In conversations about compliance, the terms Know Your Customer (KYC) and Anti-Money Laundering (AML) are frequently thrown around. However, there are important distinctions between the two that can shape the way compliance officers approach them.
In this blog post, we will discuss the similarities between the two concepts, as well as the differences.
What is KYC Verification, and How Does it Relate to ID Verification?
Know Your Customer (KYC) verification is the process of ensuring that current or prospective customers are who they claim to be, and aren’t engaging in illicit business through the financial institution. It is an integral part of these institutions’ wider compliance and AML efforts.
KYC verification frequently takes place when customers are onboarding to a bank, credit company, or insurance company in the form of ID verification checks. Customers may also need to provide other documents that prove they are working for a legitimate purpose and aren’t engaged in money laundering.
KYC has risen to institutions’ attention due to growing awareness of international terrorism financing, front companies, and corruption. Some countries’ KYC procedures are referred to as a “Customer Identification Program.”
Clues of illegitimate activity can be found by checking names, addresses, and identity numbers.
Once this data is known, banks compare it to institutional and government databases that list individuals known for their connection to organized crime or corruption. Revealing information about them, such as geographic location, line of work, and relationships to other known individuals can suggest whether they have an increased likelihood of engaging in money laundering or other criminal activities.
A prospective customer that’s been flagged as high-risk isn’t automatically disqualified from opening an account. But their account activity will be continuously compared to other clients whose profiles are similar, and significant deviations from the norm may result in further investigation.
Is KYC Verification Mandatory?
Given the widespread perception of KYC as a bureaucratic, time-consuming task, some financial institutions might wonder if it’s really a necessity.
The answer is a resounding yes. Government agencies prescribe rules and regulations that require institutions to follow set procedures for verifying and authenticating their customers. Approved KYC procedures include ID verification, face verification, document verification, background checks, and database comparison.
What is AML Compliance?
Anti-money laundering (AML) are the rules, regulations, and procedures that regulatory bodies require financial institutions to comply with to prevent illicit activity. Through these measures, institutions can prevent unscrupulous individuals or businesses from hiding their true source of income.
While some banking transactions aren’t required to comply with AML laws, many others are. This is especially the case with customer account opening, in which a new relationship is being established between an entity and a hitherto unknown person or company.
KYC is a more specific term that refers to the verification of customer identities before permitting a transaction to take place.
AML refers to a wider set of measures designed to prevent money laundering, terrorist financing, and criminal financing. It includes but isn’t limited to KYC.
Compliance officers who are committed to AML procedures frequently watch out for large cash transactions, unusual spikes in activity, transactions related to high-risk businesses such as casinos, and transactions related to individuals or geographic locations that have a history of engaging in criminal activity.
Can a Company Perform AML Without KYC?
KYC is an important part of any institution’s AML efforts. Institutions that enable new customers to open accounts will need to use KYC rules to guide their onboarding process. AML involves more than KYC alone, but KYC is inseparable from AML for most financial institutions.
Think of KYC as a doorman at an apartment building’s lobby. Maintaining the building’s security involves additional elements such as doors with highly secure locks, reliance on neighbors’ observations of suspicious or bothersome behavior, and the like. But the presence of a doorman keeps the vast majority of the bad guys out, just as KYC processes prevent bad actors from signing up to the bank in the first place.
What is Meant by CDD/EDD as Part of KYC/AML?
Customer Due Diligence (CDD) is a particular aspect of KYC. It involves collecting customer information such as names, places of residence, addresses, and so on — and then weighing the risk it presents.
Yet not all potential customers are at equally high risk of money laundering or other illegal activity. Furthermore, not all types of financial transactions have the same high stakes. That’s why many institutions break KYC down into different tiers of stringency: simplified due diligence, basic due diligence, and enhanced due diligence.
Here are the differences between these types of due diligence:
- Simplified due diligence: A minimally involved due diligence process when the likelihood of risk is low, or the potential for damage is minimal.
- Basic due diligence: A standard due diligence process that applies to all customers, which involves ID verification and estimate of risk (determining whether the next level of diligence is recommended).
- Enhanced due diligence: Customers who were found to be high-risk during the basic due diligence process are investigated more thoroughly. If they are permitted to open an account, that account will be monitored more closely than that of a low-risk peer.
Enhanced Due Diligence (EDD) is perhaps the most important level of due diligence for financial institutions to master. Understanding the risk associated with certain business locations, types of businesses, or professional or personal associations held by the customer makes it easier to make smart decisions about that account holder.
Understanding EDD also means that banks can take calculated risks rather than automatically turn away every prospective customer that raises some red flags. Through EDD, they can follow procedures that allow them to keep an eye on higher-risk customers while still benefiting from their business.
The Cutting Edge of ID Verification, AML, and KYC
By employing AML and KYC procedures, companies can prevent undue risk while still keeping business opportunities flowing. While ID verification is a critical first part of KYC, there are many other aspects of both KYC and AML that ensure financial institutions protect themselves while maximizing their opportunities.
Lightico’s solution enables financial institutions to instantly complete KYC and ID verification procedures through effortless mobile technologies. End-customers simply take a picture of their ID, upload it together with a live selfie, and get automatically verified in seconds. This allows companies to stay compliant without sacrificing business-critical efficiency.
Learn more about digitizing your compliance at Lightico.com.