What is Know Your Customer, or KYC? What do you need to know?
Across the world, banks and financial institutions must comply with a variety of laws, regulations, and standards to prevent financial crime. One of the most crucial among them is Know Your Customer (KYC): a standard that plays a vital role in ensuring that financial systems are not exploited for illicit activities.
KYC aims to verify the identity of clients in the investment and financial services industry. KYC is more than just a regulatory requirement – it’s a safeguard that helps protect institutions, customers, and the broader economy.
In this article, we’ll cover Know Your Customer (KYC) and its key components, why KYC is important, and the role it plays in Anti-Money Laundering.
What is Know Your Customer (KYC)?
Know Your Customer (KYC) is a fundamental process in financial and regulated industries that verifies clients’ identities to prevent fraud, money laundering, and other illicit activities.
KYC processes help companies ensure they aren’t inadvertently doing business with individuals or entities involved in illegal activities.
Key components of KYC
The KYC process involves a number of key components whose purpose is to gather identifying information about customers, assess risk levels, and monitor transactions.
These include:
- Customer Identification Program (CIP): The first step in KYC is to collect and verify basic information about the customer, including their name, date of birth, address, and ID, to confirm that the individual or business is who they claim to be.
- Customer Due Diligence (CDD): Next, companies perform due diligence to assess the customer’s risk level. This may include investigating the customer’s background, financial history, or source of funds.
- Enhanced Due Diligence (EDD): High-risk customers, such as politically exposed persons (PEPs), may be subject to enhanced due diligence. This involves a deeper analysis of their information to identify and assess any potential risks or threats associated with the customer.
- Ongoing monitoring: KYC doesn’t end once the customer has been onboarded. Companies must continuously monitor their clients’ activities to detect suspicious patterns or changes in behaviour that may indicate money laundering or other illicit activities.
- Record keeping and reporting: Institutions must keep records of KYC documentation and report any suspicious transactions to financial authorities to help regulatory bodies track potential financial crimes.
Why is Know Your Customer (KYC) important?
KYC is important because it plays a critical role in maintaining the security, integrity, and trustworthiness of financial systems. By verifying customer identities, KYC helps organisations and regulators address key risks related to financial crimes and operational issues.
Here are some of the main reasons KYC is essential:
- Preventing financial crimes: KYC protects institutions and customers from fraud and financial crimes and helps uncover and disrupt funding streams for terrorist organisations.
- Regulatory compliance: KYC ensures financial institutions must comply with Anti-Money Laundering (AML) laws, Counter-Terrorist Financing (CTF) regulations, and other local or international requirements.
- Building trust and confidence: Customers are more likely to trust businesses that prioritise transparency, security, and ethical practices. KYC processes demonstrate a company’s commitment to protecting its clients and maintaining system integrity.
- Supporting a stable financial ecosystem: Effective KYC implementation reduces opportunities for financial crime, strengthens the global financial system, and ensures institutions aren’t inadvertently facilitating illegal activities.
- Adapting to the challenges of digital finance: With the rise of online banking, e-commerce, and cryptocurrencies, the potential for anonymous transactions has increased. KYC ensures accountability in digital transactions, helping mitigate risks in the evolving financial landscape.
By implementing robust Know Your Customer processes, businesses safeguard themselves, their customers, and their financial ecosystem as a whole.
What is KYC in banking?
In the banking sector, KYC requires bankers and advisors to identify their customers, beneficial owners of businesses, and the nature and purpose of customer relationships.
Banks must also review customer accounts for suspicious transfers and illegal activities and maintain and ensure the accuracy of the customer accounts.
What is KYC in open banking?
Open banking allows third-party providers (TPPs) to access customer financial data (with consent) via APIs, promoting innovation in financial services.
In open banking, customer data flows between banks and TPPs. Both parties are responsible for ensuring that data sharing is secure and consensual and KYC procedures are aligned across institutions:
- Bank-level KYC: When a customer opens an account with a bank, the bank conducts full KYC checks, including identity verifications and risk assessment.
- TPP-level KYC: If the customer wants to use a TPP, like a budgeting app or payment service, the TPP will a) rely on the bank’s KYC (if deemed sufficient and compliant), or b) perform its own KYC, depending on local regulations or risk factors.
KYC in open banking ensures a balance between innovation and security. It helps to:
- Enhance the customer experience: KYC ensures customers can enjoy the benefits of open banking – such as personalised financial services – without compromising security.
- Improve security and trust: Strong KYC processes reduce the risk of fraud and enhance trust in open banking platforms.
- Ensure regulatory compliance: KYC ensures both banks and TPPs meet local and international AML/CTF obligations.
By verifying identities, assessing risks, and monitoring transactions, KYC helps prevent misuse of open banking systems while enabling safe and efficient financial services.
Read more about open banking here: ‘Open banking explained and simplified’
What is the relationship between KYC and Anti-Money Laundering (AML) laws?
KYC regulations are essential for compliance with Anti-Money Laundering (AML) laws. They help prevent financial systems from being exploited for illegal activities and serve as a foundational step in detecting and deterring money laundering, terrorist financing, fraud, and other financial crimes.
With the rise of cryptocurrency and online transactions, which has brought new risks and challenges to AML efforts, KYC regulations have evolved to include digital identification methods.
KYC measures adapted for these technologies help ensure AML compliance across all transaction types and reduce the risk of these new mediums being exploited for money laundering.
Read more about AML here: ‘The 6th AML Directive: What You Need to Know’
Know Your Customer and Instant Payments
Know Your Customer (KYC) is a fundamental part of AML, banking, and open banking. It is a priority to work with a payments business that ensures your business’ safety.
If you would like to learn more about Brite Payments’ Know Your Customer (KYC) solutions, contact our payments experts today.
