One of the first lines of defense of our financial system against money laundering, terrorist financing, and other financial crimes is Know Your Customer (KYC), a process that allows financial institutions and other regulated organizations to make sure that their customers are properly identifiable. Despite the complexity of KYC protocols, it is vitally important to ensure compliance.
By doing so, our financial system can prevent financial crime, mitigate risk, and build customer trust. Unfortunately, the actual process of implementing KYC is complex, with laws and policies differing from place to place.
Any institution seeking to implement KYC protocols needs to tackle these KYC and AML challenges. From handling customer transactions, to verifying identity documents, effective KYC processes need to be able to fight money laundering, tax evasion, and other financial crimes at any risk level.
The most common KYC challenges
Balancing compliance and customer experience
KYC in banking needs to balance compliance and customer experience.
The customer onboarding process needs to be made as smooth and fast as possible while also accurately verifying the customer identity. By reducing friction, institutions can improve efficiency greatly while complying with KYC compliance policies. Digital KYC processes are one of the better ways to handle these issues.
That said, friction still occurs in the digital KYC process as well. Most people do not have their bank account or Aadhar number memorized, and it slows the process down. External factors like server downtime can also cause friction. All in all, there are some downsides to be mitigated, even with the increased efficiency brought about by digital KYC processes.
Overcoming paper-based processes and manual verification
Due to their importance in anti money laundering efforts, KYC systems require a series of checks and cross-checks across multiple databases. Unfortunately, a number of these processes are not digitized, causing the verification process to be slow and prone to human error.
Until regulated institutions can take full advantage of the internet and the many kinds of automation software, they will have to suffer through paper-based processes and manual verification methods. Getting past this challenge will require investment in infrastructure, but the resulting increases in efficiency are sure to be worth it, especially when it comes to higher-risk customers.
Navigating evolving regulations
Criminals and money launderers are always trying to get around KYC regulations, and as a result, the laws and policies are constantly evolving to counter new techniques. As a result, setting up a KYC compliance system is not something that can be launched and ignored, it is something that requires regular maintenance and updates.
Maintaining a functional global KYC system requires the institution to keep abreast of evolving regulations, and comply with the new rules accordingly. To do this properly, the KYC compliance system must adapt, and should change when needed. Global KYC systems equipped with ML/AI are a good bet when it comes to navigating regulations as they evolve, as these technologies make the system flexible while requiring less manual effort to adjust it.
Verifying high-risk customers
High-risk customers are of many different kinds, and a proper KYC system should be able to differentiate between, for example, normal people from a high-risk country and actual criminals. As such, the KYC system needs to be able to perform proper risk assessments, and fast. If it fails, it can block out legitimate customers, or worse, allow money laundering to happen.
As such, KYC solutions need to be able to run a customer identification program and be able to verify documents remotely. Analyzing customer identity documents is an important step in stopping potential money laundering.
AML laws are harsh towards any organization suspected of allowing money laundering, and they have imposed a variety of fines and penalties on offenders. Overcoming this KYC compliance challenge requires making sure that the system verifies honest customers, while filtering out Politically Exposed People, money launderers, and financial criminals.
Global KYC challenges
As technology has advanced, money laundering organizations have taken full advantage. By using a wide variety of techniques, criminal organizations can transfer large sums to their target organizations. The most useful among these techniques is international money transfers.
By creating a web of transfers from different bank accounts and shell companies, criminal organizations can hide the flow of money. Catching them requires cooperation from the law enforcement agencies of multiple nations, often slowing down the process in a tangle of red tape. Customer identification, especially of Ultimate Beneficial Owners (UBOs) has become very difficult.
To get around all this red tape, KYC systems need to be able to handle corporate customers, analyze politically exposed persons, perform in-depth risk assessments, meet KYC obligations, protect personal identifying information, and so much more.
While these five challenges are the biggest ones, there are many more, and they all feed off of each other. So how can you overcome these without taxing limited resources?
Overcoming KYC challenges
KYC compliance challenges are complex and varied, and so the solutions are complex and varied too. There is no perfect solution, but by putting together many different systems and technologies, institutions can make sure that their KYC systems are robust and efficient. To know your customer properly, you need to perform KYC as comprehensively as possible. Let’s take a look at how to overcome these challenges.
- One of your first steps should be to hire a compliance officer who can effectively guide your KYC and AML initiatives. Ideally, they should help you set up your AML program, solve any issues that may crop up, and make sure all the policies are being followed.
- The next step is to set up the infrastructure for digital ID verification, which is a prerequisite to proper ID verification management.By combining this with a risk-based approach to digital KYC, people deemed to be high-risk will be examined in detail, which will ensure that effort is not wasted on people who are not potential criminals.
- Unfortunately, criminals are smart, and can get around these verification systems by hiding any evidence of suspicious behavior before the KYC process. This is where KYC workflow automation and ongoing monitoring can help improve your system. By regularly scanning the financial profiles and identity documents of all customers, KYC systems can catch any changes in their financial condition. For example, if a customer passes the KYC check, but then two months later becomes a Politically Exposed Person, then they won’t be caught unless a larger audit is triggered. But ongoing monitoring sidesteps this issue by performing regular customer due diligence.
- KYC identity verification automation can allow ongoing monitoring processes to run in the background, without wasting human effort and thereby increasing efficiency.
- Another major advancement that has turned out to be extremely useful is the combination of AI/ML. These AI/ML-enabled systems drastically improve identity verification processes using pattern recognition. By tracing financial patterns, these systems can fingerprint people based on their actions, making identity verification much easier.
- Given the large amounts of sensitive data that KYC systems deal with, customer privacy is extremely important. Since KYC procedures require a lot of cross-checks, sensitive data is often being sent back and forth, making it a tempting target. Today, blockchain technology is giving security systems a large advantage over would-be thieves. By using proper encryption and data signing, KYC systems can transfer large amounts of data, secure in the knowledge that any theft will be made immediately obvious. This is especially useful when it comes to global KYC.
There are many ways in which KYC challenges can be overcome, but a holistic solution is often hard to find. As such, it is best to partner with a trusted KYC provider like HyperVerge, to make sure that everything is being done properly.
Benefits of addressing KYC challenges
Addressing these KYC challenges is useful when protecting your organization from sanctions and penalties, but there are several major benefits to your bottom line as well.
Improved onboarding
When a prospective customer has to jump through hoops to sign up, it increases the likelihood that they’ll get bored and leave. By automating the KYC process, customers can be onboarded much faster, greatly increasing efficiency. This has a cascading effect, as time wasted with manual onboarding processes can now be used for other tasks, further increasing efficiency across the board.
Risk reduction
Proper KYC massively reduces the risk of fraud and money laundering, especially with the use of accurate risk assessment. Proper KYC processes can prevent identity theft, fake accounts, and the use of forged documents. Suspicious activity reports can further reduce risk, as they allow for quick responses. In general, proper KYC compliance can make it difficult for criminals to launder money or perform terrorist financing. Plus, these technology solutions can greatly reduce the risk of false positives as well, protecting these institutions from reputational damage.
Enhanced compliance
KYC processes are now mandated by law for all regulated institutions. Unfortunately, the level of complexity in these compliance requirements is increasing year by year. Compliance now requires complex training, infrastructure, cooperation with task forces, and more.
Worst of all, if these compliance policies are not followed, institutions can be hit with massive fines, penalties, sanctions, and can also suffer major reputational damage.
By implementing a risk-based approach, institutions can apply enhanced due diligence measures and perform ongoing monitoring to make sure all regulations are followed properly. This enables any and all financial institutions to avoid penalties while also building customer trust.
Increased efficiency
While the setup method for proper KYC processes can be relatively slow, the increases in efficiency more than make up for the slow start. A major aspect of proper KYC is automation, and KYC systems can easily automate the processes of verifying customer identities via technologies like biometric verification and optical character recognition. This makes onboarding easier.
Plus, automation can be used to reduce the day-to-day administrative work, improve customer experience, ease the process of data collection and management, and scale as needed.
KYC regulations dealing with customer data can make things slower, especially when it comes to businesses operating internationally. In this case, financial organizations can leverage technology to create automated solutions designed for global KYC.
Competitive advantage
Possibly the most important thing that a proper KYC system can do is provide a competitive advantage. Regulatory compliance is vital to building and retaining customer trust.
Put simply, which bank is more trustworthy – one that has allowed fraud to occur, or one that caught the fraudsters?
Another major advantage of these systems is providing insights. By analyzing the data provided by the users, financial institutions can customize their products to fit requirements. Plus, they can spot any inefficiencies in the process that could cause a negative impact on user experience.
Other than this, financial institutions can leverage their business relationship with KYC system providers to develop unique offerings that can allow them to differentiate themselves in an increasingly crowded market.
Final thoughts
KYC systems have now become indispensable in our current financial environment.The risk of money laundering, terrorist financing, and other forms of fraud is increasing every day.
Any failure to comply with regulations can result in fines and sanctions. To make sure you don’t fall prey to these issues, KYC compliance is necessary.
KYC requirements are such that merely performing simplified due diligence is not enough. Proper risk assessments need to be made, a verification process needs to be set up, employee training needs to be done, customer data needs to be handled as per AML regulations, and so much more.
Given these kinds of KYC requirements, it is best to consult people who specialize in KYC procedures. Stopping financial crime is a group effort, and it takes multiple different kinds of expertise to put together a comprehensive KYC strategy.
By developing one, you can make sure that your institution works the way it should. Admittedly, there are challenges to building an end-to-end KYC process.
Luckily, none of these challenges are insurmountable, and HyperVerge can help you build the systems you need. Click here to learn how our digital identity verification system can help you streamline your KYC process.
FAQs
1. What are the challenges of implementing KYC?
The five main challenges of implementing KYC are:
- Balancing Compliance and Customer Experience
- Overcoming Paper-Based Processes and Manual Verification
- Navigating Evolving Regulations
- Verifying High-Risk Customers
- Global KYC Challenges
2. What are the challenges of KYC CDD?
The challenges of KYC CDD are:
- Maintaining accurate and up-to-date customer information
- Handling complex regulations across multiple regions
- Operational costs and resource constraints
- Integration of technology into legacy systems
- Ongoing monitoring and reporting
3. What are the three types of risk in KYC?
The three types of risk in KYC are:
- Low Risk, which requires KYC to be performed once every ten years
- Medium Risk, which requires KYC to be performed once every eight years
- High Risk, which requires KYC to be performed once every two years
4. What are the drawbacks of KYC?
There are several drawbacks to setting up KYC processes, including:
- Data privacy and security issues
- Lengthy processing times
- High infrastructure costs
- High maintenance costs
- System complexity
- Compliance costs
