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Organizations such as financial institutions must have strict security measures to protect customers and stakeholders and observe compliance with government regulations.

What is Know Your Customer (KYC)?

Know Your Customer (KYC) is a set of legally mandated protocols used in the investment and financial services industry to verify people, financial profiles, and risk profiles. Also known as Know Your Client, this aims to protect both clients and investment advisors.

Elements of Know Your Customer

All banks are required to create a KYC policy with the approval of their respective boards. The Know Your Customer policy consists of the following four elements:

1. Customer Acceptance Policy

This element of KYC states the general guidelines banks abide by that allow a potential client to open an account with their establishment. 

The customer acceptance policy guideline should stipulate that no accounts will be opened under anonymous or fictitious names. Additionally, if an individual’s identity matches any person with criminal ties or is associated with banned entities, they’re often not permitted to open a bank account.

KYC-compliant organizations must formulate clear customer acceptance procedures and policies. This includes descriptions of customer types that pose a higher-than-average risk to an establishment. 

Assessing the potential risk will commonly factor in the background, country of origin, business activities, linked accounts, and public or high-profile position.

2. Customer Identification Procedures

The customer identification procedure allows your organization to verify your customers’ identities through reliable information, documents, and data. 

Your organization is also tasked to enforce and document policies to identify customers and individuals acting on their behalf. 

The best documents for customer identification procedures are those that are most challenging to obtain illicitly or create counterfeit copies of.

Efficiently proving the identity of new customers without adding friction to the account creation process is challenging, so enlisting the help of a KYC compliance facilitator like Q5id can aid and expedite the process of identity proofing.

3. Monitoring of Transactions

Ongoing monitoring is a crucial aspect of effective KYC procedures. These general protocols need to be risk-sensitive to be effective and are implemented to monitor and detect unusual or suspicious bank activity patterns.

Your organization can only effectively control and reduce the risk if you have a deep and clear understanding of normal and reasonable customer account activities. This gives your organization the means to identify transactions that stray away from regular account activity patterns.

Proper monitoring of transactions can be accomplished by establishing limits for a particular category or class of accounts, with those exceeding these limits needing special attention.

A prime example of a transaction that could be a cause for concern is one that does not make commercial or economic sense. Additionally, client transactions involving a large deposit are considered irregular if unexpected (these should trigger an out-of-band authentication request to prevent fraud). 

Moreover, unusually high account turnover inconsistent with the balance size may indicate money-laundering activities and should be flagged.

4. Risk Management

Fully embracing KYC procedures for effective practices regarding proper management oversight, systems and controls, segregation of duties, training, and other related policies is an ethical and legal requirement for your organization. 

You can execute proper risk management by appointing specific responsibilities to competent authorities such as supervisors or senior officers within your organization that will act as an AML Compliance Officer. Those selected are tasked to ensure that your organization’s procedures and policies are effectively managed and are following the local supervisory practice.

Aside from appointing the right people to ensure the observance of procedures and policies, a regular internal audit must be conducted. Internal audits and compliance functions play a significant role in ensuring adherence and evaluating your organization’s KYC regulations.

Generally, your organization’s compliance functions are responsible for providing an independent evaluation of your organization’s policies and procedures, including regulatory and legal requirements.

Internal audits are a way for the independent evaluators to alert senior management or your board of directors if it believes the administration fails to implement KYC procedures responsibly.

Requirements for Know Your Customer Compliance

The U.S. Financial Crimes Enforcement Network, or FinCEN, has set standard requirements for Know Your Customer concurrent with the core requirements expected of a due diligence program. 

Additionally, financial institutions must conduct an in-depth assessment of their customers’ risk profiles to prevent financial crimes like money laundering. The following are the essential requirements for Know Your Customer compliance:

  • FinCEN requires financial institutions to verify the identities of their customers and their respective beneficial owners who possess at least 25% of ownership. This entails that organizations with high anti-money laundering and terrorism finance risk will be subjected to additional scrutiny while lowering their ownership threshold.
  • Per FinCEN, financial institutions must understand the nature and purpose of the customer relationship upon developing their customer risk profile. The risk profile is created upon establishing the customer relationship and is utilized as a benchmark to detect suspicious activities.
  • Financial institutions that utilize a third party to verify and gather client profiles must prove that the third-party exercises specific risk controls and possesses proper government structure. 

For entities to retain compliance, this requires organizations to secure anti-money laundering (AML) and customer identification program (CIP) certification from a third party annually.

Frequently Asked Questions

If you’re still somewhat confused about some aspects of Know Your Customer, let this serve as your guide to some questions regarding KYC.

What is KYC verification, and why is it required?

Know Your Customer is a process where banks and organizations in specific industries perform specific steps to verify if a person or a company is who they say they are. They do so by obtaining data about the identity and address of their clients, ensuring that bank services are not misused.

Financial institutions must also update their customers’ KYC information regularly to reduce the risk of identity theft, money laundering, financial fraud, and the financing of criminal organizations.

How does KYC work in the banking industry?

KYC processes require the customer to undergo proper authentication. To do this, they should provide the requirements for ID card verification, face verification, document verification (such as utility bills to serve as proof of address), and biometric verification.

Banks are required to be compliant with KYC and AML regulations to decrease the chances of fraud. Failure to comply may incur heavy penalties.

What are the minimum requirements for KYC?

Minimum KYC requirements include verifying beneficial owners and setting standards for negotiating with third parties. According to the Basel Committee, verifying beneficial owners can be achieved by submitting two mandatory requirements: proof of identity with a photograph and proof of address.

These requirements are deemed particularly light, and any bank or financial institution will go above and beyond to establish the validity of identity upon opening savings, fixed deposits, insurance, and mutual fund accounts.

Why is AML important?

AML procedures help protect the most vulnerable members of society by helping to create communities where crime is less common and where financial inclusion is more accessible. Generally, AML acts as gatekeepers against fraudulent activity by investing in, leveraging, streamlining, and emphasizing KYC.

What does AML protect against?

AML protects financial institutions from money laundering and other financial crimes. Government, businesses, and financial institutions impose controls to prevent money laundering. 

With the help of the United Nations Convention Against Transnational Organized Crime, guidelines have been set forth to help governments prosecute criminals involved in money laundering crimes.

Who regulates KYC?

Depending on your industry, region, and/or country, you may have to deal with different regulators that uphold KYC compliance. International organizations like Financial Action Task Force (FATF) set regulatory standards.

Governments enact laws that act as compliance structures, while government agency regulators assigned to oversee sectors provide directions, rulings, and oversights.

What’s a PEP?

Politically Exposed Persons (PEP) are notable prominent figures in politics, the military, and government. These individuals are more likely to be categorized as high-risk customers due to their position of power, making them vulnerable to bribery attempts and unsavory business propositions.

What’s the difference between AML and KYC?

KYC and AML are often linked and used together. Both terms describe the best practices mandated for financial institutions in the United States upon implementing the Patriot Act, among other legislation.

However, there are critical differences between the concepts. AML refers to all efforts to fight and prevent money laundering, while KYC pertains to customer screening and identification.

Proof or Consequence

Know Your Customer is critical for cybersecurity as it provides the necessary security practices and measures to ensure the safety of clients and stakeholders of organizations in financial services and other concerned industries. These legally mandated protocols weren’t established to make things more difficult for customers—but rather, to protect them.

Its main goal is to ensure that customers, stakeholders, and organizations are not subjected to illegal predatory activities, like money laundering, that can jeopardize the integrity of their business affairs.

If you’re looking for a comprehensive solution to improve your authentication security procedures; Q5id is here to address your needs. Talk to us today about how our authentication solutions could be the way your business can fight identity fraud.

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