|What is Know Your Customer (KYC)?|
|Components of KYC|
|Who is Impacted by KYC Compliance?|
|Effective KYC Process|
|The Advantages of a KYC Process|
|AML and KYC|
With an increasingly globalized economy, financial institutions are becoming more vulnerable to illegal criminal activities. The KYC check is designed to eliminate risks related to money laundering, terrorist financing, corruption, fraud, bribery, and other illegal financial activities. Organizations must ensure that their customers are who they are allegation to be. Firms must understand how to effectively implement KYC as part of their anti-money laundering (AML) and counter-terrorism financing (CFT) compliances.
What is Know Your Customer (KYC)?
Developing technology and widespread internet usage necessitate implementing standards to help fight online fraud. Financial institutions can more accurately detect suspicious activity by verifying a customer's identity and intent before and when the account is opened and after that monitoring their transactions. In addition to the financial and banking fields, related sectors such as insurance, real estate, and crypto must also comply with KYC procedures.
Customers must meet KYC requirements by providing proof of identity and address, such as ID card verification, facial verification, biometric verification, and document (passport, driver's license, or utility bill) verification.
The central legal basis of the KYC principle and the KYC controls and verifications in Europe, the US, and the UK are basically as follows:
- 3rd EU Money Laundering Directive (Article 8)
- 4th EU Money Laundering Directive
- 5th EU Money Laundering Directive
- 6th EU Money Laundering Directive
- UK Bribery Act
- United Kingdom Modern Slavery Act
- Know Your Customer Program (CIP) as part of the US Patriot Act
Components of KYC
1. Customer Identification Program (CIP)
As part of KYC, organizations need to run Customer Identification Programs (CIP) to ensure the accuracy of what customers say about themselves and their business. CIP sets minimum requirements when onboarding new customers, but these requirements may vary depending on the organization. Even if there are differences, an effectively implemented CIP helps to confirm the customer's true identity. Section 326 of the US Patriot Act is recommends to identify and verify the identity of people who open an account, keep records and compare them with state lists.
2.Customer Due Diligence (CDD)
Customer due diligence (CDD) is the collection of identifying information to verify the customer's identity and accurately assess the risk level. CDD is important to assess risks and protect against criminals, terrorists, and politically exposed person (PEP) who may pose a risk. As stated in recommendation 10 of Recommendation 40 of the Financial Action Task Force (FATF), member states should implement the CDD requirements.
3. Enhanced Due Diligence (EDD)
Under the risk-based approach, high-risk customers are subject to enhanced due diligence (EDD). High-risk customers and suspicious transactions pose a greater risk to the financial sector, and CDD procedures might not detect them. Therefore, companies use EDD procedures to create a higher identity assurance by taking the customer's identity and addressing and evaluating the their risk categories. To gain a deeper understanding of customer activities and risks, EDD involves intensive scrutiny.
Ongoing monitoring is the continuous study of customers and their activities. It gives a chance to regularly check high-risk customers on sanction lists and checklists due to the threat of crime. It monitors frequently renewed sanctions, PEP lists, adverse media, and assessing customer risk. The Ongoing Monitoring Process protects businesses from risks such as non-compliance and loss of reputation.
Who Is Impacted by KYC Compliance?
Examples of financial service provider sectors that must apply KYC regulations,
- Payment companies
- Lending companies
- Investment companies
- Money transfer companies
- Crypto exchanges
- Insurance companies
Financial institutions detect the risks they may face in the future with the control procedures they apply before opening a new customer account. Know your client check; the first step of Anti-Money Laundering programs also prevents potential risks by verifying the their identities.
With the development of technology, crime techniques and risks also change. Financial institutions must follow updates in related legislation to detect and prevent crime risks that organized crime groups have developed using technology. Obligated organizations that do not comply with AML and KYC regulations remain vulnerable to financial crimes and are punished by regulatory agencies. For this reason, accountable institutions must fulfill Know Your Customer requirements.
Effective KYC Process
Source: Thales Group
Controls to be applied in customer account opening processes according to regulatory requirements:
1. Collection of customer information and checking accuracy.
KYC procedures usually start with collecting primary data about their customers using electronic identity verification. KYC data and document requirements are:
- Date of birth
- Social security number
2. Once preliminary customer data has been collected, second step is to determine if it is linked to criminal activity.
Control can be achieved with some lists:
3. To ensure that they are legitimate by understanding the nature of customer activities.
4. Determination of customer risk level by applying Customer Due Diligence and, if necessary, Enhanced Due Diligence procedures.
5. Development of a control program suitable for the customer's risk level.
The Advantages of a KYC Process
- Thanks to advanced artificial intelligence technologies, onboarding processes have improved. Difficulties and delays in remote contracting, purchasing, or concluding contracts are eliminated, and the customer can access the product or service safely and quickly.
- Thanks to automatic remote solutions, KYC verification can be performed at any time and place.
- Organizations benefit from high conversion rates and optimized customer acquisition costs with KYC solutions.
- KYC avoids reputational damage
- It builds trust between the customer and the organization.
- It brings stability and investment to the country as it makes the country's fiscal framework credible and less risky.
AML and KYC
Every year millions of dollars of money laundering and terrorist financing crimes are committed via financial systems. Money laundering activities provide the growth of crime and terrorist organizations. Financial resources must be blocked to prevent the growth of crime and terrorist organizations. Regulatory bodies around the world are working to stop money laundering and terrorism financing. With the AML know your customer requirements published for an influential fight against money laundering and terrorist financing, all institutions' risk-based approach, especially financial institutions, is compulsory. Therefore, organizations must ensure AML and KYC compliance and play an active role in fighting financial crimes.
Many local and international authority, like FinCEN, have made it mandatory for financial institutions to comply with KYC standards to prevent illegal activities. So, each financial actor have to take actions to meet KYC requirements if it wants to play a role in global economy.
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