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KYC vs. CDD: Understanding KYC Due Diligence

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Know Your Customer (KYC) and Customer Due Diligence (CDD) are two essential processes financial institutions use to mitigate risks associated with money laundering, terror financing, and other criminal activities. 

Regulators worldwide issued $6.6 billion in penalties to financial institutions in 2023, with US regulators issuing over $5 billion of those fines.  This is up markedly from 2021 ($5.4 billion) and 2022 ($4.2 billion). By implementing robust KYC and CDD processes, FIs can protect themselves from financial crimes, maintain regulatory compliance, and safeguard their reputation in an increasingly complex business landscape.

While KYC and CDD are often used interchangeably, they are distinctly different concepts that serve specific purposes, which we’ll explore below. 

What are KYC and CDD?

KYC checks involve verifying a customer's identity to prevent theft, money laundering, and other illegal activities. The KYC onboarding process includes collecting information like name, address, date of birth, and documents such as government-issued ID. Ensuring accurate customer identification helps businesses assess risk levels and meet compliance requirements. 

While CDD is a comprehensive, ongoing process of gathering and analyzing customer information to assess risk. It goes beyond identity verification to examine a customer's background, financial activities, and the purpose of their relationship with the business. CDD helps identify high-risk customers through enhanced due diligence or transactions, allowing businesses to take appropriate risk mitigation measures. Check out our blog, KYC vs CDD, for more on the differences between the two. 

KYC and CDD are crucial in preventing financial crimes like money laundering and terrorism financing. They help businesses reduce legal and reputational risks while ensuring secure and transparent financial transactions. Financial institutions like banks and investment firms adhere to stringent KYC and CDD requirements, complying with local regulations and international standards like those from the Financial Action Task Force (FATF).

Why are KYC and CDD Important?

KYC and CDD help prevent money laundering, terrorist financing and other illicit activities, promoting transparency, trust, and regulatory adherence. Key benefits of KYC and CDD include:

1. Identity Verification:

  • KYC: Establishes customer identity by collecting personal information like name, address, and ID documents. This verification helps businesses know their customers and mitigate the risks of illegal activities.
  • CDD: Goes deeper by analyzing the customer's financial background, income sources, and transaction purposes. It identifies beneficial ownership, potential red flags and suspicious patterns indicating illicit activities.

2. Prevention of Financial Crimes:

  • Compliance with Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) regulations significantly reduces the risk of financial crimes. Robust KYC and CDD practices deter criminals from targeting businesses.

3. Building Trust:

  • Implementing thorough KYC and CDD practices demonstrates a commitment to customer protection, privacy, and risk and compliance. This builds trust and credibility with regulators, law enforcement, and shareholders.

Financial institutions prioritizing KYC and CDD enhance security, ensure compliance, and provide a trustworthy environment for customers and stakeholders.

What is the Difference Between KYC and CDD?

Despite the similarities between KYC and CDD, they serve distinct purposes.

KYC requirements focus on verifying customers' identities during the KYC onboarding process. It involves collecting personal information such as name, address, date of birth, and identification documents. The goal is to confirm customers' identities at the beginning of a new relationship to ensure data is collected, verified, and used to help assess risk on an ongoing basis. 

CDD goes beyond identity verification, encompassing a broader analysis of the customer's financial background, source of funds, and transaction purposes. It involves continuous monitoring to assess and manage risks associated with the customer over time. CDD helps identify high-risk customers that may require enhanced monitoring or additional checks throughout the customer lifecycle.

What Are the Main Functions of KYC and CDD?

Three main functions are involved in KYC and CDD:

1. Customer Identification Program (CIP)

Financial services companies are mandated by the Patriot Act to have a CIP to establish a reasonable belief that they know each customer's true identity. To comply with this requirement, companies must collect four key pieces of identifying information from prospective clients: full name, date of birth, legal address, and a valid identification number (such as a Social Security Number or Taxpayer Identification Number).

2. Customer Due Diligence (CDD)

Customer due diligence checks develop a risk profile for each customer by verifying their identity and performing background checks such as examining sources of wealth. These checks are continuous and should be conducted on an ongoing basis.

3. Ongoing Monitoring

Continuous monitoring, also known as Perpetual KYC (pKYC), involves monitoring customer transactions to detect suspicious activities that could indicate financial crimes. It also encompasses further measures, such as routinely rescreening customers according to their risk profiles.

Understanding The Different Levels of CDD

Financial institutions may apply varying degrees of customer due diligence based on the nature of the interaction. For instance, a client making a small withdrawal through their banking app will face minimal verification, whereas attempting to withdraw the entire account balance from an unexpected location would trigger more stringent security measures.

CDD involves various levels of scrutiny based on each customer's risk level:

1. Simplified Due Diligence (SDD):

  • Applied to low-risk customers with low transaction volumes or limited exposure to high-risk jurisdictions
  • Involves basic identification and verification, such as collecting names, addresses, and identification documents

2. Standard Due Diligence (SDD):

  • Used for moderate-risk customers with higher transaction volumes or involvement in riskier industries or jurisdictions
  • Requires additional information like the source of funds, employment history, and business relationships
  • Includes ongoing monitoring to detect changes in a customer’s behavior or risk profile

3. Enhanced Due Diligence (EDD):

  • Reserved for high-risk customers, such as politically exposed persons (PEPs), high-net-worth individuals, or those in high-risk industries or jurisdictions
  • Involves a thorough investigation of the customer's background, including source of wealth checks and their associations with high-risk entities
  • Requires rigorous ongoing monitoring to identify and investigate suspicious activities promptly

CDD vs EDD: What's the Difference?

CDD and enhanced due diligence (EDD) are key strategies for preventing illicit activities. While they sound similar, they serve different purposes.

Customer Due Diligence (CDD):

  • Purpose: Standard procedure to gather essential customer information
  • Process: Verifies customer identity, assesses risk profile, and understands financial transactions
  • Information Collected: Basic details like name, address, date of birth, and government-issued ID
  • Goal: Establish identity and evaluate risk for potential involvement in money laundering, terrorist financing, or other crimes

Enhanced Due Diligence (EDD):

  • Purpose: In-depth investigation of high-risk customers
  • Triggers: High-risk factors like business nature, location, or personal background
  • Process: Goes beyond CDD with additional measures such as background checks, media intelligence, and negative news searches. Consults third-party databases for links to politically exposed persons (PEPs) or high-risk jurisdictions
  • Goal: Obtain a comprehensive understanding of customer activities, ensure KYC compliance, and safeguard against financial crimes

How to Improve KYC and CDD Procedures

Despite many financial institutions' reliance on in-house systems and outdated architectures, there is a growing interest in using software to automate business functions like detecting and preventing financial crimes. Almost half (46%) of banks are already using AI and machine learning to enhance rules and analytics, while 44% are focused on case management, 43% on behavior detection, and 37% on reporting. 

Digitizing KYC CDD operations gives financial institutions a deeper understanding of the risks associated with various entities and individuals throughout their life cycles. This is crucial as they face the increasing complexity of sanctions and regulatory requirements in today's unstable socio-political and economic environment.

Fenergo’s KYC solutions enable rapid identity verification, allowing users to complete the process without unnecessary friction. Traditionally, compliance within investment advisory firms has been manual, time-consuming, and error-prone. The large volume of client data and stringent regulatory requirements make it difficult for these firms to stay current with changing rules. However, Fenergo's SaaS solution offers a comprehensive approach by integrating KYC, CIP, transaction monitoring, and EDD into a single platform.

One of Fenergo's key advantages is its scalability. Investment advisory firms serve various clients, from individuals to large institutions. As these firms grow, so does the amount of client data that needs to be verified and monitored. Cloud infrastructure allows these institutions to scale their compliance operations easily to handle increasing data volumes without significant infrastructure costs.

Request a demo for more information or to see a demonstration of any Fenergo solution.