Preventing money laundering4 min read . Updated: 19 Nov 2009, 09:33 PM IST
Preventing money laundering
Recent coverage on the Madhu Koda case has hogged the limelight. According to newspaper reports, the Enforcement Directorate (ED) has lodged a case under the Prevention of Money Laundering Act (PMLA) against Koda and three former ministers as well as his associates Vinod Sinha and Sanjay Chaudhary.
So who is Koda and what is the case all about? Koda is a former chief minister of Jharkhand and is alleged to have amassed wealth beyond his known sources of income. Some estimates put the amount of money laundered by Koda and associates at more than Rs4,000 crore—almost one-fifth of the annual budget of the state he once governed.
Koda allegedly was in touch with two individuals in Mumbai, Sinha and Chaudhary, both of whom incidentally are natives of Jharkhand. Till just five years ago, Sinha used to be a milk vendor while Chaudhary’s father used to sell tobacco products on a cycle. During Koda’s tenure as chief minister, Sinha swiftly managed to procure property at different locations in Jharkhand and Jamshedpur, an iron sponge mill, a rolling mill, collectively valued at more than Rs200 crore. Investigators allege this was all Koda’s money being invested in Sinha’s name. Sinha is also reported to have deposited as much as Rs20 crore on several occasions in a Jamshedpur bank. Also, payment for the much-talked-about mine bought in Liberia was allegedly made in cash by Koda.
People familiar with the matter in ED also allege that Sinha was involved in investing and routing Koda’s money through illegal or hawala channels. The income-tax (I-T) department has uncovered illegal transactions worth Rs2,500 crore, including Rs550 crore sent to foreign nations such as Dubai, Thailand and Malaysia, among others.
Politicians illegally pilfering public money may not be new, but an incident of such magnitude has jolted everyone. PMLA was enacted specifically to curb money laundering, which begets the question: Is there weakness in our anti-money laundering (AML) regulations? In India, politically exposed person (PEPs) are defined as individuals who are or have been entrusted with prominent public functions in a foreign country, such as heads of states or government, senior politicians, government/judicial/military officers or senior executives of state-owned corporations.
PEPs are considered high-risk under most AML regulations; the reason is that the law assumes that PEPs in general represent a potential risk for corruption and bribery, given their position and contacts. Surprisingly, most jurisdictions, including India, prescribe increased scrutiny of politicians of foreign origin, but are silent on local politicians.
This case hopefully should provide an impetus for India to include domestic politicians as high-risk and demand that financial institutions undertake enhanced due diligence (EDD) on them.
One other factor that has escaped attention is the role of financial institutions in effectively implementing AML guidelines. How did banks allow transfer of high-value funds through their accounts without raising a red flag? According to newspaper reports, one branch of a bank in Mumbai failed to inform about transactions worth more than Rs900 crore by one of the group companies owned by Koda’s frontman. All financial institutions need to maintain a profile of their customers, including high-risk customers, and also identify details of all known sources of wealth. Any transaction mismatch with the profile of the customer should be investigated thoroughly. Thus, the bank owes an explanation as to how someone who used to be a milk vendor till a few years back could amass so much wealth.
Mere implementation of a transaction monitoring system is not the solution. An information technology solution is just an enabler and banks need to have proper policies and procedures in place to identify suspicious transactions. In case some transactions occurred before the implementation of their AML I-T solutions, banks need to conduct a transaction look-back exercise to identify suspicious transactions from the past and investigate them proactively. Further, financial institutions should revisit their AML policies/procedures and enhance their EDD process to include identification of beneficiaries of each account. This would also enable identification of any person associated with PEPs who would then need to be considered as high-risk.
India is a large cash economy. With the earlier incident of the display of cash in Parliament and current allegations of payment in cash for buying mines and to Bollywood personalities, it is important for competent authorities to find a remedy to this malaise sooner. A good starting point would be to expand banking services (especially to rural India) and encourage use of cashless services through channels such as cheques and credits cards. This will enable the regulatory agencies to monitor transactions effectively.
Is this case likely to have an impact on the impending Financial Action Task Force (FATF) review of India’s case for membership? A good starting point would be to re-think and expand the scope of designated non-financial businesses and professions under the AML regulations as there are certain professions in India that are recommended by FATF but not yet covered by AML regulations such as real estate agents. While it is evident that the AML regime in India has enough checks and balances in the system to identify potential cases of money laundering, what is needed is stringent implementation of these policies by the regulated entities in letter and spirit.
Arpinder Singh is executive director and K.V. Karthik is associate director, both at forensic services, KPMG. Comments are welcome at email@example.com