by Marty Aquino
Know your customer (KYC). It’s a key step in growing any business, but in banking, it’s also an integral step in combating money laundering and deepening high-quality relationships. Superficially, it seems like a fairly straightforward proposition. However, for many banks and credit unions, even in this digital age, the KYC process is often a highly analog, manual process — making it very expensive and susceptible to human error.
Banks and credit unions are often the frontlines for flagging potential money laundering. On October 26, 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, most commonly known as the USA Patriot Act, was enacted to “deter and punish terrorist acts in the U.S. and around the world and to enhance law-enforcement investigatory tools. The KYC verification process was created specifically to arm financial institutions against fraud, corruption, money laundering and financing terrorism.
According to the United Nations Office on Drugs and Crime, the amount of money laundering that occurs each year is equivalent to as much as 5% of global GDP, or $800 billion to $2 trillion in U.S. dollars.
What Is KYC?
KYC processes can vary from organization to organization. Effective KYC verification processes are often the backbone of successful compliance and risk-mitigation teams. Moreover, the demands of meeting KYC obligations are intensifying. Combined with anti-money-laundering (AML) regulations, compliance is critically important as more restrictive regulatory requirements come online. Consequently, many banks and credit unions are spending more time, resources and manpower on AML and KYC compliance.
Effective KYC processes should aim to:
- establish your users’ identities;
- understand the nature of your end users’ activities and qualify their source of funds as legitimate; and
- assess money-laundering risks associated with your end users.
The resulting KYC information is then compared to lists of organizations and individuals known to governments and law-enforcement agencies. The agencies, in turn, will attempt to identify individuals suspected of criminal activities, any intelligence on companies or individuals suspected of taking part in bribery or money laundering, and politically exposed persons.
Beyond protecting your bank or credit union from doing business with organizations or people involved in illegal activities, the KYC verification can also help you get a better understanding of your end users’ businesses, which can lead to valuable insights as well as a much more powerful and personalized banking experience.
What Is AML?
Money laundering is the process of making illegally gained proceeds, often referred to as “dirty money,” appear legal, or “clean.” Typically, it involves three steps:
- Placement: moving funds from direct association with the crime.
- Layering: disguising the money trail.
- Integration: making the money available to the criminal or network from what seem to be legitimate sources.
AML compliance has a long history, dating back to 1970, with the mission of safeguarding the “financial system from the abuses of financial crime, including terrorist financing, money laundering and other illicit activity”:
- Bank Secrecy Act (BSA) (1970): Established requirements for recordkeeping and reporting by private individuals, banks and other financial institutions.
- Money Laundering Control Act (1986): Established money laundering as a federal crime
- Anti-Drug Abuse Act (1988): Expanded the definition of a financial institution to include businesses such as car dealers and real estate closing personnel, and required them to file reports on large currency transactions.
- Annunzio-Wylie Anti-Money Laundering Act (1992): Strengthened the sanctions for BSA violations.
- Money Laundering Suppression Act (1994): Required banking agencies to review and enhance training, and develop AML examination procedures.
- Money Laundering and Financial Crimes Strategy Act (1998): Required banking agencies to develop AML training for examiners.
- Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (USA PATRIOT Act; 2001): Criminalized the financing of terrorism and augmented the existing BSA framework by strengthening customer-identification procedures
- Intelligence Reform and Terrorism Prevention Act (2004): Amended the BSA to require the Secretary of the Treasury to prescribe regulations requiring certain financial institutions to report cross-border electronic transmittals of funds, if the secretary determines that such reporting is “reasonably necessary” to aid in the fight against money laundering and terrorist financing.
Compliance with AML and KYC
AML and KYC compliance is critical. When these processes were first introduced, regulators omitted creating specific standards for verifying end users. They did this on purpose, suspecting that banks would only choose to meet minimum requirements if specific rules were put into place. Unfortunately, this has led to a convoluted system that has continuously proven incapable of meeting basic KYC and AML standards.
An example: currently, the types of documents needed to verify identities for KYC varies from bank to bank. Some require passports or birth certificates, while others want Social Security cards or other types of national IDs in addition to state driver’s licenses. For businesses, the process becomes even more complicated. Users looking to sign up for financial services will find that most KYC procedures create friction and result in a poor user experience.
Effective KYC and AML Best Practices
According to Forbes, to meet compliance rules, banks and credit unions at a minimum follow these tips to prohibit fraud and money laundering and deepen user relationships:
- Onboard high-value clients in their physical presence.
- During the initial onboarding process, ask clients to use multiple IDs for KYC and AML checks, and request these IDs randomly.
- Establish additional points of digital verification such as biometrics and facial recognition, where appropriate.
- If someone matches as a politically exposed person, place a higher risk score on that person during onboarding and while their account is active at your institution.
- Perform seamless but random identity checks throughout the lifespan of client accounts.
“Point-based identity verification solutions that served traditional financial and AML requirements will give way to digital-native verification solutions that solve both issues of user verification for access management and identity verification for KYC.”
In a McKinsey KYC Benchmark Survey, average U.S. annual operation costs for financial-crime compliance have grown by around 43%, but the majority of respondents predict that KYC-program budgets will decrease by up to 25% versus the past 12 months, as of the fourth quarter of 2020. Banks that increased end-to-end KYC-process automation by 20% saw a triple benefit effect:
- They increased their quality-assurance scores by 13% on an absolute basis.
- They improved their user experience by reducing the number of outreaches per case by 18%.
- They enhanced productivity by increasing the number of cases processed per month by 48%.
Lumin Digital: Your Trusted Partner
KYC is more important than ever, and the stakes are higher. Consider working with a trusted strategic partner to stay ahead of bad actors and become proactive in identifying and predicting not only user risk but deepening opportunities.
Marty Aquino has been a passionate writer on venture capital, technology, forecasting, risk mitigation, wealth and entrepreneurial topics since 2009. He is the founder of Carbonwolf Energy, a venture-capital firm specializing in world-changing and status-quo-defying technologies and people.
United Nations (UN) – Money Laundering
Financial Crimes Enforcement Network – History of Anti-Money Laundering Laws
Financial Crimes Enforcement Network – USA Patriot Act
Swift – The KYC process explained
Financial Crimes Enforcement Network – BSA Timeline
Biometrics Institute – KYC, AML, CFT – the challenge of online identity verification and a future with biometrics