Defining Know Your Customer: what, why and how

Financial institutions today are more vulnerable to illicit financial crimes like fraud, money laundering, and terrorist financing than ever before. The digital era has enabled criminals to conduct illicit activity using new methods and advancing technology.

This heightens the importance of Know Your Customer (KYC) as a crucial framework to help institutions effectively prevent and fight financial crime.

What is Know Your Customer (KYC)?

Know Your Customer is a key component in mitigating risks from illicit criminal activities and implementing a robust anti-money laundering (AML) and counter-terrorism financing (CTF) compliance program. It refers to the set of processes and policies that allow companies to identify and verify their customers to safeguard companies from financial crime activities such as fraud, money laundering and terrorist financing.

The purpose of Know Your Customer is to gather enough information about customers to assess any potential risks they may pose. At the core of the KYC framework is gathering relevant information about customers to verify their identity, assess their background, and understand their financial dealings. This enables companies to confirm customers are who they claim to be and to evaluate any potential risks they may pose.

How does the Know Your Customer process work?

Step 1: Customer Identification

The first part of the Know Your Customer process is to identify and verify your customers. This requires collecting basic information such as name, address, date of birth, identification number, and more. The verification process often entails checking the provided information against reliable sources such as government databases or other external or internal data sources.

Some key steps in customer identification include:

• Collecting personal information like legal name, date of birth, address, phone number, email, and government IDs.
• Verifying the name, date of birth, address and other details match official IDs, documents or databases.
• Screening customer names against watchlists like sanctions lists, PEP lists, or other high-risk indicators.
• Validating information like phone and email through confirmation messages.
• Capturing photographs, signatures, and biometrics for identity corroboration.
• Obtaining details like occupation, income source, and nature of the business to understand the customer.

The customer identification process is essential to prevent identity fraud and ensure the company deals with legitimate customers. Verifying data against reliable external and internal sources is crucial to authenticate customer details. Strong customer identification is the first step in KYC to mitigate risks. It also sets the foundation for understanding the customer better through subsequent due diligence processes.

Step 2: Customer Due Diligence

The second part of your know-your-customer process involves going beyond just identifying your customers to understanding them. This deeper level of due diligence entails the following:

• Understanding the nature and expected behaviour of the customer. This includes gathering details on the customer's occupation, anticipated account activity, and source of funds, to name a few.
• Assessing the risks the customer poses by evaluating factors like the customer's background, jurisdiction, industry, or relationships that might indicate potential for illegal activities.
• Monitoring account activity to detect unusual or suspicious transactions inconsistent with the customer's profile.
• Requesting additional documents and data to supplement your understanding of high-risk customers. Politically Exposed Persons, foreign nationals, or customers in industries like money services or gambling may necessitate enhanced due diligence.
• Conduct ongoing reviews even after the account is opened to verify the customer information remains current and consistent with your knowledge of the customer's typical activities and behaviours.

The goal is to thoroughly evaluate the customer's expected behaviour patterns and likely risks. This equips the business to monitor for and detect any illicit financing or anomalous transactions that may occur.

Step 3: Ongoing Monitoring

Keeping customer information updated is critical to effective Know Your Customer practices. As a customer's circumstances change over time, the business must update the customer profile accordingly. This involves regularly reviewing and refreshing documents, data and other information obtained during the initial customer due diligence process.

Financial institutions must monitor account activity and transactions to detect any unusual activity inconsistent with the customer's expected behaviour or suspicious behaviour. Outdated or inaccurate customer information poses regulatory and reputational risks. It diminishes the business's understanding of the customer and makes it difficult to monitor their activity.

Ongoing monitoring provides an opportunity to revisit the customer risk assessment and take appropriate action to mitigate risks. This may require enhanced due diligence, updating customer information, or even exiting the relationship if risks cannot be managed.

Implementing the Know Your Customer (KYC) process is not a one-size-fits-all solution. To succeed, your KYC process needs to be developed and designed according to your business type, customer needs, and local jurisdiction.

Why is Know Your Customer central to compliance work?

Compliance with Know Your Customer regulations is essential for businesses to operate legally and avoid hefty fines or penalties. Know-your-customer documentation and records are often required for regulatory reporting purposes. Implementing a robust structure will facilitate and ensure transparency and accountability in regulatory matters, enabling businesses to demonstrate their compliance with applicable laws and regulations.

Compliance with Know Your Customer regulations is vital for preserving your business's reputation and integrity. Upholding high standards of customer due diligence and transparency instils trust among customers and stakeholders and demonstrates a commitment to ethical business practices and contribution to the fight against financial crime.