In a world where crime is rife within the digital space, it’s in financial institutions’ best interest to assess potential clients thoroughly before allowing them to open accounts, make transfers, apply for loans, or perform other financial transactions. When you accidentally do business with terrorists, money launderers, and other criminals, it can, after all, cost banks and other institutions heavily in terms of sanctions, fines, and reputational damage.
Know Your Customer (KYC) practices protect organizations from fraud and other illicit activities. KYC broadly refers to the variety of steps financial institutions might take to establish customer identity, understand the nature of that customer’s financial activities, and assess the risk that a customer poses to the business. Confirming that the customer acquires their funds from a legitimate source, for example, is one of the major goals of KYC.
Lending institutions must be prepared to execute KYC protocols for every customer, whether they’re applying for a mortgage, a temporary bridging loan, a personal loan, or any other service. The following best practices, in particular, are essential for creating and implementing an effective KYC program.
Customer Identification
Identity theft is a widespread problem for businesses worldwide, affecting millions of consumers and accounting for billions of dollars worth of stolen funds each year. Companies need to put steps in place to combat this potential problem. Most jurisdictions legally mandate that individuals attempting to conduct any financial transaction have their identities verified. These provisions aim to eliminate or curb financial crimes such as terrorism funding, money laundering, and corruption.
Obliged entities like banks usually undertake several identity verification procedures to identify their customers correctly. Borrowers at lending institutions must furnish personal information such as their name, date of birth, and address. The institution must then verify the authenticity of that information within a reasonable amount of time, usually by checking it against documents like government-issued identification cards or comparing the customer’s details to those provided by public databases or consumer reporting agencies.
Customer Due Diligence (CDD)
Determining whether or not a potential client is trustworthy is one of the first and most important analyses financial institutions must make in vetting new customers. Customer Due Diligence (CDD) broadly refers to a series of risk assessment processes and screening measures designed to manage risk effectively. Robust CDD is an organization’s primary line of defense against bad actors whose activities might potentially compromise the business.
The Different Types Of Due Diligence
Financial institutions tend to perform customer due diligence on three levels:
- Customer Due Diligence (CDD) refers to processes the organization uses to obtain identifying information from the customer. The purpose of these processes, as stated above, is to confirm a customer’s identity and evaluate the risks they present. Most financial institutions’ clients will be subjected to basic CDD as part of the onboarding process.
- Simplified Due Diligence (SDD) is usually performed instead of full CDD for customers deemed unlikely to commit fraud or engage in other illegal activities. Examples of situations where SDD is likely to be used include low-value accounts.
- Enhanced Due Diligence (EDD) is a more intensive information-collecting process for higher-risk customers. EDD aims to provide the institution with a deeper understanding of the customer’s financial activities and help them mitigate any associated risks. Some conditions for determining when a customer is high-risk and thus in need of EDD may be codified in a particular jurisdiction’s laws. For the most part, however, it’s up to financial institutions to determine clients’ risk profiles and ensure that these individuals are not bad actors.
Practical steps to include in an effective CDD program include:
- Confirm the potential customer’s identity and location, and determine the nature of their business activities. Most businesses ask the customer to provide particular documentary requirements like a government-issued identification or proof of address.
- Define what type of client the potential customer is and assign them a risk category. Create a digital record of this information and any additional documentation.
- Ascertain whether any additional EDD is necessary. Because existing customers may transition into higher-risk categories over time, it may be beneficial for institutions to conduct regular due diligence reviews.
- Document all CDD and EDD processes performed on each customer for regulatory purposes.
Continuous Transaction Monitoring
Effective KYC doesn’t stop at checking on each customer once. Financial institutions need to have procedures for continuous transaction monitoring. These procedures may include overseeing customer accounts, documenting financial transactions, and flagging suspicious activity. The amount of monitoring a customer receives and monitoring methods may vary depending on the customer’s particular risk profile and the institution’s risk management strategy.
An organization might monitor factors as part of KYC, including large deposits and withdrawals, consistently delayed loan repayments, or unusual cross-border transfers. Institutions that do business with public figures and similar entities may also find it beneficial to keep an eye out for adverse media coverage about or around these clients.
Reviews And Reassessments
Periodic reviews of customer accounts and reassessments of the associated risk are also considered good KYC practices for financial institutions. In particular, the following considerations are likely to be especially relevant during these reviews:
- Whether the account record is up-to-date
- Whether the type and volume of transactions made through the account match the account’s stated purpose
- Whether the risk level originally assigned to this account is still appropriate
Protect Your Business With KYC Best Practices
Adhering to KYC best practices can help banks and other financial institutions protect their interests and clients’ interests. Well-designed and well-implemented KYC procedures don’t just benefit individual organizations but also help enhance the security of the larger financial ecosystem.