Ensuring the integrity and security of financial transactions in the dynamic global financial landscape is paramount. Two processes that play a critical role in maintaining this integrity are anti-money laundering (AML) and Know Your Customer (KYC).
While both are indispensable in preventing financial crime, they play distinct but interconnected purposes. In this article, we’re going to explore the key differences between AML and KYC, shed light on the functions they play within the compliance framework, and cover some of the best practices for ensuring robust compliance with AML regulations.
What is Anti Money Laundering (AML)?
AML is a series of measures and procedures conducted by financial institutions and other regulated entities to detect and prevent financial crimes. AML measures are primarily designed to stop criminals from disguising the origins of their illicit funds and integrating them into the legal financial system via money laundering.
Regulated entities such as banks and other financial institutions are required to follow AML regulations and standards, such as those set out by the Financial Action Task Force (FATF).
What is KYC?
KYC is another process that financial institutions such as banks use to safeguard against financial crime. The primary objective of KYC is to ensure that these institutions collect adequate information about their customers to assess their risk level, prevent fraud, and comply with regulatory requirements.
By knowing their customers better, financial institutions can reduce their risk of exposure to financial crimes such as money laundering, terrorist financing, and identity theft.
What’s the Difference Between KYC & AML?
KYC and AML are two distinct but closely related processes that play an interconnected role in maintaining integrity within the financial system.
The best way to distinguish the two is to think of AML as a broad range of measures that encompasses KYC as a component of these measures and includes other elements such as transaction monitoring and customer due diligence. All these things and more work together as part of the wider AML process.
AML KYC Process
The AML KYC compliance process is a series of steps, some of which are continuous processes, that financial institutions undertake to verify and understand their customers’ identities. It’s a fundamental process that helps to ensure compliance with regulations and prevent money laundering, terrorist financing, and other illicit activities.
Although the exact process can differ between different organizations, it typically involves the following components as part of a dynamic process:
● ID verification: Standard ID checks, biometrics, face scanning, and address verification are all used to ensure that first and foremost, customers are who they claim to be.
● Customer due diligence (CDD): Available data, such as publicly available information, is used to determine what risk, if any, a customer might expose the business to.
● Enhanced due diligence (EDD): Customers who are identified as high-risk may be subject to EDD, such as searches of credit histories and adverse media checks.
● Ongoing monitoring: Risk levels can change, and ongoing monitoring helps to inform risk status by carrying out periodic checks and watching for unusual changes.
● Suspicious activity reports (SAR): SARs alert law enforcement to potential instances of financial crime, and are filed by the institutions who discover it.
● AML training: Training programs for all staff, including those outside of the compliance team, help to keep organizations ahead of the latest threat trends.
What is AML & KYC Compliance?
Although the two terms are often used interchangeably, there’s a difference between AML compliance and KYC compliance.
AML compliance refers to a regulated organization’s conformity set out in AML regulations, such as the EU’s Anti-Money Laundering Directive (AMLD). These are the rules, regulations, and procedures that organizations must follow in order to prevent money laundering, terrorist financing, and other financial crimes.
In contrast, KYC compliance focuses solely on the procedures related to identifying a customer’s identity and ensuring that they are who they claim to be. Although requirements vary between jurisdictions, financial institutions are typically required to collect and verify customer information before establishing a relationship with them.
How do Businesses Become KYC AML Compliant? 8 Best Practices
1. Understand Regulatory Requirements
You can’t become compliant if you don’t know what you need to be compliant with. The first step to becoming KYC and AML compliant is therefore building an understanding of the regulatory framework that’s applicable to your organization and jurisdiction. In most of Europe, for example, this is the AMLD, but for those operating in the U.S., it’s the Anti-Money Laundering Act (AMLA).
2. Develop Policies & Procedures
Everyone has a role to play in ensuring continuous compliance within a regulated institution. Compliance leaders should therefore seek to establish robust policies and procedures that specifically outline the KYC and AML requirements of the business, including policies for customer onboarding, due diligence, ongoing monitoring, whistleblowing, and suspicious activity reporting.
3. Implement a Customer Identification Program (CIP)
Identifying your customers goes beyond merely looking at identity documents. You need to put together a structured, comprehensive CIP that involves identify verification via reliable documentation and is backed by technology like biometrics checks, liveness checks, and face verification. Your CIP should also include risk categories that dictate which checks are conducted next.
4. Conduct Customer Due Diligence
All customers will have due diligence checks carried out against them, but their risk level should dictate how extensive they are. For low-risk customers, basic checks such as sanctions list screenings may be enough, but for customers with a higher risk level, enhanced due diligence checks such as adverse media monitoring, credit checks, and deeper investigations may be needed.
5. Implement Transaction Monitoring Systems
Compliance leaders must establish processes for investigating suspicious transactional activity. Automated transaction monitoring systems are your best bet; these can detect and flag suspicious activities such as large cash deposits and transfers to high-risk countries, giving compliance teams a 360-degree overview of the organization and its customers’ activity, and enabling them to act fast.
6. Provide Training and Awareness
Compliance is something that all employees must be champions of. It’s therefore critical that employees are regularly trained on the AML landscape, your own anti-money laundering and KYC policies and procedures, and that they’re aware of the role these play in keeping your organization safe and well inside of compliance requirements, and why this is important (e.g., to avoid fines and reputational damage.)
7. Conduct Internal Audits
KYC and AML are continuous, dynamic processes. Threats are always evolving, and your procedures need to change and adapt to them. It’s for this reason that you cannot be complacent and assume that your AML and KYC program will stay robust in perpetuity. To ensure that everything is working as it should, you need to conduct regular internal audits and make improvements where any shortcomings are identified.
8. Stay Ahead of Industry Best Practices
Your organization isn’t alone; more and more businesses are finding that they need to comply with AML and KYC requirements as digital transformation makes it easier than ever for companies to provide financial services. The best way to stay ahead is to monitor industry developments, best practices, and regulatory updates to ensure ongoing compliance. Also, consider participating in industry forums to see how organizations like yours are overcoming the latest challenges.
How to Improve AML/KYC Compliance with Automation
Organizations have a choice when it comes to implementing KYC: develop and rely on manual, human-led processes or adopt automation technology which can do all the grunt work for them (hint: most organizations choose the latter!)
Manual KYC checks were the norm for decades and required lots of expensive, relatively slow, and error-prone human operators to conduct them. With the advent of digitization, however, has come a new generation of automated KYC tools that can conduct KYC checks much more quickly and with higher accuracy than a human operator. This reduces the risk of human error causing organizations to fall out of compliance while also reducing the risk of losing customers by increasing pass rates.
For almost all organizations, an automated AML/KYC solution is going to be the best option.
AML or KYC: Which Does My Business Need?
AML compliance which, as we’ve explored, includes KYC, is mandatory for regulated institutions under anti-money laundering and anti-terror financing legislation and regulations that are applicable to their jurisdiction.
The scope of such regulation varies but, as a rule of thumb, typically includes:
- Financial institutions (e.g., banks and payment processors)
- Credit providers
- Insurance companies
- Virtual asset service providers
- Gambling service providers
- Vendors of high-value commodities (e.g., art, property)
- E-money institutions
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