Know Your Customer (KYC) compliance management has taken on increased importance for financial businesses in recent years, as regulations have become longer and more complex.
KYC regulations are designed to reduce the risk of financial institutions being exploited for illegal practices, such as anti-money laundering (AML), terrorism financing, tax evasion and politically exposed persons (PEP). The regulations require due diligence on the part of the financial firm before client accounts are accepted and ongoing monitoring of the account afterward.
Conducting KYC compliance presents a significant administrative cost to financial businesses and a trying on-boarding experience for clients. More positive outcomes are within reach when the KYC process is managed more effectively, both for the bottom line and client-business relationships.
Know Your Customer (KYC) Steps
Who is the customer? The financial institution needs to know who they are dealing with. Failing to conduct proper due diligence can lead to fines or sanctions, as well as financial losses caused by fraudulent transactions.
Financial institutions take these basic steps to satisfy the KYC mandate:
- The customer’s identification needs to be verified
- Customer due diligence is carried out to ensure the source of the customer’s funds is legitimate. Levels of customer due diligence escalate in response to the perceived risk of dealing with the customer:
- Simplified due diligence (SDD) for lowest risk transactions
- Basic customer due diligence (CDD), conducted for all customers, and
- Enhanced due diligence (EDD) for customers where initial investigation triggers the need to more fully understand the customer’s activities.
Ongoing monitoring of customer transactions is required, based on thresholds established in the customer risk profile.
Issues with KYC
Even though KYC compliance is both necessary and in the financial sector’s interest, it can be a very complicated, time-consuming process. According to a survey done by Thomson Reuters in 2016, 87 percent of banks and 79 percent of financial managers who responded pointed to legislative and regulatory changes to KYC as putting more strain on onboarding processes and client relationships. Longer delays in bringing a client on-board were reported — 22 percent longer than the previous year and projected to rise by another 18 percent.
Financial firms are also incurring significantly higher costs for compliance, while 89 percent of corporate customers said they didn’t have a good experience with KYC procedures and 13 percent said they changed their relationship with the financial institution as a result.
Know Your Customer Technology
According to the CEB report “Know Your Customer Systems Market Update“, KYC compliance systems are among the most outdated technology used by financial institutions, ranking 10th oldest out of 17 installed systems. Anti-money laundering systems ranked last on the list.
The lack of investment in technology might be due to KYC compliance being experienced by financial firms only as a cost. But improving technology for KYC compliance actually helps alleviate the pressure that KYC regulations have put on the workforce and other resources of the firm, as well as the client relationship.
According to the study, 66 percent of banks that have automated due diligence processes report that onboarding times improved by 25 percent. Another 17 percent noted improvements in onboarding times by 75 percent. This represents lower compliance costs, an improved experience for the customer, and more revenue generated for the financial firm.
KYC Data Sources
With improved technology, financial firms are able to scan millions of data points in both domestic and foreign locations. Data for KYC can be sourced from utilities records, DMV files, property ownership, public records, private records, watch lists, criminal cases, business information, healthcare provider content and social media data.
The analytical tools track changes in customer risk profiles in real time, allowing accounts to be flagged when customer behavior changes, along with escalating compliance issues more efficiently as might be necessary. Using investigative software, financial businesses can access social media, cell phone, VoIP, landline, and pager coverage of all 50 U.S. states, Puerto Rico, various territories, and even Canada.
Such technology is a boon for small financial businesses, which tend to be sought-after for illicit activities since the reporting requirements are lower than those for large institutions. The right software can significantly reduce the costs of compliance and the financial risk of failing to manage compliance effectively.
Benefits of Industry Reports
In order to improve the onboarding process and retain clients, financial firms need to remain sensitive to the client-business relationship while managing due diligence. Industry surveys can be enlightening sources of information that track how clients experience the KYC process and the impact it has on their perception of the business.
The gap between what businesses and customers think can be significant, as the Thomson Reuters 2016 KYC Challenges Survey notes. For example, one discrepancy the survey found was that 70 percent of financial institutions said that they believed all or most of their customers were proactive in reporting consequential changes to their KYC status. But only 30 percent of corporate respondents said they were proactive about updating their status.
Industry reports also have benefits, providing an avenue for financial firms to improve their understanding of KYC compliance and to share insights and strategies for meeting its challenges. Collaboration within the industry could lead to a cultural shift in attitude towards KYC data management, reaching the point where due diligence could be viewed as an opportunity for growth and not just a costly obligation.