Financial institutions should know their customers. They should have appropriate procedures in place. In India, the passing of the Prevention of Money Laundering Act in 2002 has made detailed knowledge of the customer mandatory.
The Reserve Bank of India's (RBI) detailed guidelines require banks to formulate their Know Your Customer (KYC) policies incorporating key elements of the Customer Acceptance Policy, Customer Identification Procedures, Monitoring of Transactions and Risk Management.
The guidelines aim at making KYC procedures an integral part of bank's policies. The banks are required to ensure that KYC is not just restricted to initial customer identification but is a continuous process as long as they have relationship with the customer.
Many in the banking community see KYC as yet another restrictive requirement thrust upon them. They fail to realise its importance. In fact, bankers have always been doing a detailed Customer Due Diligence while extending loans. But when it comes to carrying out the same exercise while adding a customer or taking deposits, bankers consider it as a burden.
In earlier times, banking was highly personalised. The banker knew his customers' credentials, where he lived and what he did. However, as the banks grew in size, banking became more and more impersonal.
Recent strides in Information Technology has further added to impersonal nature of banking. Large amounts can now be transferred from one account to another even across countries at the click of a mouse.
In the near future, it may be possible for a customer not to visit his bank branch at all; he can do his all banking through the Internet.
There is also increased use of legal persons to conceal true ownership. In such a scenario, banks run a great risk if they don't know their customer well. KYC policies, procedures, and controls to prevent money laundering must be uniformly followed not only across the banking industry but also across all branches in a particular bank.
This requires training in KYC procedures amongst officers and staff, particularly those who regularly meet the customers or handle their transactions. They are the bank's strongest defence against money laundering or its weakest link. Their training is the foundation on which reputation of the bank can be protected or destroyed.
KYC is the cornerstone of any bank's anti money laundering strategy. Global experience shows that if banks do not adhere to KYC procedures and carry out Customer Due Diligence, they are prone to immense reputational, operational and legal risks. It is only a matter of time that such a bank will attract international criminal elements and undesirable organizations as its customer.
This leads to tarnishing of the reputation and once the reputation is tarnished it becomes difficult to subsequently rectify the image. The negative reputation results in loss of business and impacts future growth. Therefore, for a wise banker KYC makes good business sense which yields dividends in long run.
(The author is an IAS officer and is presently a Director in Finance Ministry. The views expressed are personal)