Prevention of Money Laundering Act (PMLA) 2002 & KYC – Complete Banking Exam Notes

Introduction

The Prevention of Money Laundering Act (PMLA), 2002 is the primary legislation in India designed to prevent money laundering and regulate the financial system against illegal financial activities. The Act also empowers authorities to confiscate property derived from criminal activities.

The Act was passed in 2002 and came into force in July 2005. It works alongside Know Your Customer (KYC)guidelines issued by the Reserve Bank of India (RBI) to ensure banks do not become channels for illegal financial transactions.

These regulations are part of a global framework to prevent Money Laundering (ML) and Terrorist Financing (TF).

Objectives of KYC / AML / CFT

The key objectives of implementing KYC (Know Your Customer), AML (Anti-Money Laundering), and CFT (Combating Financing of Terrorism) measures are:

1. Prevent banks from being used intentionally or unintentionally for money laundering activities.

2. Prevent terrorist financing through banking channels.

3. Enable banks to know and understand their customers and their financial dealings.

4. Help banks implement effective risk management practices.

Prevention of Money Laundering Act, 2002

Important Sections of PMLA

Offence of Money Laundering (Section 3)

A person is guilty of money laundering if he directly or indirectly attempts to indulge or knowingly assists in activities involving proceeds of crime such as:

1. Concealment

2. Possession

3. Acquisition

4. Use

5. Projecting illegal money as untainted property

Punishment under PMLA (Section 4)

The punishment for money laundering includes:

• Rigorous imprisonment minimum 3 years

• Maximum imprisonment up to 7 years

• Fine as decided by the court

If the offence relates to Narcotic Drugs and Psychotropic Substances Act (NDPS):

• Maximum imprisonment can extend to 10 years.

Concept of Money Laundering

Definition

Money laundering is the process by which criminals attempt to hide the origin and ownership of money obtained through illegal activities.

Stages of Money Laundering

1. Placement

Introduction of illegal funds into the financial system.

2. Layering

Conducting complex financial transactions to disguise the source of funds.

3. Integration

Reintroducing laundered money into the economy as legitimate funds.

Financial Action Task Force (FATF)

• Established by G7 countries in 1989.

• Headquarters located in Paris, France.

• Developed 40 recommendations for combating money laundering and terrorist financing.

FATF periodically releases lists of countries with weak AML systems.

Example of FATF Blacklisted Countries

• North Korea

• Iran

• Myanmar

Regulated Entities under AML

The following institutions are required to comply with AML/KYC regulations:

1. Scheduled Commercial Banks (SCBs)

2. Regional Rural Banks (RRBs)

3. Local Area Banks (LABs)

4. Urban Cooperative Banks

5. State and Central Cooperative Banks

6. All India Financial Institutions

7. NBFCs

8. Payment System Providers

9. Prepaid Payment Instrument issuers

10. Money Transfer Service Scheme agents

Monitoring of Transactions

Banks must monitor certain high-value or suspicious transactions.

Transactions to be monitored

1. Cash transactions above ₹10 lakh

2. Monthly aggregate cash transactions exceeding ₹10 lakh

3. Transactions involving Non-Profit Organisations above ₹10 lakh

4. Cash transactions involving counterfeit currency

5. Cross-border wire transfers ₹5 lakh and above

6. Any suspicious transaction regardless of amount

Types of Reports under AML

Cash Transaction Report (CTR)

• Applicable for cash transactions above ₹10 lakh

• Includes aggregated transactions in a month

• Submitted monthly

• Reporting deadline: 15th of the next month.

Suspicious Transaction Report (STR)

Filed when transactions:

• Indicate proceeds of crime

• Have no economic rationale

• Show unusual complexity

• Are attempted but abandoned

Reporting deadline: within 7 days of identifying the suspicious activity.

Counterfeit Currency Report (CCR)

Important procedures include:

• Impound notes with stamp “Counterfeit Bank Note”

• Report to FIU-IND

• FIR required if more than four counterfeit notes

• Preserve notes for 3 years

Non-Profit Organisation Transaction Report (NTR)

Required for transactions of NPOs exceeding ₹10 lakh.

NPOs include entities registered as:

• Trusts

• Societies

• Section 8 Companies under Companies Act 2013.

Cross Border Wire Transfer Report (CBWTR)

Required for cross-border transactions above ₹5 lakh.

Includes funds:

• Originating from India

• Received in India from abroad.

Maintenance of Records

Banks must maintain records containing:

• Nature of transaction

• Amount and currency

• Date of transaction

• Parties involved in the transaction

Retention period

Failure to submit reports can attract penalties between ₹10,000 and ₹1 lakh per instance per day.

Trade Based Money Laundering (TBML)

Trade Based Money Laundering is the use of trade transactions to disguise illegal money.

Methods include:

• Over invoicing

• Under invoicing

• Multiple invoicing

• Variable pricing

• Shipment of smuggled goods disguised as legal goods.

AML Compliance Structure in Banks

Designated Director

Responsible for overall compliance with AML regulations.

Example:
In some banks, the Managing Director in charge of compliance acts as the designated director.

Principal Officer

Responsible for:

• Updating AML/KYC policy

• Coordinating compliance functions

• Reporting to FIU-IND

• Monitoring suspicious transactions.

Other Responsible Units

1. AML Monitoring Units

2. Transaction Processing Units

3. Branches and Field Units

4. Compliance and Audit Departments

Risks due to Non-Compliance

Failure to comply with AML/KYC regulations can lead to:

• Operational Risk

• Compliance Risk

• Reputation Risk

• Legal Risk.

Key Elements of KYC

The four major elements of KYC guidelines are:

1. Customer Acceptance Policy

2. Customer Identification Procedure

3. Monitoring of Transactions

4. Risk Management.

Customer Acceptance Policy

Banks must ensure:

• No anonymous or fictitious accounts

• No accounts for persons with criminal background

• No accounts for individuals listed in sanctions lists

• Risk classification of customers into:

  • Low Risk

  • Medium Risk

  • High Risk.

Customer Identification Procedure

Customer identity must be verified using Officially Valid Documents (OVD).

OVD List

1. Passport

2. Driving Licence

3. Voter ID

4. Aadhaar Card

5. NREGA Job Card

6. National Population Register document.

PAN is not considered an OVD but required for tax purposes.

If PAN is unavailable:

• Form 60 (non-agriculturist)

• Form 61 (agriculturist) must be obtained.

Simplified KYC for Low Risk Customers

Acceptable identity proof includes:

• Government identity cards

• PSU employee identity cards

• Letters from gazetted officers

Acceptable address proof includes:

• Utility bills (within two months)

• Bank passbook

• Pension payment orders

• Municipal tax receipts.

Video Based Customer Identification Process (V-CIP)

V-CIP is a digital method of KYC verification that includes:

• Live video interaction

• Facial recognition

• Real-time verification by bank official

It is treated equivalent to face-to-face KYC verification.

Central KYC Registry (CKYCR)

Central KYC Registry is managed by CERSAI.

Functions include:

• Collecting and storing KYC records

• Generating a 14-digit KYC Identifier

• Sharing KYC records with regulated entities

Banks must upload KYC data within 10 days of opening the account.

Unique Customer Identification Code (UCIC)

Banks assign a unique identifier to each customer.

Benefits include:

• Linking multiple accounts

• Preventing duplication

• Improving risk monitoring.

Example: In many banks, CIF number acts as UCIC.

Customer Due Diligence (CDD)

CDD is the process of verifying the identity and financial profile of customers.

Steps in CDD

1. Identify and verify the customer.

2. Identify the beneficial owner.

3. Understand the nature of business activities.

4. Monitor financial transactions.

Types of CDD

1. Normal CDD

2. Simplified CDD

3. Enhanced CDD for high-risk customers.

Beneficial Owner

A beneficial owner is the person who ultimately controls a customer entity.

Identification of beneficial owner is not required for listed companies.

Exam Important Quick Facts

• PMLA enacted: 2002

• Implemented: 2005

• FATF established: 1989

• CTR threshold: ₹10 lakh

• Cross border transfer reporting: ₹5 lakh

• CTR/NTR/CBWTR reporting: 15th of next month

• STR reporting: within 7 days

• Record retention: 5 years