Financial institutions, needless to say, are subject to a higher degree of scrutiny than most other businesses. Numerous laws, regulations and institutional guidelines have emerged over the years to limit the occurrence of financial crimes. Of course, fraudsters will always try to exploit loopholes or other systemic weaknesses, and some will inevitably succeed in their efforts (at least for a while).
That’s why it’s essential that banks and other financial firms adhere to industry best practices to protect their assets as well as their reputations.
Know your customer
KYC (Know Your Customer) is one of the best lines of defense against dishonest clients and customers. Put simply, KYC is a set of risk assessment procedures used to verify the identity of customers and ensure that their activities are aboveboard, thus fostering a culture of transparency and legitimacy.
The process involves a new client submitting various financial and personal documents which are then checked against databases to confirm that the individual is in fact who they claim to be, and moreover that they’re not the target of any sanctions or suspected of being party to terrorist activities.
Customer identification program
Bound up with the KYC practice is a customer identification program (CIP). Again, this is a method of identity verification, which is done after a few basic details about a new customer (name, DOB, address, etc.) are provided.
In order to be effective, CIP ought to be an official, hard-and-fast policy of which all relevant parties have a clear understanding. A CIP that has been haphazardly constructed isn’t much use to anyone—except perhaps criminals. The same is true of CIPs that are performed with only a cursory attention to detail.
For many firms, basic CIP is sufficient to complete a screening of a new customer. On the other hand, for larger firms (e.g. investment banks), CIP is only the beginning.
AML vs KYC
In many countries, KYC is required by law and is an aspect of AML (anti money laundering) legislation. In view of that, AML checks are a common feature of the KYC process.
KYC and AML are not one and the same, but they are similar in what they are designed to achieve. The main difference is that AML represents a more rigorous and intricate process. AML includes KYC, plus additional measures like enhanced due diligence (EDD), ongoing risk assessment and monitoring, compliance training, etc.
EDD is one of three customer due diligence (CDD), the others being simplified due diligence and basic due diligence. In general, a company will turn to EDD after simplified or basic CDD reveals a client to be high risk, meaning they’re liable to run afoul of the law.
EDD offers a more in depth glimpse into the customer’s background and patterns of behavior, allowing a business to make an informed decision about whether the individual is worth transacting with.
Even if it weren’t the law of the land, KYC would be an invaluable part of developing, expanding and protecting a business. Learning to do it properly can make the difference between prosperity and ruin.