Know Your Customer (KYC) Best Practices

Resource Type: Useful Info

Know Your Customer (KYC) refers to the processes that financial institutions, banks, and businesses use to verify that all money they handle comes from legal and verified sources. It is designed to prevent financial crimes such as fraud, money laundering, and terrorist financing from taking place.

KYC forces you to verify and authenticate the identity of your customers. It is such a vital tool for combating financial crime that failure to follow strict KYC regulations and compliance can result in severe penalties and fines of up to $250,000 or even imprisonment.

However, despite the best efforts of these organizations, there has been a steady increase in money laundering cases since 2016, and it is now estimated to be worth between 2% and 5% of global GDP. Therefore, it has never been more important to implement effective measures and follow best practices for KYC compliance to combat financial crime.

What are the 6 key elements of KYC best practices?

people in n office reviewing papers

How well do you know your customers? Any bank, business, or financial institution could face significant fines, sanctions, and reputational damage if money intended for financial crimes passes through its system.

KYC is a fundamental practice designed to reduce this risk of financial crime and protect your organization from fraud, money laundering, and terrorist financing as well as losses that may arise from handling illegal funds.

Below are 6 essential KYC best practices to follow to ensure full compliance is met and organizations know precisely who their customers are.

1. Customer identification and verification

The most important step in the KYC process is customer identification and verification. It is usually the first step in the process and is a legal requirement for all banks, businesses, and financial institutions.

Customer identification and verification typically involves obtaining information about the customer including their name, address, date of birth, and other personal data. This is usually sourced from official government-issued documents such as passports and driver’s licenses that enable an organization to verify that the customer is who they claim to be. Verification tools such as fingerprint scanning, and facial recognition are also used to verify a customer’s identity.

2. Customer due diligence

The process which banks, financial institutions, and businesses use to verify the identity of their customers and check their financial background is known as customer due diligence. It involves assessing the risk associated with each customer based on their profile and transaction activity.

Customer due diligence is a legal requirement that helps us understand the risks involved with financial crime. It allows organizations to analyze key information about a customer such as their occupation, source of funds, reason for holding an account, and their spending history.

The level of due diligence often varies, and high-risk customers such as politically exposed persons are likely to be held to extra scrutiny. This is to establish the source of their funds and the potential risks of bribery, corruption, money laundering, terrorist financing, and other criminal activities.

3. Transaction monitoring

Ongoing transaction monitoring refers to the process for scrutinizing customer financial behavior to determine suspicious and fraudulent activity. By closely inspecting customer transactions, organizations can identify unusual activity that may indicate a financial crime and require further investigation.

Transaction monitoring is an ongoing process and commonly involves a three-pronged approach:

  • Search for unusual or suspicious activity: There are multiple techniques used for identifying abnormal financial activity such as transaction amount, location, transaction frequency, and the type of transaction itself. For instance, money transferred to a high-risk individual or country could point to fraudulent activity and require further investigation.
  • Establish customer transaction behavior patterns: Looking back through someone’s transaction history allows organizations to understand customer behavior. This could involve regular transactions, the type of transactions they make, and the amount. New transactions that don’t follow a customer’s usual patterns may suggest suspicious behavior.
  • Report suspicious activity: Organizations must investigate any suspected fraudulent activity to determine if there’s a genuine risk of financial crime, or if there’s a reasonable explanation. When a case of financial crime has been identified, the organization must immediately report it to the relevant authorities and law enforcement agencies. This is likely to result in customer accounts being frozen, a Suspicious Activity Report being filed, and deeper investigation by the regulatory authorities.

4. Risk assessment

It’s essential to adopt a risk-based strategy when evaluating a customer’s risk. In that respect, high-risk customers such as politically exposed persons should be subjected to greater checks than low-risk customers to establish the precise level of risk.

Similarly, customers and entities may also undergo sanctions screening to check for compliance with national and international sanctions regimes. When an individual or entity has been identified, they will be checked against official lists that include people, businesses, or countries where trade sanctions or other restrictions are in place.

In the case of a potential match, you should determine whether an economic or trade sanction is in place for that individual or entity. When a positive match occurs, you are required to report your findings to the relevant authority and freeze the account or transaction while further investigation takes place.

5. Documentation and record-keeping

It’s essential that up-to-date records are safely stored to assist with KYC processes. This provides evidence of compliance by the bank, financial institution, or organization which can be used to assist an investigation into fraud and other financial crimes by the relevant regulatory authorities or law agency.

Not only should you keep records that prove a customer’s identity securely in a database, but you should also store details of ongoing monitoring, due diligence, and other processes that are relevant to that individual or entity.

6. Employee training

Training staff is an effective way to create a culture of compliance in the workplace and give employees the skills they need to identify suspicious activity and mitigate risks associated with fraud, money laundering, and other financial crimes.

Programs can be tailored to meet the individual or collective needs of employees based on their knowledge, level of experience, and any specific risks associated with their roles. Staff training should be conducted thoroughly and regularly so that any new KYC processes are incorporated into the program.

KYC training and education also ensure that businesses comply with KYC regulations in the right way. This can help businesses fully understand KYC compliance, the processes involved, and the risks associated with financial crime. Not only that, but it also improves customer trust and loyalty in the organization.

Why are KYC best practices important?

man walking outside offices

KYC best practices are important for a multitude of reasons when combating the threat of financial crime.

For example, a person enters your bank claiming to be someone they’re not. They’re carrying false identification, but you open an account for them without performing the necessary checks and verification. It then transpires the person has been involved in money laundering, fraud, or other illegal activities. As a result, your bank would be put at serious risk and liable to severe fines, penalties, legal consequences, and reputational damage.

With the right KYC processes in place, the probability of the above scenario happening is greatly reduced. KYC allows you to effectively filter out bad actors from genuine customers, which protects your business from financial and reputational damage, and ensures full regulatory compliance is met and maintained.

Using automation and technology in KYC best practices

KYC sometimes relies on manual processes which are prone to human error. However, automation and technology can help streamline KYC processes, improve compliance and consistency, and make it faster and more accurate than ever before.

Automation such as AI and machine learning can greatly reduce the time and costs associated with manual KYC processes. Similarly, technology has become an effective tool for enhanced customer profiling, risk assessment, and due diligence.

Identity verification systems, customer profiling software, and transaction monitoring facilities are all examples of KYC automation and technology in action. Not only do they help organizations assess potential risks and identify suspicious activity, but they also ensure full KYC compliance is always met.

KYC best practices in the workplace

Banks, financial institutions, and organizations licensed to hold and transfer monetary funds, such as global payroll platforms perform regular KYC checks so they remain fully compliant with laws and regulations. This self-screening process is used to prove the organizations are not involved in illegal activity such as money laundering and financial crimes and are not violating any pre-existing sanctions.

You are likely to start every payroll run with a KYC process to identify any anomalies or suspicious activity. These days, more and more organizations choose to automate some or all of their KYC processes to improve efficiency, compliance, and reduce manual errors. In fact, the global identity verification market is expected to grow from $9.5 billion in 2022 to $18.6 billion by 2027 due to the growing popularity of automation and machine learning.

Need help implementing KYC best practices into your global payroll?

At IRIS FMP, we pride ourselves on our reputation as a trusted provider of global payroll and HR solutions for organizations operating all over the world. Contact us today to find out how we can support your business strategy.