Know your KYC Process

Customer Due Diligence, Enhanced Due Diligence, Know Your Customer, KYC, Standard Due Diligence
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KYC or Know Your Customer/Client is a process most of us are now familiar with.  For most of us, this process is all about proving that we are indeed who we are to almost every institution we deal with on a daily basis like banks and Internet Service Providers (ISPs). The thoroughness of the process also varies as per countries and industries. The KYC process for getting a new internet connection may not be as strict as that for opening a bank account or getting a loan.

How KYC became so important?

For the importance of KYC, let us look at two examples.
All of us know about money laundering. The process remains the crooks’ favorite way to ‘legalize’ their bad money. The loopholes in the law allowed a lot of crooks to live the high life. A great example of this is the notorious Cali Cartel made famous by the Netflix series ‘Narcos’.  They did not bury their money all over the country like their more famous rival Pablo Escobar. They used banks to get their now clean money back.

However, steps were already being taken to curb the menace. Things began to change in 1970 when the Bank Secrecy Act came into being. The law took some of the first steps to stop financial institutions from being used to launder ill-gotten wealth. The Narcos and the still-continuing ‘war on drugs’ helped tighten the screws further. Money laundering was made a federal offense in the 1986 Money Laundering Control act. Other countries followed suit. The formation of the Financial Action Task Force or FATF was another step in the right direction. But it took a tragedy to see sweeping banking reforms come into play.

The 9/11 attacks on the US saw massive destruction of property and life. What followed was the ‘Patriot act’. The act introduced sweeping changes to various sectors. It strengthened the fight against money laundering and terror financing by tightening Anti Money Laundering (AML) norms. KYC was made a key area of AML processes. It became mandatory to authenticate the client before doing business with them.

Levels of scrutiny in KYC processes

Coming back to the point, any KYC process will involve inquiry and submitting proof of at least three details: full name, address, and date of birth.  The levels of KYC processes are classified depending upon the risk associated with the client/customer.

The most basic level is called simplified Customer Due Diligence (CDD). This is the most basic KYC process and does not usually involve in-depth screening. A CDD usually involves less ‘risky’ customers/clients. Here, risk denotes the possibility of the customer/client posing a risk to the verifying authorities/institutions or indulging in criminal and shady activities like terror financing, money laundering, etc.

Next comes Standard Due Diligence (SDD). This type of diligence is usually reserved for clients who may be potentially risky, but there is a high chance that the risk will not be realized. Apart from verification of personal identity, SDD also involves trying to understand the nature of the relationship the client will have with the institution to ensuring the prevention of misuse of its services.

The third process is Enhanced Due Diligence (EDD). This is the process needing the most extensive checks. It involves high-risk individuals who have to be thoroughly vetted for possible involvement in terror financing, money laundering, and corruption. The process involves the identification of beneficiaries, sources of income, as well as global law enforcement databases.

Why KYC is needed and who (mainly) uses it?

Speaking about law enforcement, earlier oversight by law has been a big factor in the enforcement of stringent KYC norms. In the US, it was the use of a bank account by the perpetrators of 9/11 which led to the inclusion of stringent KYC norms into the Patriot Act. In fact, KYC is now very strongly associated with banks. The process benefits banks in a big way.

While the process fulfills its key criteria of keeping an eye on preventing misuse of banking services, the KYC process also helps in authenticating both sender and recipient in case of remote transactions. This use is especially necessary for evolving digital transactions where customers prefer online payments to physical ones.

Complete KYC process helps financial institutions understand their clients, their behaviors, and transaction patterns better while building up a risk assessment profile. KYC process needs financial institutions to follow regulations. Therefore, implementing KYC processes saves companies from fines and damage to reputation occurring out of non-conformance to regulations.

The second most prominent sector utilizing KYC is insurance. As more and more people opt-in for digital registration (or onboarding in management-speak), KYC processes are increasingly utilized as proof of authenticity. That is, the applying customer is indeed the same person who applied for insurance.

Another area where KYC is increasingly utilized is the loan and mortgage industry and brokerage firms. Here, KYC works as an extra layer of protection from financial wrongdoings.

However, all of this information is just the tip of the iceberg called KYC. Stay with us as we explore the topic in detail.

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