Unit 6

Banking Compliance
 Banking Compliance
• The banking compliance ensures that a business adheres
to external rules and internal controls.
• In the financial services sector, compliance departments
work to meet key regulatory objectives to protect
investors and ensure that markets are fair, efficient and
transparent.
• They also seek to reduce system risk and financial crime.
• Compliance officers within the compliance department
have a duty to their employer to work with management
and staff to identify and manage regulatory risk. Their
objective is to ensure that an organization has internal
controls that adequately measure and manage the risks it
faces.
 Anti-money laundering
• Money laundering is the illegal process of
concealing the origins of money obtained illegally
by passing it through a complex sequence of
banking transfers or commercial transactions. The
overall scheme of this process returns the money to
the launderer in an obscure and indirect way
• Anti-money laundering (AML) is a term mainly used
in the financial and legal industries to describe the
legal controls that require financial institutions and
other regulated entities to prevent, detect, and
report money laundering activities.
continued
• As part of the fight against financial crime,
governments across the world require their
financial institutions to put in place anti
money laundering compliance programs.
• To achieve compliance, it is often necessary to
appoint an AML Compliance Officer: a
principal figure responsible for overseeing the
effective development and implementation of
their institution’s AML program.
 Prevention of Money Laundering Act, 2002
• The Act and Rules notified there under impose obligation on
banking companies, financial institutions and intermediaries
to verify identity of clients, maintain records and furnish
information in prescribed form to Financial Intelligence Unit –
India.
• The act was amended in the year 2005, 2009 and 2012

• The PMLA seeks to combat money laundering in India and has

three main objectives:

– To prevent and control money laundering

– To confiscate and seize the property obtained from the laundered
money; and
– To deal with any other issue connected with money laundering in
India
 Customer due diligence
• Customer Due Diligence or CDD, is the process
where relevant information about the customer is
collected and evaluated for any potential risk for
the organization or money laundering/terrorist
financing activities.
• The information comprises the facts about a
customer that should enable an banks to assess
the extent to which the customer exposes it to a
range of risks.
• These risks include money laundering and terrorist
financing.
 Know your customer (KYC) norms
• It is a process by which banks obtain information about the
identity and address of the customers.
• This process helps to ensure that banks' services are not
misused.
• The KYC procedure is to be completed by the banks while
opening accounts and also periodically update the same.
• The objective of KYC/ CFT/ AML/ guidelines is to avert
banks/ FIs from being used, intentionally or unintentionally
by criminal elements for terrorist financing activities or for
money launderings.
• These procedures also enable banks/ FIs to know and
understand their customers and their financial dealings
better and to manage their risks wisely.
 International sanctioning
• Sanctions are measures of the international community
against a violation or threat to international peace and
security. They are a way to change the behavior of a
country or government. They can apply to a country, an
organization or a person.
• Financial restrictions includes loans, payments, letters of
credit)
• The United Nations (UN), the European Union (EU) and
the United States (US) have imposed restrictive measures
('sanctions') against certain countries with the aim of
achieving a change in activities or policy. Other countries
in which the bank operates may also have imposed their
own restrictive measures.
 Financial Intelligence Unit
• FIU-IND is an independent body reporting directly
to the Economic Intelligence Council headed by the
Finance Minister.
• Financial intelligence unit (FIU) is a central agency of
a government that:
– receives financial information pursuant to country's anti-
money laundering laws
– analyzes and processes such information and
– disseminates the information to appropriate national
and international authorities, to support efforts for anti-
money laundering and combating financing of terrorism
Fraud detection & management in Banks
• Modern systems allow fraud examiners to
analyze business data and check how well the
internal control system is operating.
• If the risk of fraud is really high, financial and
banking institutions can employ a constant or
continual approach to fraud detection.
• Fraud detection and prevention pose a big challenge
to the financial services industry.
• Banks’ fraud detection and prevention solutions, on
the other hand, are unable to keep pace with
fraudsters’ shifting techniques as evidenced by the
rapid rise in cybercrime in the financial services
industry.
• Banks and financial institutions typically invest
significant time and resources on combating fraud
and financial crime.
• A key component of these programs is the software
solution used to monitor, detect, and report
suspicious or fraudulent activity within financial
institutions.
 Documentary Letter of credit
• A letter of credit, also known as a documentary credit
or bankers commercial credit, or letter of undertaking,
is a payment mechanism used in international trade to
provide an economic guarantee from a creditworthy
bank to an exporter of goods.
• It is a credit letterfrom a bank guaranteeing that a
buyer's payment to a seller will be received on time
and for the correct amount. In the event that the buyer
is unable to make a payment on the purchase, the bank
will be required to cover the full or remaining amount
of the purchase.
 Types of Letters of Credit
• Commercial Letter of Credit: This is a direct payment method
in which the issuing bank makes the payments to the
beneficiary.
• Revolving Letter of Credit: letter allows a customer to make
any number of draws within a certain limit during a specific
time period.
• Traveler's Letter of Credit: this letter will guarantee that
issuing banks will honor drafts made at certain foreign banks.
• Confirmed Letter of Credit: involves a bank other than the
issuing bank guaranteeing the letter of credit. The second
bank is the confirming bank, typically the seller’s bank. The
confirming bank ensures payment under the letter of credit if
the holder and the issuing bank default. The issuing bank in
international transactions typically requests this arrangement.
 Process of LOC
• The issuing bank pays the beneficiary or any
bank nominated by the beneficiary. If a letter
of credit is transferable, the beneficiary may
assign another entity, such as a corporate
parent or a third party, the right to draw.
• Banks also collect a fee for service, typically a
percentage of the size of the letter of credit.
 Correspondent banking
• A correspondent bank is a bank that provides services
on behalf of another, equal or unequal, financial
institution. It can facilitate wire transfers, conduct
business transactions, accept deposits, and gather
documents on behalf of another financial institution.
• This is called correspondent banking – Bank A calls Bank
C its correspondent bank, and calls its account there it’s
“nostro” account. (Nostro is Latin for “our”, so using the
word nostro is basically a pretentious way of saying “our
account”. If you felt like it, you could refer to your bank
accounts as your nostros, but you would lose your
friends.)
 NRI Accounts
• An NRI Account refers to the accounts opened
by a Non-Resident Indian (NRI) or a Person of
Indian Origin (PIO) with a bank or financial
institution which is authorised by the Reserve
Bank of India (RBI), to provide various
services.
 Bad Banks
• A bad bank is one, set up to buy the bad loans and
other illiquid holdings of another financial
institution.
• The entity holding significant nonperforming assets
at will sell these holdings to the bad bank at
market price. By transferring such assets to the bad
bank, the original institution may clear its balance
sheet—although it will still be forced to take write-
downs.
• A bad bank structure may also assume the risky
assets of a group of financial institutions, instead
of a single bank.
 McKinsey 4 Basic models for bad banks
• An on-balance-sheet guarantee (often a government
guarantee), which the bank uses to protect part of
its portfolio against losses
• A special-purpose entity (SPE), wherein the bank
transfers its bad assets to another organization
(again, typically backed by the government)
• A more transparent internal restructuring, in which
the bank creates a separate unit to hold the bad
assets (a solution not able to fully isolate the bank
from risk)
• A bad bank spinoff, wherein the bank creates a new,
independent bank to hold the bad assets, fully
isolating the original entity from the specific risk
Thank you