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Understanding KYC Requirements for Banks

Know Your Customer (KYC) checks are the first step in safeguarding your operations against the risk of money laundering, fraud, identity theft, and other financial crimes. Making sure you fully understand KYC requirements is crucial for your bank's compliance process. 

In the digital era of finance where both compliance and risk are changing rapidly, banks and other regulated financial institutions are under mounting pressure to not just know their customers and clients but understand them in more detail than ever before.  

What is KYC? 

KYC is a process designed to protect banks and other financial institutions from fraud, money laundering, terrorist financing, and other economic crimes.  

KYC achieves this by enabling regulated financial institutions to identify and verify a client’s identity, the source(s) of their funds, whether the source(s) of such funds is lawful, and assess the risks associated with their clients.  

KYC is a mandatory process that must be conducted during new client onboarding and periodically throughout the lifecycle of the client relationship in accordance with individual client risk profiles. A high-risk client, for example, will have KYC checks run more frequently than a client who is deemed low risk.  

KYC checks help to prevent identity theft, money laundering, terrorism financing, and other financial crimes through processes such as ID verification, biometrics checks, and document vetting.  

Why KYC is important 

In short—because there’s a legal requirement for banks and other financial services firms to conduct KYC checks. Failure to meet KYC requirements can result in severe penalties, including large fines and potentially prison time.   

In the European Union, KYC is primarily governed by the Financial Action Task Force (FATF) Recommendations which are enforced through the Anti-Money Laundering Directives (AMLD).  

The FATF Recommendations set out a comprehensive and consistent framework of measures that countries should implement to combat money laundering and terrorist financing. Although the FATF Recommendations are exactly that—recommendations—virtually all EU Member States, and a total of 200 jurisdictions, treat them as law. Although not every jurisdiction is currently able to meet these recommendations.  

The AMLD, which was first introduced in 1991 and, as of 2021, is in its sixth iteration (6AMLD), is a set of regulatory requirements intended to prevent money laundering and terrorist financing and establish a consistent regulatory environment across the EU.   

Breaking down the KYC process 

The KYC process can broadly be broken down into three constituent parts: pre-requisites, identification, and ongoing monitoring. 

KYC pre-requisites 

One of the fundamental elements of any KYC process is its pre-requisites; a set of criteria that banks can use to define their ideal customer profile(s) and separate the customers that they want to work with from those they want to avoid.  

By collecting sufficient information about a prospective customer from the outset, banks and financial institutions can ensure that they’re only working with customers who are unlikely to expose them to an unacceptable amount of risk as per their internal risk policies.  

Using customer pre-requisite criteria is useful for this purpose because it filters out obviously unsuitable customers prior to the identification stage.    

KYC identification and customer due diligence 

Prospective customers who ‘pass’ the initial filter will proceed to the identification stage, which is the first step in customer onboarding.  

The KYC identification stage helps banks to ensure that customers are who they say they are by verifying their identity and the nature of their business. This involves verifying information provided by a customer using identification documents as well as third-party data sources. 

The identification process will usually involve: 

  • Verification of official government ID documents. 
  • Customer authentication using biometric technologies. 
  • Building an understanding of the nature of the customer’s activity.  
  • Assessing risks associated with doing business with the prospective customer.  

When a prospective customer’s identity has been verified, the next step is to carry out due diligence to determine what risk, if any, they carry, and whether this fits the business’s risk appetite.  

Customer due diligence (CDD) highlights risk factors by analyzing data from a variety of sources, such as:  

  • Information provided by the prospective customer. 
  • Information from sanctions and politically exposed persons (PEPs) lists. 
  • Publicly available data, such as company listings and media. 
  • Private data sources from third parties. 

Where CDD highlights a prospective customer as high risk, enhanced due diligence (EDD) checks, such as credit record and adverse media searches, may be carried out.  

KYC and ongoing monitoring 

KYC is not a one-and-done process. It’s important to maintain and update customer information throughout the lifecycle of the customer relationship because customer risk profiles are susceptible to change with the passage of time.  

Ongoing monitoring involves carrying out periodic checks to inform risk status by monitoring for things like: 

  • Sudden, unusual fluctuations in transactional activity. 
  • Unusual cross-border activity. 
  • Adverse media references. 
  • Unusually large deposits and withdrawals. 
  • Transactions involving sanctioned entities or those on watchlists. 

What’s the difference between KYC and AML? 

Although the terms KYC and AML are often used together (and sometimes, interchangeably), it’s important to note the differences.  

AML is the framework of legislation and regulations that banks and financial institutions are required, by law, to follow in order to prevent money laundering. In contrast, KYC is a process that forms a part of the AML framework by requiring regulated institutions to know who they are doing business with.  

KYC is critical for banks 

As the adoption of online banking continues to grow, so does the risk of fraud. This is illustrated by an endless slurry of alarming statistics, such as the 70% increase in U.S. fraud losses between 2020 and 2021, which amounted to $5.8 billion. KYC is therefore becoming increasingly important for banking service providers. Knowing your customer is who they say they are when accessing your products is key to preventing customer losses.  

For banks, KYC provides a way to assess and monitor the risks associated with a specific customer and prevent things like: 

  • Money laundering. 
  • Identity theft. 
  • Terrorist financing. 
  • Money mules. 

The threat actors that carry out these financial crimes not only leave banks on the hook for large fines, but they can also destroy the trust that their customers have in them. This can easily lead to lost revenue and diminished business.  

Automated KYC 

The evolving nature of the KYC and AML space, alongside the relentless demand that it places on compliance teams, makes it virtually impossible for banks to meet their KYC obligations when relying on legacy processes and workflows.  

To ensure that you’re not missing any critical customer information and that your obligations under key AML and KYC regulations are being met, automation should be at the forefront of your KYC process.  

Automated KYC makes it easy to quickly carry out multiple checks on new customers during the initial KYC process while simultaneously monitoring existing customers in the background. By adopting a centralized and automated solution to manage KYC, banks can: 

  • Establish a single source of truth for all customer profiles. 
  • Quickly run customers against sanctions and PEPs lists. 
  • Automate repetitive workflows to free up resources. 
  • Maintain accurate risk profiles based on point-in-time data. 

KYC and regional variances 

In all developed economies, it’s a legal requirement for banks and regulated institutions to carry out KYC checks. What this means, however, varies between different jurisdictions.  

In the European Union, as we mentioned earlier, member states are given a great degree of autonomy when it comes to implementing KYC, which means there’s some variance between KYC requirements across the 27 states. However, the bloc is slowly moving towards a more unified approach which will see KYC applied more consistently.  

In the UK, banks are required to perform customer due diligence measures so that they can understand the purpose and intended nature of business relationships, including building an understanding of where their customers’ funds come from. 

Meanwhile, in the US, financial institutions are required by federal law to adopt a risk-based approach to customer due diligence and collect beneficial ownership information. As per the so-called “Patriot Act”, financial institutions must also have Customer Identification Programs (CIPs) in place and, in situations involving foreign jurisdictions, apply “special measures” that impose obligations such as additional record keeping, the reporting of certain transactions, and the collection of information relating to ‘payable through’ accounts.  

No matter the jurisdiction, the core goal of KYC initiatives is to ensure that regulated financial institutions know who they are working with and know the level of risk that’s involved in working with each individual customer. That’s the only way to deliver truly transformative KYC journeys.  

Find out how Fenergo can transform your bank’s KYC journeys here