By Larry Wright
Doing dealings with a fraudster or terrorist may result in penalties, prohibitions, and harm to your image if you own a financial institution (FI). Know Your Customer (KYC) is a key technique to safeguard your firm from deception and liabilities stemming from illicit money operations.
What is Know Your Customer (KYC) Policy, and How Does It Work?
When it comes to interacting with clients during the establishment and maintenance of institutions, the Know Your Client (KYC) standard is an ethical responsibility for individuals in the financial sector.
The Know Your Customer policy demands that banking professionals make an effort to verify the identity of all the individuals they are planning to make a business connection with. This process is a critical part of a bank’s overall anti-money laundering policy, which includes a variety of other measures too.
The investing industry’s “Know Your Client” or “KYC” guideline assures that financial advisers are well-versed in their customers’ risk tolerance, investment expertise, and financial situation before they finally make an investment. Clients and investment advisers are both protected under this policy.
Perhaps, clients are better safeguarded when their financial adviser is aware of the assets that are the greatest fit for their individual circumstances. Because experts understand what may and cannot be included in their clients’ portfolios, they are better protected. Regulations like risk assessment, acceptance criteria rules, and transaction surveillance are often required for KYC compliance to be achieved.
Apart from banking, KYC policies are critical in the brokerage business too. According to the Know Your Customer Rule, every dealer must make a sincere attempt to identify their clients while creating and managing their records. It is necessary to be aware of and retain records of the basic details about each client, as well as to recognize each individual who has permission to operate on the consumer’s account.
The Know Your Client (KYC) rule is critical at the outset of a customer-broker interaction since it allows the broker to acquire basic information about each consumer before making any suggestions.
In addition, the broker must be acquainted with each individual who has the ability to intervene on behalf of the customer, and he or she must adhere to all legal requirements, guidelines, and regulations of the commodities business in order to be successful. Indeed, they are in place to safeguard both the broker and the consumer and ensure that brokers and businesses behave fairly with their customers in the financial markets.
An organization (or company) that has implemented Know Your Customer (KYC) procedures has done the following steps:
- Confirm the identity of the client.
- Recognize the characteristics of the customer’s operations (the key aim is to be satisfied that the origin of the customer’s finances is legal).
- In order to keep tabs on the customer’s activity and assess the danger of money laundering and other forms of online financial crimes.
Three Critical Elements of the KYC
The following factors are required in order to develop and maintain an efficient KYC program:
Customer Identification Program
What is the best way to tell whether somebody is actually who they are claiming to be? Imagine you are the owner of some bank, and you just got a notification that someone named “John” has just made an account in your bank. Tell me, how can you be sure that it’s actually “John” and not some other person who’s claiming to be John? Well, this is where you’d refer to the Customer Identification Program for verification and authorization purposes.
Identity theft is highly prevalent these days, impacting approximately 16.7 million customers in the United States and resulting in the loss of 16.8 billion dollars in 2017. In order to combat this, CIP was primarily formed.
In the United States, the Consumer Identification Program (CIP) requires that every person who is undertaking a financial transaction should have their identity confirmed. The CIP, which was established by the Patriot Act, is intended to curtail money laundering, terrorist financing, corruption, and other unlawful acts.
One of the most important components of a good CIP is the risk assessment, which should be performed both at the organizational level in general and also at the level of individual account entities. While the CIP offers guidelines, it is the responsibility of each individual enterprise to establish the specific degree of risk and the appropriate policy for that degree of risk exposure.
The CIP clearly delineates the bare minimum conditions for opening an individual bank account, which are as follows:
- Name
- Date of birth
- The unique identification number
- Address
While acquiring this information upon opening an account is adequate, the institution is required to verify the identification of the account owner “within a reasonable period” after getting the notification.
Documentary or non-documentary procedures, which include verifying the credentials given by the client with customer credit bureaus, public databases, and other due diligence processes, are all acceptable ways of identity verification.
CIP is based on a set of processes that must be followed meticulously, just like other standards such as the AML one. They must be explained and codified in order to give ongoing advice to employees and executives, as well as for the advantage of regulatory authorities. Nevertheless, the specific policies will be determined by the institution’s risk-based strategy, which may take into account issues such as:
- The many sorts of accounts that the bank provides.
- The bank’s procedures for establishing new accounts.
- The several sorts of personally identifiable information that are accessible.
- The geographic location, size, and client base of the bank
Customer Due Diligence
One of the very first analyses performed by every financial organization is to establish whether or not a prospective customer can be trusted. Customer due diligence (CDD) is a vital component of efficiently managing your risks and defending yourself from cybercriminals, terrorists, and other digital hackers who might just constitute a threat to your organization.
Among the practical procedures, you should include in your client due diligence program are the following:
- Identify the prospective customer’s name and location, as well as get a thorough grasp of their company operations. Obtaining evidence that proves your customer’s identity and address might be as easy as searching for and discovering the appropriate documents.
- Prior to saving this data and any further paperwork digitally, identify the prospective client’s risk category and determine what sort of customer they are in before verifying or validating them.
In addition to basic CDD, it is critical that you follow the proper procedures to determine whether EDD is required. EDD stands for Enhanced Due Diligence, which is stricter and more advanced compared to the fundamental CDD one.
The practice of doing periodic due diligence evaluations on current customers might be advantageous since existing customers have the ability to shift into increased risk categories over time. One must evaluate a number of factors while determining whether or not EDD is necessary, which may include:
- The person’s physical location
- The person’s place of employment
- The nature of the transactions
- A predicted pattern of activities in terms of operation kinds, dollar amount, and frequency
- The anticipated manner of payment
Keeping detailed records of every CDD and EDD done on each client or prospective customer is essential in the event of a governmental audit by the appropriate regulatory authority.
Ongoing Monitoring and Evaluation
In order to effectively monitor your consumer, you must implement a program that is automated and runs on a continuous basis. As part of a client’s risk profile, the continuing monitoring role comprises the supervision of financial activities based on factors that have been established for that client.
Elements to keep an eye on may vary depending on the consumer and company risk prevention and mitigation plan, but they may include:
- Increases in the number of activities
- Activities that are out of the ordinary or uncommon for cross-border operations
- The inclusion of individuals on penalty lists
- Negative coverage in the media
If the account owner’s behavior is judged strange, submitting a Suspicious Activity Report to the appropriate authorities may be necessary.
Periodic risk assessments of the account are also regarded as good practices:
- Is the customer’s account information up to date?
- Do the types of transactions and the number of transactions in the account corresponds to the declared purpose of the entity?
- Is the risk level adequate for the kind and volume of transactions being considered?
What Are the Advantages of Adhering to KYC Policy?
When you are working remotely, this is the most effective method of protecting your earnings, avoiding deception, and resisting bribery.
Although it may be detrimental to the notion of anonymity, Know Your Customer (KYC) allows consumers to have access to the benefits they demand while also ensuring a secure and smooth user experience. KYC verification doesn’t really violate any laws and is required to take place in compliance with US regulatory requirements.
The benefits you get are as follows:
- Scammers will be unable to access the website. Because of this, your consumers won’t have to be concerned about dealing with incorrect information.
- The use of money laundering is prohibited. Utilizing Know Your Customer (KYC) verification prevents any possible hazardous or terrorist organizations from using the company’s services. Users will not face any repercussions for participating in such programs.
- The security of the assets of investors is ensured. The more sophisticated the Know Your Customer (KYC) process, the more protected the money of investors and companies is.
- There would be no fiscal, regulatory, or reputational concerns to be worried about. Your organization’s reputation would not be tarnished under any condition.
- All of the information you want is available online and in one location;
- NLP and machine learning provide a straightforward identification procedure. You do not need to wait an eternity in exchange access to the resources you desire.
- All information pertaining to customers is kept totally confidential. It can’t be utilized for anything other than customer authentication.
- If you employ KYC, your trustworthiness with any domestic or international lenders will be greatly enhanced.
Why do Cryptocurrency Exchanges Need to Adhere to Know Your Customer (KYC) Policy?
For its decentralization and as a means of trade that fosters secrecy, cryptocurrency has received a great deal of attention; yet, the same advantages also offer difficulties in the fight against money laundering.
Consequently, governing bodies are exploring ways to implement Know Your Customer (KYC) requirements on cryptocurrency exchanges, which would require cryptocurrency operating systems to authenticate their clients in the same manner that financial firms do. Despite the fact that it is not a requirement yet, many frameworks have incorporated Know Your Customer (KYC) practices.
Exchanges can be divided into two categories: crypto-to-crypto and fiat-to-crypto. Since crypto-to-crypto exchanges do not operate in conventional money, they are not subjected to the same regulatory constraints as those dealing in fiat currencies.
Because fiat money is the country’s national currency, the vast majority of the fiat-to-crypto exchanges implement some form of Know Your Customer (KYC) procedure. Moreover, these platforms also conduct due diligence on their customers according to KYC regulations to keep a close eye on the activities of all the investors in their marketplace. This simultaneously ensures strict compliance with regulatory requirements and legislation.
The goal of Know Your Customer (KYC) when it comes to online exchanges is deterring illegal activity and identifying suspicious behavior as soon as possible. Cryptocurrency exchanges use this information to track transaction patterns in order to ensure that their interests are well protected under all circumstances.
The lack of exchange to due diligence on its customers may result in the exchange being held liable if one of its customers did something illegal and keeps getting away with it. KYC compliance has therefore been maintained by the majority of the trading platforms.
KYC vs. AML: Are These the Same?
Anti-money-laundering (AML) is another term that you may hear tossed in the cryptocurrency world, in conjunction with Know Your Customer (KYC). In spite of the fact that these two abbreviations are commonly used indiscriminately, I’m here to inform you that it is not the situation. It is critical to grasp the differences between KYC and AML to understand the concepts behind these.
When it comes to the link between KYC and AML, one way of viewing it is to think of Anti-Money Laundering laws as a large group of regulations, while “Know Your Customer” rules as a collection of rules that come under the category of those standards. In a word, anti-money-laundering (AML) is a general concept, and know-your-customer (KYC) is one of the critical elements that belong under the overarching term of AML.
In the field of cryptography, the Anti-Money Laundering (AML) Legislation is very significant as these are all about ensuring the no illicit activities take place on the trading platform under any case. Several exchange platforms, for example, Binance, have strict anti-money-laundering regulations and standards in place for the sake of their safety and security.
KYC and Decentralization
As previously mentioned in the introduction of this piece, KYC is typically associated with centralization. Before being able to access any of the services provided by a centralized cryptocurrency corporation, its customers will almost always be required to identify their identities.
On the other extreme, KYC checks are not required for decentralized cryptocurrency trading platforms. To put it another way, you can exchange bitcoins while being completely anonymous. For starters, decentralized digital currencies are usually seen as high-risk investments. Anonymity is excellent, but it also draws a large number of nefarious individuals.
Nobody knows who is registering a profile on your cryptocurrency exchange – it might be a genuine individual, or it could be a scammer! The fact that the network is decentralized means that if a criminal manages to steal your crypto assets, there will be no way to trace down and identify them.
When it pertains to KYC criticisms, the reasoning is quite self-explanatory: KYC verification recognizes the individual, which directly conflicts with cryptography’s fundamental concept of confidentiality. KYC improves the security, reliability, and accountability of a system. However, given the looming threat of stricter regulations, there really is no way around it for crypto enthusiasts who want the core principle of the concept to remain untouched.
Final Words
Financial institutions are becoming more exposed to unlawful criminal activities in an increasingly globalized economy. Standards for Know Your Customer (KYC) are primarily intended to safeguard banking firms and online brokerages against deception, mismanagement, money laundering, and funding terrorists.
Productive regulatory and risk management programs solely rely on effective KYC procedures, and therefore, they form the backbone of present-day financial institutions. Though the requirements for achieving these commitments are increasing every day, they are vital for user protection and safety and therefore, should be strictly abided by. Financial regulatory bodies around the world are making KYC identification necessary for all financial companies dealing with cryptocurrencies. Without providing details for KYC protocol, it is now impossible for traders and investors to trade digital assets.