In order to address the growing problem of money laundering, both national and international bodies around the world provide guidelines for the finance industry. These impose certain screening and monitoring processes on all financial institutions so that the financial system is safeguarded from abuse by criminals. KYC or Know Your Customer checks are one of these processes which regulators mandate financial institutions to undertake. There are specific Know Your Customer laws and regulations to be followed by financial institutions. In order to successfully comply with anti-money laundering regulations, financial institutions must understand their KYC obligations and develop effective KYC compliance programmes.
What Does KYC Mean?
Know Your Customer or KYC is defined as the process that institutions use to verify the identities of their customers and come to a conclusion on the financial crime risk they may pose. In some countries, KYC is expanded as Know Your Client.
KYC is a fundamental process in any financial institution’s anti-money laundering programme. This greatly helps financial institutions to adequately assess the risk associated with each client. For example, all customers of a bank must be verified before they can use services such as checking accounts and credit cards. Fintech companies are mandated to gather ample, verifiable information on their client and their identity in order to determine their legitimacy before beginning any business activities.
What Is The Importance of KYC in Finance and Banking?
An effective KYC programme helps verify the identities of customers, review their financial activities and assess their financial crime risk. It assists banks and financial services to identify and prevent crimes such as money laundering and terrorism financing at an early stage. By doing KYC checks, financial institutions are assured that their customers are really what they say they are, and they are not likely to be engaged in any criminal activities.
The following are some of the reasons why global regulators are mandating KYC for financial institutions:
- Tackling money laundering and related crimes: Money laundering is a growing problem for the world both in terms of volume and complexity. Along with that, the problems of terrorist financing, drug trafficking and other organised crimes are daunting the regulators.
- Growing cybercrimes: With most financial services now going online, crimes such as data breaches, phishing schemes, fraudulent online transactions and identity theft are rising significantly. KYC checks can contain these issues to a considerable extent.
- Rising importance of digital identities: Personal data such as Social Security numbers, email addresses, passwords, credit card numbers and medical records are now available for sale on the internet. As the data can easily be misused by bad actors to their advantage, there should be an effective system to verify a person’s identity.
By using KYC procedures, financial institutions may protect themselves from the above-mentioned crimes, remain in the good books of regulators and protect their brand reputation.
What Is The KYC Process?
KYC is the first step in the implementation of an AML programme or policy. It is the process through which the client’s identity is verified. The objective of KYC checks is to understand the clients, their demographics and financial dealings on a deeper level, in order to effectively manage AML risks. In general KYC involves the following processes:
- Customer Due Diligence or CDD: It is the basic process of verifying customer identity either physically or through electronic means. It is applicable to all customers of a business.
- Enhanced Due Diligence or EDD: It is a more advanced KYC procedure that is used primarily for high-risk customers. These customers are generally more prone to being involved in financial crimes, including money laundering and terrorist financing, hence the need for more thorough verification and sometimes more verification after onboarding.
What Are The Know Your Customer Regulations?
Financial watchdogs across the world have made it mandatory for all financial institutions to carry out KYC checks and identify verification procedures. The following are some of the key KYC measures notified by major regulators:
The Financial Action Task Force (FATF) – Global
The intergovernmental organisation, which is committed to fighting financial crimes with its various measures, is tasked with framing global standards for anti-money laundering compliance. As part of its AML/CFT guidance, the FATF has made it mandatory for financial institutions to conduct KYC procedures along with screening, risk assessment and due diligence before onboarding customers.
KYC Regulations in the US
KYC requirements for organisations in the US originate from the 1970 Bank Secrecy Act. The country introduced formal KYC processes in the PATRIOT Act of 2001, and they were strengthened in 2016 by the Financial Crimes Enforcement Network (FinCEN) rulings around customer due diligence (CDD). According to the new regulatory framework proposed by FinCEN, financial institutions are required to:
- Perform KYC checks for customer onboarding
- Assess customer risk and give a risk rating
- Perform EDD for high-risk customers
What Are The KYC Regulations in the EU?
The European Union’s Anti-Money Laundering Directives – notably the 5th anti-money laundering directive (5AMLD) and the 6th anti-money laundering directive (6AMLD) form the base of the region’s KYC norms. The EU is set to comply with the 6AMLD. However, the General Data Protection Regulation (GDPR) in 2018 and the Second Payment Services Directive (PSD2) in the EU are creating additional hurdles for organisations in meeting CDD procedures for KYC compliance.
What Are The KYC Regulations in the UK?
After Brexit, the UK is following the Sanctions and Money Laundering Act of 2018 to formulate its KYC measures. The Act recommends institutions to perform due diligence checks on all the entities to maintain domestic security and comply with the international security standards.
What Are The KYC Regulations in Australia?
In the aftermath of the COVID-19 pandemic, the Australian Transactions Reports and Analysis Center (AUSTRAC) amended the country’s KYC/AML regulations to suit the situation. For identity verification, AUSTRAC allowed the use of electronic copies of government-issued ID documents as alternative proof. In case that does not work, institutions must use video KYC for identity verification, according to AUSTRAC.
The Role Of Regtech In KYC and AML Compliance
Apart from having skilled professionals, financial institutions should also invest in effective software solutions to run their AML compliance programmes successfully. Many of the current AML-KYC solutions are not robust to capture the complexities of modern-day customer risk management. Customer AML risk ratings are either carried out manually or are based on models that use a limited set of pre-defined risk parameters. This leads to inadequate coverage of risk factors which vary in number and weightage from customer to customer.
Furthermore, the information for most of these risk parameters is static and collected when an account is opened. Often, information about customers is not updated in the required format and frequency. The current models do not consider all the touchpoints of a customer’s activity map and inaccurately score customers, failing to detect some high-risk customers and often misclassifying thousands of low-risk customers as high risk.
Misclassification of customer risk leads to unnecessary case reviews, resulting in high costs and customer dissatisfaction. Adding to this, the static nature of the risk parameters fails to capture the changing behaviour of customers and dynamically adjusts the risk ratings, exposing financial institutions to emerging threats.
Tookitaki’s Solutions for AML – KYC Compliance
Tookitaki developed an end-to-end AML-KYC compliance platform called the Anti-Money Laundering Suite (AMLS). It offers multiple solutions catering to the core AML activities such as transaction monitoring, name screening, transaction screening and customer risk scoring. Powered by advanced machine learning, AMLS addresses the market needs and provides an effective and scalable AML compliance solution.
To know more about our AML solution and its unique features, speak to one of our experts.
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