What is KYC? ‘Know Your Customer’ Verification and Compliance

In any financial services industry sector, Know Your Customer (KYC) is a crucial part of the fight against fraud, money laundering, and other types of financial crimes. Financial crimes are a tremendous source of risk for banks and other payment service providers. KYC standards verify customers’ identities, analyze the risks associated with issuing or trusting individuals with money and provide various other security features.

In this article, we discuss what KYC is, who needs to be KYC compliant, and more. In other words, this article will help you know Know Your Customer.

What is KYC in Banking?

Know Your Customer, or KYC, are regulations and associated processes in banking used to verify a client’s identification before allowing them to open a financial account. These regulations also require financial institutions to review that information periodically over the lifetime of the account.

KYC requirements were first introduced in the early 1990s by the recently formed Financial Crimes Enforcement Network (FinCEN). They were an effort to fight money laundering, a problem that began flourishing due to the recently introduced World Wide Web.^[1]Business Forensics. “The History of Financial Crime: Know your Customer (KYC)“. Accessed March 3, 2022.

The Patriot Act of 2001 further complicated this process. Following the 9/11 terrorist attacks, the United States government sought to analyze financial information alongside classified intelligence to identify terrorist groups, thus preventing future terrorist attacks. As a result, KYC requirements became stricter.

Today, to prevent fraud and other financial crimes, banks must confirm their clients are who they say they are. If the customer is unable to verify their identity or provides inaccurate information, the bank should refuse to open their account. This mandatory process has increased in complexity. As fraudsters get more sophisticated, new regulations and rules are added.

To achieve KYC compliance, banks must do more than simply verify the identity of account holders, account beneficiaries, and, when issuing business bank accounts, those with significant ownership of businesses. Additionally, they must verify their relationships with their customers and review their transaction history for suspicious activity.^[2]FinCEN. “FinCEN: Know Your Customer Requirements“. Accessed March 3, 2022. It’s expected that banks keep an eye on these elements of accounts over time.

(Note: Generally, individuals with more than 25 percent ownership of a business are considered to have significant ownership of that business.)

What does KYC stand for?

KYC stands for Know Your Customer. Or, in some contexts, Know Your Client. A KYC check, therefore, is a mandatory process of verifying the potential account holder’s identity. In other words, getting to know your customer. Banks and other financial sector businesses need to maintain KYC compliance, as the fault for improper KYC processes rests on the bank’s shoulders.

Why is KYC Important?

KYC is important for detecting and reducing risks of financial fraud and money laundering. The KYC form asks for information to:

• Establish, verify, and confirm the customer’s identity.
• Understand of the customer’s intentions with the account.
• Assess risks associated with this account and this person.

The bottom line is that preventative steps are more effective than recourse. Completing processes of due diligence can (and does) prevent disasters for which there may be no recourse.

KYC vs Anti-Money Laundering (AML)

KYC compliance and Anti-Money Laundering (AML) regulations relate and even overlap. Know Your Customer (KYC) procedures are a portion of the requirements businesses need to follow to comply with Anti-Money Laundering (AML) laws. The differences between Anti-Money Laundering regulations and Know Your Customer processes are as follows: 

• AML regulations are standards maintained both nationally and internationally. 
• AML requirements are an umbrella of requirements under which KYC fits. In other words, KYC verification is one of the many obligations required of financial institutions under AML. If you are in KYC compliance, you are partially AML compliant. 

Three Components of the KYC Process

When learning about KYC verification and KYC compliance, it’s helpful to break down the process into components. If you’re adding KYC compliance to your customer onboarding procedure, below are the three major components you need to be aware of.

Customer Identification Program (CIP)

The first component is the customer identification program (CIP). This component ensures the customer is who they say they are. Documents required for this component should be requested during the onboarding process. To comply, your onboarding process may request/require documents such as a passport, government-issued photo identification, proof of residency, etc.

Customer Due Diligence (CDD)

Next is customer due diligence (CDD). CDD assesses the level of risk associated with the customer’s bank accounts, as well as any other substantial stake owners of an entity. Should the substantial stake owners change over time, or customer transactions show signs of irregularities, this may be reevaluated during the lifetime of the account.

Ongoing monitoring

Continuous monitoring is the third component. Ongoing monitoring requires that banks continue to monitor client transactions and behavior patterns, reporting anything seemingly suspicious. This is an ongoing requirement and does not have an end date.

What is KYC Verification?

Know Your Customer is a regulation standard. As such, KYC is the standard requirements banks and other financial institutions must follow to verify their customers. Meanwhile, the phrase “KYC verification” is the process in which banks and financial institutions request documents to achieve KYC compliance.

KYC Requirements Checklist: What Documents Are Required?

If you’re looking to set up a business bank account, international bank account, investment account, etc., you need to bring verification. While the requirements differ by region, below is a general list of documents you may need for the KYC verification process:

• Government-issued identification. Examples include a passport, birth certificate, social security card, residence permit, or driver’s license. (Note: Some institutions require two forms of ID.)
• Address confirmation. You may be able to use your government-issued ID as your proof of address. Additionally, you can bring another form of proof such as a recent utility bill.
• Business licenses. If you’re operating a high-risk business or specialty business, you may need to show that you’ve obtained the necessary licenses to operate it.
• Ownership structure. If you run a business that’s incorporated or has multiple owners, you may need to bring an organization chart defining the ownership structure and percentages. (Note: Each significant shareholder will need to bring KYC verification documents.)

KYC Compliance

The Financial Crimes Enforcement Network created the KYC requirements to prevent money laundering. Banks and financial institutions are subject to heavy fines if they aren’t in compliance with these requirements. Below we review some finer details about KYC compliance to ensure you avoid these heavy fines.

Who needs to be KYC compliant?

Financial institutions opening and maintaining customer accounts need to comply with KYC. These include but aren’t limited to:

• Banks
• Credit unions
• Credit card processors
• Payment service providers
• Wealth management firms
• Broker-dealers
• Private lenders and lending platforms
• Finance technology applications that create and maintain financial accounts

What Is eKYC?

Put simply, eKYC is an electronic or digital KYC procedure. 

If an organization offers eKYC, they verify your identity electronically instead of in person. You may need to submit to biometric verification, such as a live photo. The financial institution may also request that you upload any necessary documents.

What Triggers KYC?

The Know Your Customer process is only required in certain situations. Such situations include new account initiation and the request for major changes to an existing account. The following may trigger KYC verification procedures:

• Client onboarding
• An adjustment to the owner(s) of the account
• A new or existing client needs a new product

A Look into the Future of KYC

KYC continues to evolve as globalization continues and fintech develops. New technologies offering alternative payment methods, like blockchains and cryptocurrencies, continue to shift the existing KYC landscape. These advancements also increase access and global participation. As financial data spreads globally, regulations will predictably follow. It’s only a matter of time before these regulations expand to new sectors and industries.

Cryptocurrency

Cryptocurrency presents a complicated case for KYC procedures. This is because one of the biggest draws to cryptocurrency is anonymity. But such anonymity led to nearly $1.3 billion in estimated fraud in 2021.^[3]Aljazeera. “Crypto’s dirty side: 270 addresses laundered $1.3bn in 2020“. Accessed March 3, 2022. Because of their nature, crypto exchanges should comply with KYC. However, in practice, it’s largely left up to the platforms.

That said, KYC protocols will stringently apply to cryptocurrency networks as regulators start to pay increasing attention to them.

Know Your Customer: Final Thoughts

Know Your Customer protocols are an important part of ensuring financial integrity. These regulations decrease fraud and money laundering. However, this requires more work from the account holder and financial institution during the onboarding process. Regardless, it’s worth the effect.

When opening an account with a financial institution, ensure they’re protecting your assets with KYC compliance, payment fraud protection services, and other various security procedures.