KYC in Banking and Finance

What is KYC in banking?

KYC, or "Know Your Customer," is a vital protocol employed by financial institutions to verify the identities of their clients and assess the risk associated with their activities. At its core, KYC is designed to ensure that banks have a comprehensive knowledge of their customers, thereby mitigating risks related to money laundering, terrorist financing, fraud, and other financial crimes. But KYC is more than just a regulatory obligation; it is a means to establish trust and transparency between banks and their clients.

Banks embrace KYC for a number of reasons, with risk management and regulatory compliance taking center stage. By verifying the identity of customers and understanding the nature of their financial activities, banks can proactively detect suspicious transactions and reduce their exposure to potential risks. Furthermore, KYC is not just about protecting the bank's interests; it also safeguards customers from identity theft and fraud, contributing to a safer financial ecosystem for all.

What is the KYC process in banks?

For KYC to fulfill its intended purpose, it must be both effective and efficient. An effective KYC process ensures that banks truly understand their customers, while an efficient one minimizes the burden on both clients and institutions. Key requirements for a successful KYC process include robust customer identification procedures, the use of cutting-edge technology for data verification, ongoing monitoring of customer transactions, and a commitment to regulatory compliance.

The KYC process in financial institutions is a series of steps and procedures implemented to verify the identity of customers, assess the risks associated with their financial activities, and ensure compliance with regulatory requirements. 

The process typically involves the following stages:

Customer onboarding

It’s at this point that a customer hands over a lot of personal information. It’s the responsibility of a financial institution to safely store details like a client’s name, address, date of birth, and copies of any identification documents. This needs to be shared with the customer, and clear evidence provided as to how this sensitive data is being kept private.

It’s at this point that an initial risk assessment is also carried out to determine potential red flags about customer activity. This assesses factors like their profession, source of income, and the nature of transactions they are likely to undertake (for individuals) or their location, type of business activity, nature of products they will need, and their client base (for business clients).

Customer due diligence (CDD)

This stage revolves largely around verifying the identity of a customer, as well as ascertaining whether a specific account could be at higher risk of being politically exposed. This stage encompasses identity verification and name screening for individual clients, as well as beneficial ownership verification in the case of business accounts. The latter is particularly important in preventing hidden ownership – largely negating the risks of fraud or money laundering. 

Ongoing monitoring

Periodic reviews and the monitoring of transactions are carried out to ensure information is up-to-date, accurate, and assigned the appropriate risk level. Thresholds can be used to determine this risk, with suspicious activity on an account getting flagged and potentially bumped up a risk bracket. 

Enhanced due diligence (EDD)

In the case of customers with a higher risk factor – whether through suspicious activity or as a result of potential political exposure – further due diligence is required to ensure the right measures and procedures are being taken. This might include gathering further evidence to generate a clearer picture of a client’s account, or even assigning a numerical figure to the potential risk of money laundering. 

Risk management

Any accounts that pose a potential risk need to be categorized according to threat level. These risk profiles should be paired with detailed documentation, which provide a sense of accountability for banks, as well as providing transparency for customers.  

Exit process

Whether a customer actively chooses to close their account, or a financial institution deems it necessary to do so, a strict exit procedure needs to be followed in order to do this safely. Information needs to be stored at the point of the customer’s exit, while no private details should be shared or exposed. 

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How do KYC policies affect financial institutions?

Changes in regulations and policies significantly impact the KYC process of financial institutions, requiring them to adapt swiftly. New regulations may necessitate adjustments to customer onboarding procedures, risk assessment criteria, and enhanced due diligence measures. 

In summary, KYC policies within a bank are essential for maintaining regulatory compliance, managing risks, preventing fraud, and sustaining the trust and confidence of customers. They provide a structured framework that enables the bank to navigate a complex regulatory landscape while efficiently and effectively serving its clientele.

How much does KYC cost financial institutions?

KYC more than warrants its worth in time – but that doesn’t negate the need to budget for costs. There are two facets which need to be considered when it comes to how much KYC might cost a financial institution: initial upfront costs and fees, as well as the potential losses garnered from neglecting the due diligence and maintenance of a KYC process. 

Let’s look at how much each might equate to: 

1. Upfront costs. The cost of KYC compliance for financial institutions encompasses various factors, including substantial technology investments in advanced identity verification and risk assessment tools. 

Human resources contribute significantly to ongoing costs, requiring a skilled team to navigate complex regulatory landscapes and conduct thorough due diligence. It’s thought that the typical cost of a corporate KYC account setup could be as much as $311, while for regular clients it’s closer to $12.

For a corporate account, the total cost of KYC setup breaks down roughly as follows:

• Document validity and collection – $14

• Publicly available information – $42

• Screening – $77

• Complete requirements – $81

• Four-eye review – $93

• Approval – $4

In total, it’s believed two thirds of AML budget is spent on people-related costs, and just a third on technology. Continuous training programs to keep staff updated, secure data management systems, and investments in compliance software are all additional expenses.

Customer outreach and communication, audit processes, and potential penalties for non-compliance add to the overall financial burden. For institutions operating globally, achieving consistency across diverse regulatory environments presents complex challenges and increased costs. 

Despite the substantial investment, many see KYC compliance as a necessary expenditure to mitigate risks, maintain regulatory standing, and build trust with customers, especially as technology advancements promise increased efficiency long term. While 40% of all anti-money laundering costs come from KYC, these are an acceptable price to pay for heightened security measures at every stage of an account’s lifecycle.

2. Losses for non-compliance. Neglecting proper due diligence and KYC processes as a bank poses multifaceted risks. Legal consequences, including regulatory penalties and potential lawsuits, loom large for non-compliance, leading to substantial financial losses. 

Reports from 2022 found that one European bank was fined as much as $52 million for failing to carry out due diligence on 1,000 customer profiles. That same year, another bank in the Eurozone was fined $150 million for failing to do due diligence on the mitigation of one of their customers who was a high-profile sex offender.

Reputational damage is also a critical concern, as failures in preventing financial crimes erode customer trust and impact the bank's standing in the market. Increased risk exposure, strained relationships with regulators, and operational disruptions such as account closures are also at stake. 

Globally, consequences may extend to cross-border restrictions and limited access to markets. Beyond financial implications, inefficient KYC processes can lead to customer dissatisfaction and a loss of business opportunities. 

Overall, the stakes are high, emphasizing the imperative for banks to prioritize robust due diligence and KYC practices to navigate regulatory complexities, protect their reputation, and ensure sustained success in the financial landscape.

What is the difference between KYC and AML?

Anti-money Laundering (AML) and KYC share thematic similarities which could see them confused for one and other. These two facets of financial protection differ in that KYC is just one component of the overall AML framework. 

With focus placed on understanding and protecting the identity of a customer, KYC software ultimately serves to safeguard against and reduce the chance of money laundering.  While creating strong KYC processes is the responsibility of an individual financial institution, AML management will often require strict adherence with federal or state legislation. 

As such, AML standards could be seen as the guidepost with which KYC processes must follow and comply. In short, it’s KYC that identifies a client, in turn serving to support wider AML approaches. 

How to remain compliant with KYC in banking

Ensuring compliance with KYC requirements is paramount for financial institutions, and a multifaceted approach is key to success. Establishing comprehensive KYC policies that align with regulatory standards is the foundational step, providing a clear framework for customer onboarding, risk assessment, and ongoing monitoring. 

Beyond this, banks needs to stay fluid with their approach to KYC, keeping all of the following in mind to guarantee that they stay compliant: 

• There needs to be enhanced efficiency and accuracy in every aspect of the organization. Financial institutions should invest in advanced technologies such as automation and artificial intelligence, streamlining identity verification and risk assessment processes.

• Thorough customer due diligence processes, including identity verification, beneficial ownership checks, and ongoing transaction monitoring, form a critical component of KYC compliance. 

• Proper documentation and record keeping support transparency and provide evidence of compliance during audits. In the last few years, financial institutions have been looking at how to transform the classic periodic due diligence process to increase regulatory compliance by continuously monitoring customer information and activity in order to remain aware of the risk (emerging or disappearing) they bring, and ensure they apply the adequate monitoring capabilities as a result.

• Adherence to global standards, especially in diverse jurisdictions, reinforces the institution's commitment to a robust and consistent KYC framework. By integrating these strategies, financial institutions can navigate the complex landscape of KYC compliance effectively, mitigating risks and ensuring the integrity of their operations.

• Continuous training and education for staff are essential, keeping them informed about evolving regulations and emerging risks. Adopting a risk-based approach allows institutions to tailor due diligence measures based on the assessed risk level of each customer, optimizing resource allocation.

• Transparent communication of KYC requirements to customers fosters cooperation and helps collect necessary information during the onboarding process.

• Robust data security measures are imperative to protect sensitive customer information, and regular internal and external audits ensure the effectiveness of KYC procedures. 

Financial institutions must remain adaptable to regulatory changes, promptly adjusting policies and procedures to stay compliant. Collaboration with industry peers and regulatory bodies for information sharing enhances the collective effort in combating financial crimes.

How often do banks need to update KYC information?

While no strict legislation exists to dictate exactly how regularly KYC processes need to be monitored and updated, the expectation and onus is on banks to do due diligence at least once a year. This should be done on a fluid basis, with accounts being regularly checked and updated to ensure personal information is accurate and up-to-date. 

If this is beyond the scope of a financial insulation, a risk-based prioritization can be assigned to accounts for the purposes of monitoring. Higher-risk accounts should be checked more often, while low-risk clients might only require diligence carried out every few years. 

This is something that needs to be assessed on in accordance with your own capacity and capabilities. However, a templated approach might be:

• High-risk accounts – once or twice a year

• Medium-risk accounts – once a year 

• Low-risk accounts – once every 2-3 years 

A financial institution needs to allot only the time and manpower they can realistically afford to siphon off from other areas in order to monitor and update these accounts. Work out a timeframe that adheres to industry standards, but doesn’t put a strain on other commitments. 

What are the benefits of KYC?

Implementing robust KYC processes in financial institutions provides a host of benefits. Here are some of the most important that a bank optimizing the KYC process will experience: 

• Risk mitigation. Beyond regulatory compliance, KYC serves as a crucial tool for risk mitigation, fraud prevention, and the enhancement of overall security within the financial ecosystem. 

• Customer trust and satisfaction. Transparent KYC procedures build trust with customers, fostering confidence in the institution's commitment to safeguarding their interests. 

• Optimization. Additionally, efficient resource allocation is achieved through risk-based KYC, optimizing operational costs and streamlining processes in the long run. 

• Global banking opportunities. KYC not only prevents financial crimes, but also contributes to global collaboration, standardized practices, and the prevention of financial exclusion, ensuring that legitimate customers, even those in high-risk categories, have access to essential banking services. 

• Adaptability and future-planning. Furthermore, KYC processes offer adaptability to emerging risks and changing regulatory landscapes, making financial institutions more resilient in dynamic environments.

What are the challenges of KYC?

Just as with any measure implemented with optimization in mind, KYC carries challenges that a bank will need to hurdle. While the payoff is worth the time and effort put into combating these challenges, it’s important to have a clear picture of what to expect when utilizing KYC: 

Addressing these challenges requires a holistic and adaptive approach, involving a combination of technological innovation, streamlined processes, ongoing training and a commitment to staying abreast of regulatory developments. Financial institutions that successfully navigate these challenges can establish more resilient and efficient KYC and due diligence practices.

Approved KYC documentation

While each individual bank or financial institution will have their own regulations to abide by in accordance with geographic location, a universal approach can be adopted for adhering to the correct use of identification documents for clients. These fall into three categories: proof of identification, proof of address, and proof of income.

Each of the following can be classified as an acceptable document for their respective bracket:

Identification documents:

• Passports

• Voter’s registrations or voter cards

• Drivers' license

• Residence visas or work permits

• National identity cards

Proof of address documents:

• Utility bills

• Tax bills

• Bank statements

Proof of income documents: 

• Tax returns

• Salary slips

• Bank statements

• Most recent paychecks/stubs

How banks can accelerate their KYC processes with Quantexa

One pivotal aspect of KYC process optimization is the streamlining of data acquisition and management. Quantexa works to make this piece of the puzzle as fluid as possible for financial institutions, working to support them across a number of areas, such as: 

• Automating KYC data gathering and investigation processes

• Reducing time spent on periodic reviews 

• Move from time-based and lengthy KYC refreshes to trigger-based mini-refreshes driven by data changes

• Continuously reassessing customers for financial crime risk using their changing context

If you’d like to discover more about how Quantexa can support you in all data-related aspects of KYC management, be sure to reach out to us today.