Implementing Know Your Customer (KYC) procedures is essential for financial institutions to mitigate risks and ensure compliance with regulatory standards.
The primary objectives when gathering KYC information, using a risk-based approach are to identify the customer, verify the client’s true identity, understand the customer’s activities and source of funding, and monitor the customer’s activities. To achieve these primary objectives the necessary steps of KYC must be followed:
Customer identification, which includes customer verification measures;
Customer Due Diligence or CDD, which consists of regular customer background checks; and
Enhanced Due Diligence or EDD, which is a more detailed review or investigation, performed on customers with a higher risk.
Implementing Know Your Customer: Three Steps of a KYC Screening Compliance Framework
Step 1: Customer Identification
Prior to checking a client’s ID reports, it is important to confirm their and examine all suitable data for any irregularities. You should be certain that your potential client is not on any of the sanctions lists, (for example, the OFAC or Interpol List).
You likewise need to be educated assuming your imminent client is politically exposed, as it is considered at a global level that a PEP (Politically Exposed Person) is more defenseless to corruption, consequently, such clients ought to be thought of as high risk, and dependent subject to explicit mitigation measures.
Step 2: Customer Due Diligence (CDD)
The collection of all customer data from reputable sources, the identification of the relationship’s purpose, intended nature, and key beneficiaries, as well as ongoing monitoring of the relationship to ensure that all activity is consistent with recorded customer information, should all be part of due diligence measures.
The foundation of a successful internal compliance program or ICP is the CDD policies, procedures, and processes, as stated in the FFIEC Manual. The goal of CDD is to empower banks and other monetary foundations to comprehend the nature and motivation behind their client connections, which may include understanding the kinds of exchanges for which a client is probably going to engage.
Even more explicitly, CDD is a far-reaching assessment of a client, performed by financial institutions preceding laying out a business relationship. A business relationship is shaped when at least two parties consent to participate in normal business or conduct a “one-off” exchange. Consequently, when carried out appropriately, CDD enables financial institutions to evaluate the degree to which a customer exposes the institution to a variety of risks, such as the risks associated with money laundering and terrorist financing (ML/TF).
Overall, CDD permits the monetary foundation to have a sensible conviction that the client is who they say they are. When done correctly, CDD processes can identify high-risk individuals in advance. After that, institutions can either modify internal compliance controls or terminate the business relationship because onboarding criminals could result in fines and reputational harm for the institution.
The four fundamental components (core elements) of a Customer Due Diligence or CDD program are as follows: a) verifying and identifying the identity of clients or customers, b) verifying and identifying the identity of ultimate beneficial owners or UBOs of clients that are legal entities, c) grasping the nature and reason for customer relationships, and d) continuous monitoring to keep up with and update client data and distinguish suspicious transactions.
Appropriate CDD not only shields the organization from AML fines and punishments, but it likewise safeguards the business from any type of fraud. Additionally, the institution receives valuable customer data, which can be used to enhance customer service quality.
Step 3: Enhanced Due Diligence (EDD)
Assuming that the client is considered at higher risk than anticipated, enhanced due diligence or EDD measures are needed.
High-risk clients are in particular politically exposed persons or PEPs, those with a current relationship with contenders, or anybody whose nation of origin is on an international list for High-Risk Third Countries. EDD measures for the most part incorporate intensive monitoring of the client relationship and more profound insightful background research.
The most effective method to comply with KYC requirements is to incorporate the respective acquired data into existing processes, for example, the onboarding of customers. Furthermore, it tends to be troublesome and tedious to execute these processes reliably at scale. To resolve these issues, the automation of processes is an undeniably important part of compliance with KYC.
The identification of the client’s identity is a good example here. A computer can cross-reference and verify a customer’s identity documents faster and more reliably than an individual can provide a copy, file them accordingly, and manually check for any irregularities. This is particularly inconsistent when devices like Photoshop can be utilized to edit pictures. A PC framework, which is intended to distinguish fake records, is likewise definitely more probable than a human to detect fraudulent documents.
Final Thoughts
In the realm of regulatory compliance, KYC (Know Your Customer) stands as a crucial framework designed to validate a customer’s identity, understand their financial behavior, and mitigate associated risks. Central to the KYC process are three pivotal steps: the first is Customer Identification, ensuring clients are not associated with sanctions or high-risk categories such as PEPs. The second, Customer Due Diligence (CDD), delves into understanding the nature of client relationships, backed by stringent internal compliance measures.
Lastly, Enhanced Due Diligence (EDD) comes into play for high-risk clients, demanding a deeper assessment of their profiles. Leveraging technology, especially automation, in these processes ensures accuracy, efficiency, and reliability, emphasizing the need for institutions to integrate modern solutions to address the challenges of KYC compliance comprehensively.
