Anatomy of a probe: Too many suspicious bank accounts not reported

Photo: Abhijit Bhatlekar/ Mint

Live mint ;Tamal Bandyopadhyay  : Sun, Apr 07 2013. 11 50 PM IST

Commercial banks have let themselves be used by cooperative banks for high-value cash transactions

Mumbai: The Reserve Bank of India (RBI) seems to have completed the first round of its investigation of Cobrapost’s allegations on three Indian private banks being involved in money laundering even as the digital magazine on Friday released fresh videos of officials from these banks admitting to laundering money for politicians. In March, Cobrapost had released videos of its undercover sting operation that captured on camera bankers suggesting they could help clients avoid tax and convert black money into white.

RBI is unlikely to make its findings public, but senior bankers confirmed over the weekend that the chief executives of all three banks—ICICI Bank Ltd, HDFC Bank Ltd and Axis Bank Ltd—had met RBI’s top brass and promised to pull up their socks and plug all loopholes.

RBI’s findings are not sensational, but they indeed point out that front-desk employees of banks do not always follow the rule book. They sell large amounts of gold and high-value insurance policies without following the know-your-customer (KYC) norms, allow high-magnitude cash transactions, and even fill in forms with the wrong PAN (permanent account number, issued by the tax department) to facilitate transactions.

Apart from these, banks have also let themselves be used by India’s cooperative banks for high-value cash transactions. Many such transactions have come to the regulator’s notice.

These executives may or may not be aiding and abetting money laundering, as it is still not clear whether the source of money is criminal activities and some of it is aimed at funding terrorist groups. It is also unlikely that the money will flow out of the country. Still, the transactions are very suspicious, and even if they slip through the first line of defence, the front desk of a bank, they must be classified as suspicious accounts and investigated thoroughly. The banks have not done that.

The law does not entirely prohibit banks from selling gold and insurance policies without adhering strictly to KYC norms when the buyers are not their existing customers, but they do need to report such transactions to the Financial Intelligence Unit (FIU), the central agency responsible for receiving, processing, analysing and disseminating information relating to suspect financial transactions to enforcement agencies and its foreign counterparts.

There is a thin line between tax evasion and money laundering. In the case of the latter, the funds may not necessarily need to flow out of a country. There could be domestic money laundering, too. These transactions may have been carried out to evade tax, and because of this the income-tax (I-T) authority should get involved in the investigation.

While the presence of high-value cash transactions and the incidence of bank branches selling gold and insurance policies without KYC have not come as a surprise, the real eye-opener is the way cooperative banks have used commercial banks to help their customers evade tax. (A retired central banker, however, said this has all along been the case and, in fact, such incidents may have come down recently.)

Cooperative banks are not full-service banks and, hence, nearly all of them tie up with commercial banks through the so-called correspondent banking arrangement to expand their reach. On their own, they cannot directly take part in the payment and settlement system, but can participate in clearing operations through a commercial bank, a member of the clearing corporation.

Unholy cooperation

It is clear that this corresponding banking relationship has been misused with thousands of cash transactions, just below Rs.50,000, the threshold for tax reporting. Under banking rules, nobody can buy a bank draft worth Rs.50,000 or more without quoting a PAN. Also, any transaction of Rs.20,000 has to be settled through an account payee cheque that can only be credited to a bank account and, unlike a bearer cheque, cannot be encashed over the counter.

Most cooperative banks extend the draft-drawing facility to their consumers through a full-service commercial bank for better acceptability of the draft by the counterparty and nationwide branch network. For this, cooperative banks enter arrangements with a commercial bank to issue drafts for their consumers for a fee.

The cooperative banks collect draft request forms from their customers, backed by either a cash deposit or cheques, and deposit the equivalent amount in the current account maintained by them in a commercial bank. The commercial bank debits the amount from the cooperative bank’s current account with itself and issues the drafts. The cooperative banks, in collusion with their customers, avoid issuance of a single high-value draft by breaking it into multiple drafts in favour of the same beneficiary, each just below Rs.50,000.

The RBI investigation has revealed that many cooperative banks have been issuing cheques in favour of the beneficiary of the draft from their current accounts maintained with the commercial banks. In terms of the current account rules, issuing a cheque in favour of the third party is perfectly legal, but the transaction should be related to certain commercial liabilities.

Also, proper KYC norms must be followed and cash transactions beyond Rs.20,000 are not permitted. Cooperative banks have taken care of this by keeping the value of transactions just below Rs.20,000 (so they can issue bearer cheques that can be encashed over the counter) and depositing cash just belowRs.50,000 for buying drafts (so that KYC norms do not come in the picture).

Transactional banking stinks

In other words, they have short-circuited the transaction-tracking process, helped their customers evade tax, and may have even facilitated money laundering—all in violation of banking rules. The commercial banks involved may feign ignorance of this, but under the norms of Prevention of Money Laundering Act, 2002, they are required to file cash transaction reports (CTRs) and suspicious transaction reports (STRs) to FIU.

Section 12 of the Act categorically says that every banking company, financial institution and intermediary needs to maintain a record of all transactions, their nature and value, and verify and maintain the records of the identity of all its clients, and furnish such data, particularly when there is a reason to believe that a single transaction or a series of transactions integrally connected to each other have taken place within a short period of time.

There have been instances where RBI has found that money was deposited in certain accounts through countless demand drafts valued at between Rs.49,500 and Rs.49,900 within months.

What does a cooperative bank gain from such transactions? It allows its customers cash transactions, helping them earn money on which they may not be paying tax.

Why are commercial banks extending a helping hand to them? They earn fees for issuing demand drafts and get so-called float money—or free money on which they do not pay interest—for a few days till a transaction is complete.

The customers are happy as it helps them avoid being identified and evade tax. So, it’s a win-win-win for all three parties involved.

There are some 1,618 urban cooperative banks, 402 state and district cooperative banks, and close to 95,000 rural cooperatives in India, including primary cooperative societies. Overall, the urban cooperative banks had Rs.2.4 trillion deposits and Rs.1.6 trillion loan assets in March 2012.

Historically, cooperative banks have been the soft underbelly of the Indian financial system. Subject to dual control by the respective state government where they are located, as well as the banking regulator, these banks have been a cesspool of politics and poor administration. RBI has tightened its supervision and merged many urban cooperative banks over the past few years to make them strong, but the latest findings of the regulator show that much more needs to be done.

Commercial banks need to change their work culture where marketing executives are under pressure to fulfil business targets at any cost. They must own up the responsibility and make transactional banking foolproof. Now, it stinks.

RBI, on its part, must look into the systems and processes related to transactional banking, something it had never done before. It’s not difficult as the so-called core banking solution can catch every transaction—good, bad and banned.

Along with the quality of assets and the process of loan appraisals and recovery, the regulator must also closely monitor all banking transactions in the entire system. Thus far, in transactional banking, RBI’s focus has been technology that can speed up the process and throw light on consumer behaviour through data analytics, but technology is run by human beings and not robots. Bank officials, under pressure to achieve business targets, cannot afford to keep their eyes closed.

Incidentally, RBI had penalized about a dozen cooperative banks in Gujarat in 2011—including Gujarat Mercantile Co-operative Bank Ltd, Shree Savli Nagrik Sahakari Bank Ltd, Shree Bharat Co-operative Bank Ltd, Waghodia Urban Co-operative Bank Ltd and Navsarjan Industrial Co-operative Bank Ltd—for violation of its directives relating to filing of STR as required under anti-money-laundering guidelines. In 2012, another cooperative bank, Abhyudaya Co-operative Bank Ltd, was penalized for a similar violation. On an earlier occasion, it was found to be not complying with guidelines while carrying out a transaction with Union Bank of India’s Zaveri Bazaar branch in Mumbai.

While every bank should be forced to file CTRs and STRs regularly, the banking regulator and the insurance regulator should also take a close look at the systems and processes of selling gold and insurance products from bank branches, and the I-T authority should step in and follow the money trail. Thousands of crores that have flowed into the banking system through transactions that haven’t strictly followed the rule book may not have left the system. If the transaction trails are followed, the government can bolster its tax collection.

Tamal Bandyopadhyay keeps a close eye on everything banking from his perch as Mint’s deputy managing editor in Mumbai.

 He is also the author of A Bank for the Buck, a book on HDFC Bank. Email your comments to bankerstrust@livemint.com