Banks are one of the main institutions in which a country's economy relies heavily upon.
Financially healthy banks mean that the economy is also resilient and stable. That's why the banking and financial industry are one of the most heavily regulated, which means that governments expect them to strictly adhere to any laws stipulated by them or by financial governing bodies like a country's central bank.
These laws often have the shared purpose of helping businesses to get a clear understanding of whom they are entering into a business relationship with, regardless if it's an individual or another company.
The laws are a crucial step for the prevention of financial crimes, especially since criminals hide their identities during the onboarding process so they can freely execute various illegal acts such as money-laundering or terrorist funding.
One of the critical stipulations found in financial compliance laws requires organisations to familiarise themselves with their clients by authenticating their identity with Know Your Customer (KYC) protocols.
In this article, we will discuss what KYC is and why it is crucial to the banking industry.
What is KYC (Know Your Customer)?
Some industries are particularly vulnerable to misuse by criminals due to the types of services they offer. One of these is the banking industry where criminals use their bank accounts as a gateway for conducting money laundering activities.
Money Laundering involves either depositing money into a bank account without paying the required taxes (ex. income tax) or depositing illegally earned funds and using them to make multiple purchases to make it look like they came from a legitimate source.
Criminals abusing banking services to help further their activities forced governing bodies from the private and public sector to work together to come up with a solution that would help prevent this from continuing to happen in the future.
One of the solutions that they came up with is the Know Your Customer protocol which is mandatory for many industries but primarily for banks and other financial institutions.
As we mentioned above, Know Your Customer helps with the prevention of this crime by using the collection of data to identify who your clients and business partners are. This requires using both private and public sources to collect detailed information about your consumers which then needs to be verified for authenticity and accuracy.
The KYC Process Undertaken by Banks & Financial Institutions
Above we have discussed what KYC is and the process of collecting and verifying data that establishes your customer's identity. And although KYC procedures vary from country to country, it is up to the individual institution to come up with their risk mitigation strategy, (how they define a risk level and address it).
There are some basic steps that all KYC policies share that apply to both individuals and companies. They are as follows:
The KYC Processes
Customer Identification Program (CIP): Stipulates that any individual that wishes to participate in a financial transaction must have their identity authenticated. It also sets the standard for the minimum information that an individual is required to provide to open a bank account including their name, identification number, date of birth and home address.
Customer Due Diligence: Banks need to ensure that all their customers are trustworthy. Customer Due Diligence is a critical tool for assessing a customer's trustworthiness and helping businesses to manage risk and shield themselves against those involved in illegal activities like money laundering. Due Diligence has three levels to accommodate different customer risk levels. They are:
- Simplified Due Diligence ("SDD"): this is the most appropriate for low-level risk clients or low-value accounts.
- Basic Customer Due Diligence ("CDD"): this level of due diligence screening applies to all clients.
- Enhanced Due Diligence ("EDD"): clients at this level are high-risk, which requires the collection of additional information to provide greater understanding.
Ongoing Monitoring: Financial institutions need to make sure that they remain informed regarding all potential risks so that their business is always protected. The only way to do this is by implementing a procedure for the ongoing monitoring of clients.
The Importance of KYC in Banking
Here are the reasons why KYC in banking is critical for this sector:
There are cases where people want to hide their income because they have either obtained it illegally or because they earn large amounts which also means high-income taxes. Because of this, they will use their bank accounts to either 'launder' dirty money (hide the source) or make large purchases so they can avoid paying income tax. The result of this is the loss of revenue which can eventually affect the country's economy.
Money earned from illegal actions is often repurposed for terrorist funding or to support other criminal activities. Because of this, it becomes a threat to national security.
Implementing KYC within your risk mitigation strategy creates a standardised and simplified process for onboarding new clients.
You avoid facing expensive penalties due to incompliance.
Customers that have successfully gone through the KYC process are more trustworthy.
But the main reasons that KYC in banking is so important are:
• Confirming that your clients are honest about their identities.
• Gauging and monitoring each client's risk level.
• Fulfilling financial regulatory requirements.
If you need help with KYC screenings on your clients, we are here to help. Our expert team has over 23 years of experience and can verify anything from registration details, company registration certificates and unique identifiers such as address, date of birth to national ID numbers.