Money laundering, fraud, and terrorist financing pose a great risk for financial institutions and their clientele. In recent years, there has been a collective effort to prevent financial crime by implementing policies that safeguard businesses (especially in the financial sector) and their everyday customers.
In this article, we will define the key terminology and the role each set of legislative guidelines play in averting financial crimes.
Defining AML, KYC, and CDD
What is AML?
AML stands for “Anti-Money Laundering”. As the name suggests, it is a set of laws that strive to prevent money laundering, terrorist financing, fraud, and other forms of financial crime. These regulations prevent criminals from disguising illegally obtained money as funds from legitimate sources.
What is KYC?
KYC is a subset of Anti-Money Laundering (AML) requirements. In order to fight fraud and money laundering, it is important that financial institutions verify whether their customers are real, legal, and law-abiding citizens. This is done by adhering to the KYC requirements.
KYC stands for “Know Your Customer” or “Know Your Client”. It is an identity verification process, designed to obtain, verify, and monitor customer data. Financial institutions, like banks, are required by law to fulfill KYC requirements, i.e., to gather information about their customers and check their credentials before entering into a business relationship with them.
KYC requires the completions of the following three stages:
- Facial verification
- Document verification
- Address verification
There are five main components of the KYC process:
- Customer Identification Program (CIP)
- Customer Due Diligence (CDD)
- Enhanced Due Diligence (EDD) / Continuous monitoring
What is Due Diligence?
Due Diligence can be divided into two stages: Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD). Both play a vital role in the KYC process.
Customer Due Diligence (CDD) is the second step in the KYC process. During this step, more customer data is gathered to help a business evaluate their potential client. By increasing the amount of information available, CDD determines what the potential risk factor is for onboarding a customer.
The duration of this step depends on the customer’s risk factor. Higher-risk customers require more enhanced checks. By collecting and evaluating the client’s information, CDD allows financial institutions to make the right choice.
After a customer passes the initial check, their activity and status will continue to be monitored so that companies can be informed the moment a client poses a risk to the interests of the company. This continuous monitoring is called “Enhanced Due Diligence” (EDD).
Understanding the CDD process
The goal of CDD is for a business to gather enough information about a client to confirm that they are not taking on a corrupt customer with sideways motives.
Useful indicators of a customer's intentions include:
- Customer identity: This includes validating their identity, as well as finding out additional information such as their company address, their individual executives, etc.
- Customer activities: Is the customer engaging in known illegal or high-risk activities?
- Customer risk profile: What is the likelihood that the customer enters into risky or illegal transactions?
- Financial markets: In which markets does the customer trade?
- Other entities: What other businesses is the customer involved in?
To meet KYC standards, CDD must contain reliable information from several different sources.
These sources include, but are not limited to,
- The customer
- Sanctions lists
- Public data sources, e.g., company listings
- Private data sources (from third parties)
Importance of CDD
CDD is a crucial step for a company to “know their customer”. By fulfilling the KYC requirements, financial institutions do their part in actively preventing fraudulent activities in the financial sector.
In the rare case that a customer does commit an act of financial crime, the company can easily assist law-enforcement to catch these criminals. Financial institutions must also provide proof that they themselves were not involved in the illegal activities and that they went through the required CDD process. This is important, since companies that do not apply with KYC regulations are subject to hefty fines.
Nowadays, there are several different identity verification solutions that can easily detect fraudulent documents. The popularity of online verification is increasing, mainly due to its cost-efficiency and simplicity.
We recommend PXL Ident. Check out our SaaS Auto-Ident PXL Ident. It is easy to implement, adaptable for any business, and compliant with all legal requirements.
When must you conduct CDD?
If your business is part of the financial sector.
What are the three types of CDD?
Standard, simplified, enhanced.
What is on the CDD checklist?
- Conduct basic CDD (identity verification)
- Select third parties (gather information)
- Determine whether EDD is needed; if yes, implement it
- Secure record keeping (in case you need to assist law-enforcement)