Know your customer (KYC) is the process of verifying and confirming the customer’s identity. It’s an ongoing process conducted throughout the customer journey to help prevent cases of fraud, money laundering, and financial crime.
Backed with an anti-money laundering(AML) framework, KYC regulations help businesses avoid involvement in financial crime. Businesses can face penalties in billions if they fail to comply.
Well, ignorance surely isn’t an escape now.
With this blog post, we’ll help you understand the top 3 components of KYC and the regulatory framework guiding it. Also, we will share guidelines to implement an effective KYC program.
Ready to dive in? Let’s get started.
The three key components of KYC
The 3 step KYC approach is standardized by most countries. These three components form the foundation of KYC processes and include:
1. Customer identification program (CIP)
The basis of any transaction is trust. That’s exactly what the first component of KYC focuses on.
Through this process, it’s verified that the customers are who they actually claim to be. This applies to both individuals and corporate customers.
Here, you collect, document, and verify the relevant documents to confirm the customer’s identity. This KYC process generally consists of two steps:
Document verification
Here you check the customer ID against government databases to verify their identity. Generally, government-issued IDs are used to confirm the following details.
- Name
- Address
- Date of birth
- Government-issued identity number
However, for corporate customers, organizations may require additional KYC documents. This includes:
- Business licenses
- Incorporation papers
- Partnership agreements
- Financial statements
Businesses can automate this process with advanced identity verification tools. Such tools provide accurate results and can verify multiple identities at a time.
Biometric check
Another part of identity verification is a biometric check. Here, a person’s face is checked against the provided ID to detect fake activities. Tools like Hyperverge’s identity verification can come in handy to ensure that no fake profiles get verified.
This first step establishes the customer’s identity, making sure they are who they claim to be.
2. Customer due diligence (CDD)
The next step of KYC compliance focuses on evaluating the customer’s risk profile.
Here, businesses determine the risk carried by each customer and its impact on the business. This safeguards the businesses from building relationships with any criminals or fraudsters.
That said, customer due diligence is also an important aspect of anti-money laundering (AML) compliance.
Thorough customer diligence involves two steps:
Simplified due diligence
Businesses must conduct basic due diligence for every customer. This helps them determine whether the customer is high-risk or low-risk.
In the case of corporate customers, businesses conduct due diligence on ultimate beneficial owners (UBOs).
To perform due diligence, businesses should analyze customer data and transaction patterns. If they find something suspicious, it calls for an enhanced level of screening.
Enhanced due diligence
Enhanced due diligence is for customers deemed to be at higher risk. Here, the company will search through litigation records, credit histories, and sanction lists to make sure the customer isn’t involved in any illegal activities.
Now, there’s no fixed process to conduct enhanced due diligence. Financial institutions may dig deeper depending on the customer and the risk they carry.
| Note: Organizations must maintain their CDD and EDD records for regulatory compliance and audit checks. |
3. Ongoing monitoring
As discussed earlier, KYC doesn’t stop at onboarding. The risk profile of a customer can change at any moment.
Through ongoing monitoring, financial services companies can identify unusual changes in the customers’ profiles and update their risk status.
Now, ongoing monitoring involves carrying out a regular check on customers by analyzing:
- Transaction patterns, i.e., location, frequency, and amounts of transactions
- Inclusion in politically exposed persons(PEP) and sanction lists
- Negative media exposure
- Transactions with people on sanction lists and watch lists
- Changes in the customer’s location
Such thorough monitoring can help companies spot fraudulent activities in customer accounts. If they find anything, a company must file a suspicious activity report (SAR).
Like enhanced diligence, there’s no fixed process for ongoing monitoring. Organizations can decide their own monitoring process depending on the risk profile of their customers.
| Pro tip: KYC automation tools can make your monitoring process time and cost-efficient. |
With that, you now understand the 3 pillars upon which the fundamentals of KYC rest. Let’s now understand the regulatory compliances surrounding KYC implementation.
Regulatory framework and compliance
KYC is a component of the anti-money laundering (AML) framework that helps to prevent illegal activities and financial fraud. While its purpose remains the same universally, the regulatory bodies enforcing these rules vary by region.
More than 190 countries follow the guidelines of the Financial Action Task Force (FATF) to form their AML/KYC rules. Some of these KYC laws include:
- The Banking Secrecy Act of the US. This legislation mandates financial institutions to verify the customer’s identity and report to the Financial Crimes Enforcement Network (FinCEN) in case of any suspicious activity.
- The US Patriot Act mandates organizations to develop client identification programs to spot criminals and fraudsters. The guidelines safeguard the business from building any illegitimate customer relationships.
- The Money Laundering Act of the US dictates customer verification rules for the reporting entities. These guidelines require businesses to verify and report illegitimate customers, i.e., terrorists.
Similarly, countries like the UK, the EU, and Australia have outlined their anti-money laundering regulations through directives and legislative acts.
Now, there are too many businesses that require KYC implementation to remain compliant. This includes financial institutions, banks, insurance companies, gambling companies, e-commerce businesses, and payment applications.
These businesses must strictly abide by the KYC framework. Fraudulent and criminal activities in these sectors can bring down the entire economy.
Lack of compliance here will damage the business’s reputation and attract government penalties of millions of dollars.
This leaves businesses with no option but to implement a stringent KYC framework.
Benefits of a robust KYC program
While the compliance and regulatory requirements sound a bit too much, a business has a lot to gain from KYC implementation.
Here are the benefits of implementing a robust KYC program in your business.
1. Fraud protection
KYC establishes the basis for trust. A robust KYC system verifies the customer’s identity and helps avoid spoofing cases. Also, monitoring and due diligence checks can safeguard the business against money laundering cases.
That said, a resilient system makes it hard for fraudsters to exploit your system.
2. Ensure regulatory compliance
A reliable KYC program is an important component of an active AML regime. By adhering to a well-structured KYC program, businesses can minimize the risks of regulatory breaches and huge penalties.
3. Establish customers’ trust
A resilient KYC system safeguards customers’ information and protects their accounts from illegal access. By prioritizing their privacy, you win customers’ loyalty and build long-term relationships.
4. Facilitates risk management
KYC identifies potential risk factors associated with customers. This includes credit risk, ties with PEP, mentions in negative media, and inclusion in sanction lists.
By implementing KYC, it is easier to address and manage such risks thoroughly.
5. Strengthens the brand’s reputation
Implementing a robust KYC program demonstrates your commitment to customers and society. It reinforces your company’s reputation as a strong and reliable brand committed to ethical practices and data protection.
KYC fosters a secure business environment for stakeholders, the public, and the economy at large.
That said, KYC serves the interests of both the company and its customers.
How to implement an effective KYC program
Implementing a robust KYC program safeguards your business against financial crimes and helps you stay compliant.
While the three-step approach builds a foundation, a well-structured KYC program helps you keep that foundation intact.
Here’s a step-by-step guide to implementing an effective KYC program for your business.
1. Choose the KYC solution
First things first, choose the right KYC solution for your business.
Businesses can choose between one of these digital KYC solutions:
In-house KYC solution
In-house KYC solutions are hosted and managed on the company’s servers, giving them complete control over their data and security. However, deploying a robust in-house KYC system requires a significant investment in hardware, IT resources, and maintenance.
Cloud-based KYC solution
Cloud-based KYC solutions are managed and hosted by third-party service providers. Such solutions are scalable, cost-effective, and extremely easy to deploy. However, in the case of cloud-based solutions, organizations may lack complete control over their data and security.
Hybrid KYC solution
Hybrid KYC solutions are a combination of in-house and cloud-based KYC business models. They leverage the processing speed and scalability of cloud models while allowing businesses to retain their important data. Such solutions strike a balance between security, cost-efficiency, and scalability.
Implementing KYC processes might be challenging. But with AI-powered technology, you can streamline the processes of identity verification, AML compliance, data classification, and ongoing monitoring.
2. Train your staff
Effective KYC implementation doesn’t stop at technology. One needs a well-trained staff to maintain the integrity of the KYC processes.
After choosing the KYC solution, train the people involved in customer onboarding and risk management activities. Devise a thorough training module to acquaint them with KYC procedures and protocols.
Walk them through the technology to show how it assists with identity verification, background checks, data extraction, and AML compliance.
Define a clear KYC process for your business and convey it efficiently, leaving no room for doubts.
Lastly, don’t stop after training them once. Conduct regular training, show them the best practices to implement KYC, and keep them updated with the changing compliance requirements.
3. Review and update
The regulatory landscape dictating the KYC rules continues to evolve and so should your KYC program.
Businesses should regularly review and update their KYC approach to remain vigilant against the new threats. An updated system helps you meet KYC compliance while enhancing your ability to manage fraud and security breaches efficiently.
A well-updated KYC approach shows your commitment and dedication towards customer security helping you build a reputable brand.
Takeaways
The components of KYC efficiently meet the compliance requirements of AML. It safeguards businesses against illicit crimes and empowers them to manage risks.
However, KYC requirements are quite comprehensive. It’s nearly impossible for businesses to implement them manually. Even through KYC tools, KYC implementation is quite tactical.
From ensuring that the verification process is accurate to conducting due diligence and consistently assessing the risk profile of customers—a lot goes into implementing an end-to-end KYC program.
Well, let’s help you ease the process with Hyperverge.
Hyperverge’s highly intuitive AI verification tool can accurately screen users against global databases, verifying their identity in less than 3 seconds.
FAQs
- What are the key components of KYC?
The fundamentals of KYC, also known as the pillars of KYC, are as follows:
- Customer identification program (CIP)
- Customer due diligence (CDD)
- Ongoing monitoring
- What are the 5 stages of KYC?
The five stages of KYC can be identified as:
- Customer identification
- Customer due diligence
- Enhanced due diligence
- Ongoing monitoring
- Suspicious activity report (SAR)
- What are the core elements of AML KYC?
The core elements of AML KYC include verifying the customer identity (customer identification), risk assessment (identifying high-risk customers), identifying money laundering risks (transaction monitoring), and maintaining a detailed record of customer interactions.
