be by debit to the customer’s account or against cheques only and not against cash.
Banks were advised to stick on to the prescribed norms and safeguards while opening accounts.
Banks were asked to make sure that when customers withdrew amounts from their cash credit/ overdraft accounts that funds were not diverted for the acquisition of fixed assets, acquisition of shares and other capital market investments and investments in associate companies.
Banks were instructed to be alert and ensure proper end use of bank funds. They were to keep an eye over heavy cash withdrawals by account holders that may be disproportionate to their normal trade/ business requirements.
On account of fraudulent encashment of dividend warrants / interest banks were instructed to not open accounts without proper introduction.
Banks were asked to ask for customer identification while opening accounts including the obtaining of photographs of customers.
RBI instructed that photographs should be obtained for both residents and non- residents and for those authorized to operate accounts.
On account of fraudulent operations in deposit accounts, banks were asked to inspect every request for opening joint accounts vigilantly. “Generally crossed cheques” and payable to “order” were to be collected only on proper endorsement. Banks were also instructed to exercise care in the collection of cheques of large amounts and make sure that joint accounts are not used for “Benami” transactions.
Banks were instructed to introduce a system of close watch of new deposit accounts and observe cash withdrawals and deposits for Rs. 10 lakhs and above in deposit, cash credit and overdraft accounts.
Banks were instructed to report to the RBI all transactions of Rs. 10 lakhs and above.
Banks were asked to keep a vigilant eye on transactions that may be by terrorist organizations.
Banks were instructed to freeze the accounts of individuals and entities identified by the Security Council Sanctions Committee of the United Nations (UN).
Banks were instructed to make sure that no new accounts were opened by banned organizations.
Reserve Bank of India (RBI) reinforced its instructions stating :
The key principle of “Know Your Customer” procedure must be the identification of an individual/ corporate opening an account. This must involve an introductory reference from an existing account holder/ person known to the bank. The board of directors should have in place adequate procedures to verify the authentic identification of individuals. There must also be processes to monitor transactions of a suspicious nature. This instruction raised the requirement of submitting PAN to transactions of Rs. 50,000 or more (earlier it was Rs. 10,000).
- There should be good control systems plus audits and checks to ensure the bank stick on to its KYC policies.
- There must be a system at branch level to ensure that lists of terrorist entities are circulated so that accounts/ transactions are not opened/ consummated.
- Transactions of a doubtful nature should be reported to the appropriate authorities.
It was stated that information collected from the customer for KYC purposes must not be used for cross selling.
In recent years on account of the proliferation of banks and their opening of branches in new areas, it has been difficult to stick on strictly to KYC guidelines. In these cases, introductions by well-known citizens and individuals known to the bank are considered acceptable. The concern is generally with respect to accounts introduced by outsiders retained for this purpose who are remunerated on the basis of the number of accounts they introduce. The consensus in these days of tough competition is that this is an acceptable risk if proper documentation to verify the antecedents of the person is taken.
RBI issued comprehensive guidelines. These repeated that the objective of “Know Your Customer” (KYC) guidelines is to stop banks from being used, intentionally or unintentionally, by criminal elements for money laundering activities or for the financing of terrorism. KYC procedures also enable banks to understand their customers and their financial dealings better which in turn help them manage their risks carefully. The guidelines are applicable to foreign currency accounts / transactions and to all kind new accounts.
Banks have been asked to structure their KYC policies incorporating the following four key elements :
- Customer Acceptance Policy
- Customer Identification Procedures
- Monitoring of Transactions
- Risk management
For the purpose of KYC policy, a ‘customer’ has been defined as:
A person or entity that maintains an account and / or has a business relationship with the bank;
- One on whose behalf the account is maintained (beneficial owner). This includes beneficiaries of transactions conducted by professional intermediaries, such as Stock Brokers, Chartered Accountants, Solicitors, etc. as permitted under the law.
- Any person or entity associated with a financial transaction, which can pose significant reputation or other risks to the bank, such as a wire transfer or issue of a high value demand draft as a single transaction.
Know Your Customer” (KYC) procedure should be the key principle for identification of an individual / corporate opening an account. The customer identification should involve verification through an introductory reference from an existing account holder / a person known to the bank or on the basis of documents provided by the customer.
The Board of Directors of the banks are to have in place sufficient policies that establish procedures to verify the authentic identification of the individual / corporate opening an account. Policies to set up processes and procedures to monitor transactions of a suspicious nature in accounts and systems of conducting due diligence and reporting of such transactions should be in place.