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
12.1OBJECTIVES
Knowyourcustomer(KYC)processismeanttoweedoutthebadcustomers,to
protectgoodones(andthebanks).Itis,therefore,importantthatbanks
continuetostayfocusedonbusiness,ongoodcustomerrelationship;getto
knowmoreaboutclientneedsandpreferences.TheKYCprocessisonlyto
ensurethatbankingoperationsarespotlesslyclean;tohelpclientsandbank
personnelintheproperconductofbusiness,withcomfortandconfidence.KYCis
essentialtoensurethatthereisnoslippagefromthisbasicbankingprinciple.
Knowingacustomerisabasictenetinbanking.Detailedinformationtobuildupa
customerprofilehasbeencollectedtoservepurposeslike

satisfyinglegalrequirementsforthebankercustomerrelationship;
toknowcustomerneeds,toextendappropriateservices,and
to know the various categories of customers (size, habits,
types andpreferences)toenhancebanksownbusiness.
Usingsuchdatafortrackingcustomertransactionsandtomonitortheaccountfor
possible abuse or illegal use is also one of the objectives of the KYC.
Growing incidents of banking channels being misused by individuals and
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organizedsyndicatesforpurposeslikemoneylaunderinghaveintroducednew
dimensionsandfocustotheKYCrigour.
KYCdeficienciescanleadtovariousbusiness,operational,legalandconcentration
risks.Evenwhenabankgetsunknowinglyusedformoneylaundering;such
involvement can lead to substantial risk of loss of reputation; andthrough
that,tolossofbusiness.
12.2.INITIATIVESBYTHERBI
TheRBIhastakenstrong,stagewisesteps.Guidelinesissuedbyitin2002have
beenrefinedcontinuously.Guidelinesrelatetoidentificationofcustomersand
systemsandproceduresthatallbanksshouldhaveinplaceforearlydetectionand
preventionoffinancialfrauds,moneylaundering,scrutinyandmonitoringoflarge
valuecashtransaction,etc.,undersection35oftheBankingRegulationAct,1949.
Guidelinesweremadesharper(November29,2004)inthelightoftherecom
mendationsmadebytheFinancialActionTaskForce(FATF)onAntiMoney
Laundering(AML)standardsandoncombatingfinancingofterrorists(CFT).These
standardsaretheInternationalbenchmarksforframingAMLandCFTpoliciesby
theregulatoryauthoritiesinallcountries.
DeadlineswerestipulatedbytheRBIforallbanksinIndiatohaveclearpolicieson
AMLandCFT(February25,2005)andtobecomefullycompliant(December
21,2005.)
12.3.SOMEBASICDEFINITIONS
Beforegettingontotheknowyourcustomerdiscussions,letustakealook
backintothedefinitionsrelatingtothetwoplayersinthisscenariothebankerand
thecustomer.
Thetermbankingisdefinedundersection5(b)oftheBankingRegulationAct.
1949.Banking meansaccepting, forthepurposeoflendingorinvestment,
depositsofmoneyfromthepublic,repayableondemandorotherwise,and
withdrawablebycheque,draft,orpayorder.Accordingtothedefinition,the
bankerisonewhoengagesinthebusinessofacceptingdepositsfromthepublicand
utilizingsuchdepositseitherforthepurposeoflendingorforthepurposeof
investment.
Customerisgenerallyonewhoconductstransactionswithabank.
Acustomercouldbeanindividual(anaturalperson),apartnershipfirm,a
company(privateorpublic),aSociety,aTrust,alocalCorporationorinstitution,
oranyintermediary(likeastockbroker);itmayevenbeaGovernmentor
Governmentagency.
Bankercustomerrelationshiparisesfromanyservicerenderedbyabanktoits
customerinanyoftheaboveforms.Therelationshipcouldbecasualorshortterm
(likeastrayissueofademanddraft)orlongterm(likehavingacurrentaccountor
aloanaccount).

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On account of this, the relationship assumes any one of the various legal
relationshipslikedebtorcreditor,creditordebtor,mortgagormortgagee,bailee
bailor,trusteebeneficiary,lessorlessee,agentprincipalandsoon.
Withthewidenedrangeofproductsandcomplexservicesextendedbybanksto
customersinrecentyears,therelationshipsalsospanalargevarietyofforms.Each
relationshipislegal;henceanytransactionunderanyrelationshipwillneed to
satisfy the laws and processes that govern such relationship andtransaction.
Furtherasthebanksarethebackboneofanyeconomyandtheenginesofits
growth;theseneedtoensurethatnocustomeroftheirsandnotransactionby
themadverselyimpactsocietyatlarge.
Organizedfinancialcrimeshave,progressivelyandquietly,assumedan
increasinglydevastatingsizeandpowertothreatentheveryfabricofinternational
societyandthesecurityofitspeople.Theperpetratorsingenuityandtheir
economicandpoliticalinfluencehavebeenfoundtounderminefinancialand
economicviability,collectiveethicalstandardsandultimately,societyatlarge.It
isforthisreasonthattheidentificationandotherproceduresregardingopeningof
accountsetc,whichhavebeenpractisedbybanksovertheyears,havebeen
reclassifiedunderKYC.
12.4.KYCPOLICY:ORIGIN
The Basel Committee1reports of 1997 and 1998 adopted a statement of
principlesconcerningantimoneylaundering.Thestatementcarriedthefirst
internationalmentionofKYCproceduresandencouragedbankmanagementsand
theircentralbanks,internationally,todrawguidelinesforfullidentificationof
customers,tomaptheirtransactions.
Amongothernationalcontrollers,theFederalReserveoftheUSAinitiated,
almostimmediately,proposalsrelatingtothemonitoringofcustomer
transactionsandthereportingofsuspicioustransactions.Itrequiredbanksto
drawupcustomerandtransactionprofiles,recordsourcesoffunds,determine
normalandexpectedtransactions,identifythosewhichwereinconsistentand
report suspicious ones to a central monitoring authority. These are being
followed,religiously,byallbanksintheUSAwithquickpunishmentsbeing
awardedbytheregulatorswhenseriousaberrationsareobserved.
12.5.CUSTOMER:DEFINITIONUNDERTHEKYCPRINCIPLES
5.1ForKYCpolicy,acustomerisdefinedas
apersonoranentitythatmaintainsanaccountwithabank,
one on whose behalf the account is maintained(i.e.,the
beneficialowner),
beneficiariesoftransactionsconductedbyprofessional
intermediaries,likestockbrokers,solicitors,etc.,aspermitted
underlaw,and

1.AcommitteeconstitutedbyBankforInternationalSettlementinvolvingthe
centralbankauthoritiesof10developedcountries.

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anypersonorentityconnectedwithafinancialtransactionwhichcan
posesignificantreputationorotherriskstothebank(e.g.,awire
transfer,or,theissueofdemanddraftofhighvalueinasingle
transaction).

RBIsApproachandobjectives
TheapproachtotheKYCregimeinRBIsguidelinesis,basically,
topreventbanksfrombeingused,intentionallyorunintentionally,
bycriminalelementsfortheirmoneylaunderingactivities,and,
tohelpbankstoknowtheircustomerandtheirfinancial
transactionsbetter;this,inturnwillhelpthebankstomanagetheir
risksprudently.
KYCprocessesaretobelaiddownatthecorporatelevelandshouldbefollowedby
theoperatingunits/branches.TheRBIguidelineshavecertainkeyexpectations
inthisregard.
12.6.GUIDELINESONKYC
TheRBIexpectsallbankstohavecomprehensiveKYCpolicies.
Thesepoliciesshouldbeonkeyareasmentionedbelow.BankBoardswillhaveto
evolverelativepoliciesandprocessesandensurethattheseareimplemented,
faithfully,atalllevels.
(a)CustomerAcceptancePolicy(CAP)
Explicitcriteriaforacceptanceornonacceptanceofacustomerandhis/her
relationshipwiththebank.
Broadaspectsofpolicycouldbe:
noaccountshouldbeopenedinanonymous/fictitiousorbenaminame(s);u
noaccountshouldbeopened(oranexistingaccountcontinued)wherethe
banksduediligenceexercisesrelatingtoidentity,andtheobtentionof
evidentialdocumentsarenotfulfilledorsuccessful;whentheapplicantdoes
notcooperate;orthereliabilityofdata/informationfurnishedinthe
documentsisindoubt

ensuringthattheneworexistingcustomersidentitydoesnotmatchwith
that of apersonanongrata,i.e.,anypersonwithknowncriminal
background,anybannedentityliketerroristorganizations,FERAviolatorsetc.
whenacustomerdesirestoactonbehalfofanotherperson,ananalysis
shouldbemadeonthecircumstancesunderwhichsuchoperationis
required,thetypeandsizeoftransactionsandthatthetransactionsdo
notinfringethelawofthecountry
documentationrequirementsandotherinformationtobecollectedin
respectofdifferentcategoriesofcustomersshoulddependupontherisk
perceivedandalsokeepinginmindtherequirementsofthePreventionof
MoneyLaunderingAct.

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(b)Customeridentificationprocess
Procedurestobefollowedbybankpersonnelinopeninganewaccountor
reviewinganexistingaccount.
ThePolicyapprovedbythebanksBoardshouldclearlyspelloutthe
customeridentificationproceduretobecarriedoutatdifferentstages
i.e.,whileestablishinganewbankingrelationship,carryingoutafinancial
transactionorwhenthebankhasdoubtontheauthenticity/veracityor
adequacyofthepreviouslyobtainedcustomeridentificationdata(inthe
caseofexistingaccounts).
Customer identification means identification of the customer and
the verifying of his/her identity by using reliable and independent
sourcedocuments,dataorinformation.
Forcustomerswhoarenaturalpersons,banksshouldobtainsufficient
identificationdatatoverifyidentityofthecustomer,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 that
person.
(iii)Understandtheownershipandcontrolstructureofthecustomerand
determine the natural persons who ultimately control theentity.
(c)Monitoringofcustomertransactions:
Thisisacriticalaspect.Thepolicyandproceduresshouldclearlyhelpthe
parameterisingofthetypeandsizeofnormaltransactionsinacustomers
accountandthequickidentification,forfurtherenquiry,ofanabnormal
transactionliketheonethatfallsoutsidethenormallevelandpattern
ofactivityrecorded.
Special attention should be placed on all complex, unusually
largetransactionsandsuspiciouspatternswhichindicateviolationof
thelawsofthecountryorthreateningitsfinancialwellbeing.
Itshouldbeensuredthatthereisnostructuring,i.e.,manipulation
ofthesizeoftransactionssothat,ifseenindividually,theyfallbelow
thevaluesorthresholdthatneedtobereportedtothe
regulators/monitoringauthority.
Transactionsthatinvolvelargeamountsofcashinconsistentwith
thecustomersnormal/expectedactivityshouldreceivespecial
attention.
Veryhighaccountturnover,inconsistentwiththebalancemaintainedor
incomesdeclared,mayindicatewashingofillegalfunds.

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Arecordshouldbemaintainedofalltransactions,depositsor
withdrawals,involvingRs10lakhsandabove,
Banksshouldhaveaninternalmonitoringsystemtoreportsuchtrans
actionsasalsosuspicioustransactions.

(d)Riskmanagement
Documentation/datacollectionforcustomeridentificationshouldbeas
pertheRBIguidelinesrelatingtodifferentcategoriesofcustomers.
12.7RISKCATEGORIZATION
Bankswouldneedtocategorizetheircustomersaslow,mediumandhighrisks.
(a)Lowriskcustomers:
Theseareindividuals(otherthanhighnetworthindividuals)andentities
whoseidentitiesandsourceoffundscanbeverifiedeasily;transactionsin
whoseaccountsareinconformitywithknownCustomerandTransaction
profiles.(Salariedemployees,Govtdepts,Govtownedcompanies,
regulators,regulatorybodiesetc,fallinthiscategory),Forthiscategory,it
shouldbeadequateifthebasicrequirementsofverifyingtheidentityand
locationofthecustomeraremet.
(b)Medium/highriskcustomers:
Thiscategoryincludescustomerswhocarryaninherentlyhigherthanaveragerisk
tothebank.Thecategorizationwilldependuponthecustomersbackground,
natureofactivity,location,countryoforigin,sourceoffunds,volumeand
frequency of transactions,(large and not in tune with the recorded/
anticipatedlevels),etc.Diligenceinidentification/trackingwouldneedtobeofa
highorderinsuchcustomers(examplesofthiscategory:NRIs,highnetworth
persons,potentates,Trusts/Charities,NGOsreceivingdonationsfromabroad,
Overseas Corporate Bodies, Politically Exposed Persons (PEPs) of foreign
origin,companieshavingclosefamilyshareholdingorbeneficialownership,
firmswithsleepingpartners,nonfacetofacecustomers,thosewithdubious
reputationetc.
12.8TRANSACTIONPROFILE
Compilationofacustomerstransactionprofileisimportantasitiscriticaltothe
identificationoffraudulent/suspicioustransactions.
Atransactionprofileisamatrixofdifferentcomponentslikesourceoffunds,level
ofincome,volumeandfrequencyoftransactions,originanddestinationoffunds
etc.Theprofileshouldhelpinarrivingatathresholdorbenchmarktransaction
forindividualcustomertransactionsagainstwhichacomparisoncanbemade.If
possible,itshouldalsocarryapatternthatcanbetakenasthecustomers
normaltransactionpattern.
Itwouldbeidealtoarriveatindividualthresholdlimitsparticularlyforthehighrisk
category of customers. Banks may use software programs for such

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analysis. It would help if an alert pops up or a signal gets flashed on the

computerscreenwhenthetransactioncrossesthethreshold.
Whilesophisticatedsystemsmaybeusedtodeterminethresholdlimits,broadly,
25%oftheannualincomeinthecaseofindividualsandonemonthsturnoverin
thecaseofbusinessenterprisesmaybeassumedasthresholdlimits.
ThepresentRBIguidelinessuggestmonitoringoftransactionsaboveRs10
lakhs;thosebelowthatlevelareexemptfromscrutiny.Theseguidelinesmaybe
revisedatintervalsandmustbekepttrackof.
Theprofileshouldbearchivedinsuchamannerthatitcanbequicklyaccessedfor
verifyinganytransaction,whensuchrequirementarises.TheRBIhasbeen
stipulatingcertainthresholds:theseneedtobefollowedmeticulouslyasrelatedto
KYCinscreeningaccounts,monitoring,reportingsuspicioustransactionsetc.
12.9STRATEGIESFORRISKMANAGEMENT
Banksshouldhaveknowledge,sensitivityandresponsivenesstorisksandtheir
management.Theirpolicies,proceduresandformatsused,thedistributionof
instructionstoallpersonnelconcerned,theirarchivingorrecordretention,
accessibility,periodicreviews,trainingofpersonnel,sensitivitytoandalertnessin
reportingsuspicioustransactions,organizationalstructureinthebanksforsuch
tasksetc,indicatethelevelofthebanksriskmanagementcapability.Banks
shouldhavestrongsystemsofcomplianceandauditfunctions.Theaudit
departmentshouldbeindependentofoperationsandbemannedby
knowledgeableandresponsibleexecutives.Theyshouldbecapableofevaluating
thebankspoliciesandtheircomplianceatoperatinglevels,efficiencyofthe
softwareused,particularlyformonitoringandreportingcompliancetoregulatory
authorityanddetailedverificationofKYCprocessesatbranchesandsupervisory
efficiency. An audit is not a fault finding process. It is a basicorganizational
tooltoreducedeficienciesandtominimiserisks.Itshouldbesoperceivedand
usedbybankmanagementsandoperatingpersonnel.
AuditreportsshouldbepresentedtotheBanksAuditCommittees,through
channelsasmaybedeterminedbyeachbankmanagement.Whatisimportant
hereisavailabilityofauditskills,integrityinauditprocess,transparencyand
quicknessinreportsandtheirresolution.
Ongoingtrainingprogrammes(orseminars)forbankspersonnel,designed
appropriatetotheirresponsibility(operatingstaff,compliancemonitors,audit
staff,controllersetc)shouldbeheldsothattheyarefullysensitizedtotheneedfor
KYC rationale, policy, process and important environmental events ofmoney
laundering,strategiesofcontainmentaspractisedglobally,software
programmesetc.Trainingprogrammesshouldincludecurrentevents,case
studies,situationanalyses,talkbypersonswithexposureabroadetc.

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12.10ORGANIZATIONALSTRUCTURE
Banksshouldpossessaneffectiveorganizationalstructuretoevolve,imple
ment,maintainandreviewKYCpolicyandprocesses.Thebankshouldhavea
Principal Officer for overall control, ensuring reporting and follow up on
suspiciousactivity,liaisonwithregulatoryauthorityetc.
12.11CUSTOMERPRIVACY
Banks KYC processes should, on no account, lead to any harassment of
customers.KYCimplementationshouldnotleadtoanyunreasonabledenialof
openingofaccounts.
Where banks desire to collect information for purpose other than KYC, it
shouldnotbethroughaccountopeningforms(i.e.,therelativequestionsshouldnot
bepartoftheform).Answeringtoqueriesshouldalsobeattheoptionofthe
customer.
ItwouldbegoodifbankscouldissueabrochuretoeducatecustomersonKYCand
whyelaboratequestionsarebeingasked.Thereiscertainlyaneedtobrief
customersinthisarea.
Information collected should not be divulged to others nor put to use for
commercialpurposes.Strictprivacyshouldbemaintained.Bankscouldin
cludetheseaspectsintheirKYCpolicydocument.
12.12IMPORTANTPRESCRIPTIONSINTHEKYCFRAMEWORKOFTHERBI:
DetailedguidelineshavebeenprescribedbytheRBI,forvariousKYCprocesseslike:

Customerprofiles;foropening/reviewingofaccountsofvarious
categoriesofcustomers.
Identificationofhighvalue/suspicioustransactions/terrorismfinance.u
Monitoring of suspicious transactions and reporting the same and
reportingofcashtransactionsofRs10lakhandabovetocontrollingoffices.
AccountabilityfornoncompliancewiththeKYCguidelines.
Timeframeforimplementation
TheRBIalsorevisestheguidelinesbasedonnationalandinternational
experience
Bankswouldneedtokeepthemselvesupdatedonanongoingbasis
withsuchchanges.