Welcome to Banking Quest

4.1 Definition of CDD and EDD

The Curious Case of Mr. Sharma’s Bank Account

Mr. Sharma, a retired teacher in Delhi, received a call from his bank one fine morning. “Sir, we need to conduct an enhanced due diligence check on your account.”

Sharma Ji, sipping his morning chai, was confused. “Beta, what diligence? I only have my pension and some FD interest. Why am I getting the VIP treatment?”

Turns out, a fraudster had attempted to open multiple accounts under his name. Thanks to strict due diligence checks, the bank had flagged the suspicious activity before it was too late.

This highlights the importance of Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) in banking and financial services.

4.1.1 What is Customer Due Diligence (CDD)?

Customer Due Diligence (CDD) is the standard process financial institutions use to verify customer identity, assess risk, and ensure compliance with anti-money laundering (AML) regulations.

Key components of CDD include:

• Identity verification – Checking PAN, Aadhaar, and other KYC documents.

• Transaction monitoring – Ensuring that transactions match the customer’s profile.

• Risk assessment – Categorizing customers as low, medium, or high risk based on their financial activity.

4.1.2 What is Enhanced Due Diligence (EDD)?

While CDD is the basic level of verification, Enhanced Due Diligence (EDD) is required for high-risk customers, such as politically exposed persons (PEPs) or those from high-risk jurisdictions.

Key features of EDD include:

• Additional document verification – More stringent KYC requirements.

• Ongoing transaction scrutiny – Regular monitoring of financial activities.

• Source of funds verification – Ensuring money is coming from legitimate sources.

4.2 When to Apply CDD vs. EDD

The Tale of Two Account Openings

Ravi and Sameer walked into a bank to open accounts. Ravi, a salaried professional, submitted his Aadhaar and PAN, and his account was opened within minutes. Sameer, a businessman dealing in cash-heavy transactions and international trade, was asked for additional documents, including his tax records and business transactions.

Ravi was subject to CDD (Customer Due Diligence), while Sameer was placed under EDD (Enhanced Due Diligence) because of his high-risk profile.

4.2.1 When to Apply CDD

CDD is applied to all customers as a standard verification process. It is used when:

• A customer opens a savings or salary account.

• A person applies for a small personal loan or credit card.

• Transactions are within the normal risk limits defined by the bank.

• The customer has a predictable financial profile with no unusual activities.

For example, if an individual opens a fixed deposit of ₹2 lakh and provides valid KYC documents, the bank does not need to apply enhanced scrutiny.

4.2.2 When to Apply EDD

EDD is applied in cases where a customer poses a higher risk. It is used when:

• The customer is a Politically Exposed Person (PEP) or linked to government contracts.

• Transactions involve large sums of money or cross-border transfers.

• There is a history of suspicious transactions or legal issues.

• The business involves high-cash operations (e.g., casinos, bullion trading, real estate deals).

For instance, if an importer frequently wires large amounts to offshore companies in tax havens, the bank will require additional documents and conduct frequent monitoring.

Humorous Take:😅 If opening a normal bank account is like buying a train ticket, opening an account under EDD is like applying for a visa to the U.S.—endless forms, background checks, and a lot of waiting!

Conclusion

Applying CDD vs. EDD depends on the risk level of the customer. While CDD is for regular customers with low risk, EDD ensures that high-risk individuals and entities undergo deeper scrutiny to prevent financial crimes. Banks and financial institutions must strike the right balance between security and customer convenience.

4.3 Risk-Based Approach in KYC and AML

The Great Bank Confusion: Who’s a Risk and Who’s Not?

Imagine a bank with two customers—Rahul, a software engineer earning a fixed salary, and Vikram, a businessman dealing in cash transactions. One day, Rahul deposits ₹50,000 in his account, while Vikram deposits ₹5 lakh in cash. The bank immediately flags Vikram’s transaction for further review.

Rahul, overhearing this, jokes, “Bas, Vikram! Lagta hai bank ne tujhe terrorist samajh liya!”

But in reality, it’s nothing personal. Vikram’s profile requires a risk-based approach—a fundamental principle in KYC and AML compliance.

4.3.1 What is a Risk-Based Approach (RBA)?

A Risk-Based Approach (RBA) in KYC and AML means that financial institutions don’t treat all customers the same. Instead, they categorize them into different risk levels and apply different levels of due diligence accordingly. This approach allows banks to focus more resources on high-risk customers while ensuring smooth services for low-risk customers.

Key elements of RBA:

• Customer Risk Assessment: Categorizing customers as low, medium, or high risk based on their profile, occupation, and transaction behavior.

• Geographical Risk: Higher scrutiny for customers transacting with or from high-risk countries.

• Transaction Monitoring: Looking for patterns that indicate potential money laundering or suspicious activities.

• Enhanced Checks for High-Risk Customers: Applying EDD (Enhanced Due Diligence) for politically exposed persons (PEPs), large cash depositors, or those engaged in industries like gambling or crypto trading.

4.3.2 Why RBA is Essential in AML Compliance

Applying the same rules to all customers would create an unnecessary burden on banks and customers alike. Instead, RBA ensures:

• Efficient use of resources – Banks focus on real risks rather than overburdening all customers with unnecessary checks.

• Better fraud detection – Identifying suspicious transactions that deviate from a customer’s normal pattern.

• Regulatory compliance – Ensuring adherence to FATF (Financial Action Task Force) and RBI guidelines.

4.3.3 Example of Risk-Based Approach in Action

In 2022, an Indian bank noticed that a small grocery shop owner was receiving frequent international wire transfers of over ₹10 lakh each. Since this was unusual for his business, the bank triggered an EDD process and found that he was being used as a mule for money laundering. Thanks to RBA, the case was detected before further damage was done.

Conclusion

A risk-based approach helps banks and financial institutions strike the right balance between security and customer convenience. By categorizing customers based on their risk levels, financial institutions can focus their AML efforts where they matter most—keeping fraudsters out while ensuring smooth banking for genuine customers.

4.4 Politically Exposed Persons (PEPs) and High-Risk Customers

The VIP Customer Banks Don’t Want

One day, a bank manager in Mumbai received a request to open a high-value account. The customer? A former minister’s son with significant business dealings abroad. The manager immediately flagged the application for Enhanced Due Diligence (EDD), as this individual fell under the category of Politically Exposed Persons (PEPs)—high-risk customers who require extra scrutiny due to their influence and potential exposure to corruption.

Joke Break: When a regular customer opens an account, they get a free passbook. When a PEP opens an account, they get a full-time surveillance team!

4.4.1 Who Are Politically Exposed Persons (PEPs)?

A Politically Exposed Person (PEP) is someone who holds or has held a prominent public position that may make them susceptible to corruption. This category includes:

• Government officials (Ministers, Members of Parliament, Bureaucrats)

• Senior executives of state-owned enterprises

• High-ranking military officers

• Judges and top legal officers

• Immediate family members and close business associates of PEPs

Due to their influence, PEPs pose a higher risk of money laundering, bribery, or illicit financial dealings.

4.4.2 Why Are PEPs Considered High-Risk?

PEPs are high-risk because:

• They may have access to large sums of public money.

• They could misuse their position for personal financial gain.

• Their financial transactions may involve undisclosed third parties.

• They have the potential to engage in bribery or embezzlement.

4.4.3 High-Risk Customers Beyond PEPs

Apart from PEPs, banks also apply Enhanced Due Diligence (EDD) to other high-risk customers, including:

• Individuals involved in cash-intensive businesses (casinos, real estate, money exchange services).

• Frequent international wire transfer users (especially with tax havens).

• Customers with unexplained wealth (high-value transactions that do not match their income profile).

• Beneficial owners of offshore entities (companies registered in secrecy jurisdictions).

4.4.4 How Banks Handle PEPs and High-Risk Customers

Since dealing with PEPs and high-risk customers carries potential risks, banks take several preventive measures, such as:

• Requiring additional documents (source of wealth, tax returns, and business contracts).

• Continuous transaction monitoring (flagging unusual transactions in real-time).

• More frequent account reviews (checking accounts at shorter intervals compared to regular customers).

• Approval from senior management before onboarding a high-risk customer.

4.4.5 Case Study: The High-Profile Scam

In 2019, an Indian bank was fined heavily for failing to conduct due diligence on a PEP who laundered crores of rupees through offshore accounts. The PEP used multiple shell companies to move funds abroad, all while maintaining a clean public image. When authorities finally caught on, the bank faced regulatory action for negligence.

Humorous Take: 😅 If you’re a PEP and your bank teller suddenly starts sweating while verifying your documents, just know—compliance officers are already drafting emails!

Conclusion

PEPs and high-risk customers require strict monitoring to prevent misuse of financial systems. Banks must ensure that these individuals undergo Enhanced Due Diligence (EDD) to minimize risks and comply with AML regulations. Identifying and monitoring these customers isn’t about discrimination—it’s about protecting the financial system from corruption and money laundering.

4.5 Automated Due Diligence Systems

The Bank That Didn’t Sleep

A private bank in India was struggling with due diligence. The compliance team was buried under stacks of documents, manually verifying each new account. Mistakes were common, and fraudsters slipped through the cracks. Then, they introduced an Automated Due Diligence System, powered by artificial intelligence. The results? Fraud detection improved, manual workload dropped, and criminals had a much harder time sneaking in.

4.5.1 What Are Automated Due Diligence Systems?

Automated Due Diligence Systems use artificial intelligence (AI), machine learning (ML), and big data analytics to streamline KYC and AML processes. These systems help financial institutions:

• Verify customer identities instantly.

• Monitor transactions for suspicious activities in real time.

• Reduce human error and speed up compliance checks.

4.5.2 Key Features of Automated Due Diligence Systems

Modern due diligence systems come with several smart features, such as:

• AI-Powered KYC Verification: Scans Aadhaar, PAN, and passports within seconds.

• Risk-Based Customer Profiling: Automatically assigns risk ratings to customers based on their financial behavior.

• Transaction Monitoring Alerts: Detects unusual patterns and flags suspicious transactions.

• Global Sanctions & Watchlist Screening: Cross-checks customers against international blacklists (FATF, UN, RBI watchlists).

• Fraud Detection Algorithms: Identifies fake documents, shell companies, and money mule accounts.

4.5.3 Benefits of Automation in Due Diligence

By using automated systems, banks and financial institutions benefit in several ways:

• Faster Onboarding: Customers don’t have to wait for days to open an account.

• Higher Accuracy: AI reduces errors that manual verification often overlooks.

• Cost Savings: Reduces the need for large compliance teams and manual reviews.

• Better Fraud Prevention: Identifies fraudulent patterns before they cause damage.

4.5.4 Challenges of Automated Due Diligence

Despite its advantages, automation also has challenges:

• False Positives: Sometimes, the system flags genuine customers, causing inconvenience.

• Data Privacy Concerns: Storing large amounts of sensitive customer data can be risky.

• Dependence on Technology: A system glitch can cause delays in banking operations.

• Evolving Fraud Tactics: Criminals are always adapting, so systems need constant updates.

4.5.5 Real-World Example: AI-Powered AML in Action

In 2022, a major Indian bank deployed an AI-powered AML system that detected a money-laundering network operating through fake businesses. The AI identified patterns that human auditors had missed, leading to one of the biggest crackdowns in recent banking history.

Conclusion

Automated Due Diligence Systems are revolutionizing financial security, making AML compliance faster, smarter, and more efficient. While challenges remain, AI-driven automation is the future of banking compliance. Banks that adapt will stay ahead—while fraudsters will have to look for new (and much harder) ways to beat the system.