Financial crime continues to pose a significant threat to the global financial system. According to the United Nations Office on Drugs and Crime (UNODC), between 2% and 5% of global GDP, or $800 billion to $2 trillion, is laundered through the financial system each year.
Financial institutions must comply with Anti-Money Laundering (AML) regulations to prevent their involvement in facilitating financial crime, which includes conducting Enhanced Due Diligence (EDD) on high-risk customers.
EDD is an important part of any AML program since it is the process of obtaining more information on potential money laundering activity and anyone associated with it. With the U.S. Congress tightening its AML legislation this year, EDD is more important than ever.
In this blog, we’ll be taking a look at what Enhanced Due Diligence is, why it’s so important for AML compliance, and how you can implement an effective EDD process.
Enhanced due diligence or EDD is a process used within AML regulations to identify and mitigate risk. The process involves a risk-based approach to obtaining additional information about a customer.
EDD will include an investigation into their source of wealth and funds, beneficial ownership structure, other business relationships and activities, and other factors. EDD can provide comprehensive intelligence reports verifying sources of money and informing individuals on customer risk assessment.
EDD is becoming more essential nowadays, as lenient diligence could lead to money laundering or terrorist financing. Once obtained, this additional information is then used to assess the customer and their transactions for any suspicious activity.
An enhanced due diligence process is an essential component of any effective AML compliance program. Apart from enabling a better customer experience, risk-based solutions like EDD can help establish foolproof safeguards against money laundering. As part of its 2012 recommendations, the FATF updated its recommendations to strengthen global safeguards and provide governments with stronger tools to fight financial crime.
Without it, organizations could be left vulnerable to financial crimes such as money laundering or terrorist financing. By performing EDD on customers and transactions, companies and financial institutions can identify and mitigate risk factors associated with suspicious activity before they become a problem.
Let’s examine the various other benefits that EDD can bring to an organization:
By obtaining additional information on customers and transactions, organizations can gain a greater understanding of any associated risks. This increased risk awareness allows them to be more prepared to detect suspicious activity and reduce the chances of financial crime being committed.
EDD can also help organizations strengthen their sanction screening processes. By obtaining more information on customers and comparing it against available sanction lists, companies can better assess whether they have a business relationship with any individuals or organizations that are listed as high-risk parties.
Finally, performing EDD can help improve overall AML compliance by providing additional insight into the customer’s financial assets and activities. This allows organizations to ensure that they’re meeting their legal obligations when it comes to preventing money laundering and terrorist financing.
Enhanced due diligence is required for certain customers and transactions under various AML regulations. The Bank Secrecy Act (BSA) states that banks must perform adequate due diligence until there is enough evidence for “the bank to form a reasonable belief that it knows the true identity of each customer.”
Generally speaking, organizations should perform EDD on high-risk customers and transactions that may have a higher risk of money laundering or terrorist financing. These can include:
In addition, organizations should also perform EDD on existing customers if there are any changes to their business relationship risk profile. This could include new beneficial owners being added to the account, changes in the industry sector, or sudden increases in activity.
Customer Due Diligence or CDD is a crucial process within the broader framework of Know Your Customer (KYC) procedures. It involves the thorough assessment and verification of a customer’s identity and background information to ensure they are who they claim to be.
CDD is an essential step in mitigating financial crimes, such as money laundering and terrorist financing, by identifying and evaluating the potential risks associated with a customer.
Additionally, CDD aims to identify the beneficial owner when the consumer is acting on behalf of a company. It determines the risk profile of the customer by assessing elements such as the type of business, sources of finance, and any prior questionable activity. It not only helps in complying with legal requirements but also serves as a critical line of defense against financial crimes.
It’s important to note that Customer Due Diligence (CDD) differs from Enhanced Due Diligence (EDD). CDD is a process used to verify the identity of customers, whereas EDD involves obtaining more information on the customer and their activities to assess any associated risks. Both processes are essential for effective AML compliance and should be performed before onboarding any customer or processing transactions.
Once a customer has been onboarded, organizations should continue to perform customer and enhanced due diligence checklists and diligence measures on an ongoing basis. This includes periodic reviews of the customer’s activity, assessing any changes in their risk profile, and conducting additional due diligence as needed.
Under FTAF guidelines, financial institutions may be permitted to complete the verifications as soon as reasonably practicable after the institution has established a relationship. If any suspicious activity is detected during enhanced due diligence procedures, organizations should also take appropriate remedial action to mitigate the risk.
An effective EDD program should also involve transaction monitoring and risk-based monitoring. Companies should take a strategic approach to assessing customer and transaction risks, including procedures for tracking suspicious activity and reviewing high-risk customers regularly. This will help organizations stay ahead of any potential AML issues and ensure that they’re compliant with all applicable regulations.
Enhanced due diligence is a critical process for any organization that wishes to comply with the requirements of AML regulations. The EDD process should involve collecting and verifying data on customers, including their identity, financial activities, and ongoing transactions. This helps organizations identify any suspicious activity or high-risk customers before onboarding them.
Various industries that use customer due diligence include:
Banks must comply with the KYC Hub requirements of their respective jurisdictions to assess any associated risks before onboarding customers. The FTAF specifies that financial institutions must gather “sufficient information” about any suspicious clients. The National Defense Authorization Act of 2021 allows banks to share and cross-check information as well.
These risk-based approaches help to ensure that banks and financial institutions maintain a certain level of security, helping to protect their customers’ wealth and their reputation.
MSBs should also use customer due diligence to identify suspicious activity, verify customer identities, and meet AML regulatory obligations. As with banks and financial institutions, MSBs still have to maintain their customers’ valuable assets, so ensuring they comply with AML regulations is essential.
In their Money Laundering Prevention Guide, the Financial Crimes Enforcement Network of the U.S. Department of the Treasury (FinCEN) encourages MSBs to incorporate thorough screenings. They also require MSBs to file suspicious activity Reports (SARs) if they have any reason to suspect illegal activities.
Investment firms should also use customer due diligence to identify suspicious activity, verify customer identities, and meet AML regulatory obligations. This ensures they follow the appropriate diligence procedures to maintain their clients’ finances.
Gambling companies must use customer due diligence to assess the risk of customers before allowing them to place bets or open accounts.
Cryptocurrency exchanges must use customer due diligence measures to assess the risk of customers before allowing them to transact with digital assets.
To combat financial crimes, financial institutions need to implement robust Anti-Money Laundering (AML) programs that include Enhanced Due Diligence (EDD) measures. By identifying high-risk customers, collecting comprehensive customer information, assessing customer risk, and monitoring customer activity, financial institutions can detect and prevent financial crime.
Implementing EDD measures as part of a robust AML program can help financial institutions meet their regulatory obligations and protect themselves from financial crime risks.
Here are some steps financial institutions can take to conduct EDD effectively:
Before conducting EDD, financial institutions must assess the risks associated with the customer. This includes factors such as the customer’s location, business activities, reputation, and ownership structure. This risk assessment should be based on a robust risk-based approach and should consider relevant local and international regulations.
Financial institutions must collect additional information about the high-risk customer, including the customer’s source of funds, nature of business, and beneficial ownership. This information should be obtained from reputable sources and verified by independent sources.
Financial institutions must continuously monitor the customer’s activity to ensure that it is consistent with their stated business activities and source of funds. This monitoring should include regular reviews of transaction activity, customer behavior, and potential red flags.
Based on the results of the risk assessment and additional information collected, financial institutions must implement risk-based controls to mitigate the risks associated with high-risk customers. This may include enhanced transaction monitoring, increased reporting to regulatory authorities, and additional due diligence.
Enhanced Due Diligence is a critical tool in the fight against financial crime. By implementing EDD measures, financial institutions can identify high-risk customers, collect comprehensive customer information, assess customer risk, and monitor customer activity to detect and prevent financial crime.
While EDD may require additional resources, the cost of not implementing it can be much higher. The consequences of financial crime can include regulatory fines, reputational damage, and legal liabilities. By implementing EDD measures as part of a robust AML program, financial institutions can protect themselves and their customers from financial crime risks.
Customer service and enhanced due diligence are just two parts of an effective compliance program. Companies should also have a robust KYC (Know Your Customer) process for verifying customer identities and assessing any associated risks. Here at KYC Hub, we’re dedicated to helping organizations develop comprehensive KYC processes that meet the requirements of global AML regulations. With our cloud-based platform and experienced compliance experts, companies can quickly onboard customers with confidence and protect their businesses from financial crime.
With help, you can ensure that your customer’s due diligence and EDD procedures are up-to-date and in line with global standards. Contact us today to learn more about how we can help you build a successful KYC strategy.
We hope that this blog has helped explain the importance of customer due diligence and how organizations can use it to meet their AML obligations. With the right tools and processes in place, organizations can protect their businesses from financial crime while staying compliant with global regulations. If you have any questions or would like to learn more, please contact us today.
People are also reading:
For start-up companies still in their early stages, compliance can be one of the...
Read More
