As business operations have changed with the times, so have the methods criminals use to turn illegally obtained money into what appears as legal funds. This is known as money laundering. To prevent money laundering and other forms of financial crime, companies are obliged to prove that their customers are real, lawful abiding citizens before entering into a business relationship.
Legislation concerning financial crime is broken down into various categories and dependent upon each country's specifications. In this article, we will focus on the procedures for Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations.
Because there are some similarities between AML and KYC, this may also cause confusion revolving around the terminology involved and specific procedures. Below, we will delineate everything you need to know about the fundamental differences between AML and KYC.
“Anti-Money Laundering”, or AML, is a set of laws and regulations that strive to prevent the misuse of the financial sector. Criminals often try to disguise illegally obtained money as legitimate revenue – a form of misconduct that AML laws attempt to shut down.
AML regulations are put in place to prevent two types of financial crimes:
- Money laundering
- Terrorist financing
The laws and regulations for the aforementioned categories consist of several more detailed subsets, among which are the KYC requirements.
KYC falls beneath Anti-Money Laundering (AML) regulations as a subcategory. The abbreviation stands for “Know Your Customer” or “Know Your Client”. The term refers to the specifics of identity verification and obtaining customer data. Financial institutions, such as banks, are obliged to gather information about their customers and check their credentials before and during their business relationship.
KYC was put into effect to help prevent money laundering, fraud, and financial terrorism, etc. Another term to look out for is: “electronic Know Your Customer” (eKYC), which specifically refers to the online verification process – something that is becoming more popular in today's technologically dominant business world.
What distinguishes AML from KYC?
Money laundering is not a simple undertaking. The whole goal is to conceal the origin of corrupt money, thereby covering their tracks throughout the entire process. However, money laundering typically follows three basic steps:
- Placement: The first step to money laundering is to put illegally obtained funds into financial institutions.
- Layering: To divert attention, the placement of these funds is disguised through a series of transactions so as to conceal its source and not arouse suspicion.
- Integration: Finally, as soon as the money appears legal, withdrawals can take place.
- Criminalization: The first step toward prosecuting those involved in money laundering is to define these crimes. This is known as criminalization. Criminalization is a set of guidelines determined by each country's jurisdiction.
- Know Your Customer: Know Your Customer, or KYC, are procedures that companies and financial institutions implement to verify and monitor their customers. These policies make it easier to catch and then report any suspicious activity.
- Record Management & Filtering: Financial institutions and companies keep a record of all transactions. Those records are continuously filtered through a software program that will flag suspicious activity.
As seen above, KYC differs from AML as it is a general control within AML. KYC covers the identification and verification measures taken to combat financial crime. Therefore, its use extends beyond AML. It can also be applied apart from financial institutions, for example: non-profit organizations, crypto dealers, insurance brokers, online payment services, etc.
The general KYC process consists of six steps:
- Data collection: The collection of information about a potential client.
- Document checks: This includes Proof of Identity, Proof of Address, and sometimes Proof of Income.
- Information validation: Relevant information extracted from the provided documents will then be analyzed and validated.
- Risk assessment: A number of checks are performed to ensure that the potential client will not put the company at risk. This includes media coverage, sanctions lists, etc.
- Client Approval: If all the information is verified, the client may be given approval to move forward.
- Ongoing monitoring and record keeping: Customer records are kept on file and their transactions monitored. With the implementation of advanced software filtering, any suspicious transactions or activity will be flagged and alert the company or institution.
Choosing the Right KYC Program
In order to comply with AML laws, following KYC regulations is pivotal. However, determining and implementing the appropriate KYC procedures for your business may seem daunting. Because unsuitable KYC programs can lead to non-compliance penalties, choosing the right KYC software for your business is vital.
With PXL Vision's IDV solution, we guarantee a well-suited, compatible solution that is both user-friendly for your customers and meets the needs of your organization. You can use the automated identity verification to set up or optimize your existing KYC programs.
If a customer does not fulfill all KYC requirements, a company can refuse to accept them as a client.
When a financial institution fails to comply with AML regulations, they will be fined and may also be subject to other penalties.
KYC is like a guardian that protects institutions against potential customers with a false identity. The ongoing monitoring that KYC guidelines stipulate is an essential part of successful AML.