KYC and AML: Understanding the Pillars of Financial Compliance

Stringent regulations to safeguard individual and business interests stem from the growing complexity of the financial landscape. As such, KYC, and AML, short for Know Your Customer and Anti-Money Laundering, by far are the most popular terms you will hear. At first glance, both these terms might seem similar, and many are still confused about their role in the financial and business realm.

So, what are KYC and AML and what differentiates them? In this blog, we will explore the basics of KYC and AML, understanding their role in the financial and business landscape.

KYC and AML: What You Need to Know?

Before we begin, let us establish, a clear definition of KYC and AML and their role in the world of finance:

KYC stands for Know Your Customer is a crucial compliance process conducted by businesses and financial institutions to verify the identity of their clients or customers. The purpose of KYC is to prevent fraud, money laundering, and other illegal activities that could harm both the institution and the wider economy. KYC typically involves collecting and verifying personal data such as name, proof of residence, date of birth, and/or government-issued national identification. Through the KYC process, financial institutions not only ensure compliance with regulatory requirements but also check the accuracy of customer data collected.

Global KYC Solution page

Here we will take a look at different KYC types –

  • Document-based KYC –

It involves scanning physical documents such as government national IDs, passports, driver’s licenses, tax statements, or utility bills and comparing them to the data in the system. If there is a match, the identity is considered valid.

  • Digital KYC

As the name suggests this type includes online identity verification using documents submitted digitally. This includes main subtypes –

1. Online KYC

In this process, a customer is required to fill out an online KYC form and sign it digitally or provide an electronic signature, while submitting documents online.

2. Video-based KYC

Video-based KYC involves audio-visual communication where a certified officer captures the customer’s live photograph, video, and legitimate documents. Typically, this method is employed when creating a new bank account.

Video KYC

Here are a few examples of digital KYC solutions implemented in different countries –

  • eIDAS Regulation

It facilitates credible electronic identification and trust services across boundaries. It empowers people to employ eIDs from one EU Member State to gain access to internet-based public services in another. eIDAS establishes consistent rules and an uncomplicated process for establishing a European domestic market for trust services that can be acknowledged across borders and possess the same lawful status as conventional paper-based operations.

India has established an electronic Know Your Customer (eKYC) system which allows for the electronic verification of a customer’s credentials. This system is implemented through Aadhaar, a 12-digit identification number issued by the Unique Identification Authority of India (UIDAI).

What is AML?

AML or Anti-Money Laundering is a set of regulations and procedures designed to prevent the illegal acquisition of funds through criminal activities. The purpose of these regulations is to detect and report suspicious financial transactions that may be linked to money laundering or other illegal activities such as terrorist financing or bribery. The objective of AML is to promote transparency in financial transactions and maintain the integrity of the financial system by preventing criminals from using it to launder their dirty money.

Understanding the Difference Between KYC and AML [KYC vs AML]

Incidences of money laundering continue to escalate. For instance, the United Nations Office on Drugs and Crime (UNODC) reports approximately 2 to 5 percent of the global gross domestic product (GDP) is laundered annually.

As a result, a robust fraud prevention framework comprising two essential components, KYC and AML, became imperative globally. Although KYC is a part of the AML compliance framework, both processes exist to minimize fraudulent activities. While KYC aims at the initial customer verification process, AML takes it further by keeping a close eye on detecting suspicious transactions and reporting them promptly to relevant authorities.

What is Money Laundering

In summary, while KYC and AML appear to be distinct processes, they work in tandem with one another with a common goal of preventing financial fraud. KYC acts as a strong foundation on which a robust AML framework can be built.

How Does the KYC Process Work?

A typical KYC process involves several key steps to verify the identity of a customer. By following these steps, businesses can maintain regulatory compliance, mitigate risks, and contribute to a more secure financial environment. Here’s a detailed breakdown:

How Does the KYC Process Work

  • Initial Documentation

New customers are required to provide official identity documents like a passport or driver’s license that serve as primary proof of identity.

  • Third-Party Verification

The provided data undergoes thorough verification through reliable third-party sources like government records, credit bureaus, or other financial institutions. This step ensures the authenticity and accuracy of the information.

  • Secure Data Storage

Once a customer is verified, their information is securely stored in a database allowing for ongoing monitoring of customer activity.

  • Ongoing Monitoring

Regular and continuous monitoring of the customer’s account ensures that all transactions align with the established risk profile.
This helps detect any suspicious or fraudulent activities promptly.

  • Risk Assessment and Profiling

Customers are assigned a risk rating based on factors like the source of funds, geographical location, and history of suspicious activity.
High-risk customers undergo Enhanced Due Diligence (EDD) for more in-depth scrutiny.

  • Compliance with AML Regulations

The KYC process ensures compliance with Anti-Money Laundering (AML) regulations and helps in preventing financial crimes.

Where and when are KYC and AML required?

KYC (Know Your Customer) and AML (Anti-Money Laundering) are vital components of regulatory compliance, especially within the financial sector. AML compliance is a non-negotiable requirement for a range of regulated entities, encompassing financial institutions, credit institutions, insurance companies, e-money institutions, payment institutions, and even unconventional sectors like virtual assets service providers, gambling service providers, and art dealers. These regulations are imposed both at national and international levels, making them a global imperative.

KYC, on the other hand, is an integral process that should be initiated during customer onboarding. This ensures that accurate information regarding identities and business associations is obtained. Additionally, KYC is not a one-time event but an ongoing process. It should be conducted consistently throughout the business relationship to ensure continuous compliance with regulatory requisites. This diligent approach is crucial for safeguarding against fraudulent activities, money laundering, and other financial crimes.

These compliance measures are not only legally mandated but are also pivotal in maintaining the integrity and security of financial systems worldwide. By adhering to KYC and AML requirements, institutions demonstrate their commitment to ethical and transparent financial practices, contributing to the overall stability of the global economy.

KYC Checks Demystified: A Comprehensive Guide for Businesses

Consequences of Cutting Corners in KYC and AML Compliance

According to a Deloitte Banking Report, in 2022, financial and credit institutions were fined close to $5 Bn for breaches in their know-your-customer and anti-money laundering procedures. The United States (U.S.), closely followed by Europe, the Middle East, and Africa (EMEA), was reported to be aggressive penalty imposers contributing to approximately $37 Bn and $11 Bn fines, respectively. Asia Pacific, on the other hand, caved to roughly $5 Bn in penalty.

These staggering fines imposed by regulatory bodies globally testify to the consequences of non-compliance with a KYC and AML framework.

Another recent piece of evidence elucidating the consequences of non-compliance is when Coinbase, a cryptocurrency exchange in the U.S., promised to pay a $50 Bn penalty due to identified gaps in its KYC due diligence (customer due diligence) program, record retention, and AML sanctions systems. In addition to the penalty, the company agreed to invest $50 million to improve its compliance program by 2025.

In addition to massive fines, much is at stake concerning non-compliance with proposed security prevention frameworks today. For instance, AML incidents put a financial institution’s reputation on the line. For example, according to Brand Finance surveys, the world’s top 500 banking brands have reported strong growth, with the brand value surpassing US$1.3 trillion in 2022. This trend suggests the commitment of banking institutions worldwide to maintain their reputation and strong brand image.

Therefore, as the industry continues evolving and digital transactions witness a meteoric rise worldwide, businesses and financial institutions must be vigilant while complying with proposed AML and KYC measures to avoid fines and reputational damage.

AML Regulations Across Key Geographies

1: Global

The Financial Action Task Force (FATF) is the watchdog for global terrorist financing and money laundering. It establishes international standards to avoid these unlawful activities and the resulting harm to society. Learn more about the FATF’s current focus areas, such as tactics and patterns.

2: The U.S.

The U.S.’s primary anti-money laundering (AML) law is the Bank Secrecy Act (BSA). The BSA mandates that American financial institutions comply with reporting and record-keeping requirements to prevent criminals from using their goods and services to launder illicit proceeds.

3: Europe

The European Union has taken a strong stance against money laundering, terrorism financing, and criminal activities by implementing Anti Money Laundering Directives. These directives ensure that AML laws are consistent across all member states and are regularly updated to keep up with evolving financial threats. In 2018, the E.U. released the 5th Anti-Money Laundering Directive, enforcing the same in 2020. Similarly, a draft of the 6th Anti-Money Laundering Directive was implemented in 2021

4: Asia Pacific

The APG (Asian/Pacific Group), comprising 41 member jurisdictions, is an inter-governmental organization in the Asia Pacific. The primary goal of APG is to ensure all its members efficiently implement the global standards to combat money laundering, terrorist financing, and proliferation financing linked to weapons of mass destruction.

👉Related Read: Singapore AML Regulations

A Complete Guide To AML Regulations

Tackling AML & KYC Challenges

KYC and AML frameworks face several challenges, including non-compliance, outdated technology, and workforce burnout. The administrative workload is overwhelming, and employees are often anxious about avoiding potential legal consequences.

Financial criminals are becoming notorious with a step ahead of the regulatory development. As a result, operation and compliance professionals are on edge, attempting to juggle multiple threats. The stress these compliance officers face is quite evident from a survey of 240 compliance officers conducted by Corporate Compliance Insights in 2021.

Key survey findings suggest that over 50% of compliance officers are burned, and over 40% deal with mental health conditions such as anxiety. However, over 60% of respondents agree that the pace of changing regulations is the highest contributor to increased stress levels.

Further to human challenges, compliance frameworks are usually lengthy and time-consuming. For example, KYC documentation could take weeks as it involves gathering and verifying customer data from reliable sources. Second, is the implementation cost of KYC and AML systems and reliance on third-party vendors, which could impact data privacy over the long run.

However, with the proliferation of new technologies, eKYC is gaining traction today, and automating routine tasks, including data collection, entry, and verifications, will subsequently reduce errors and onboarding time. Artificial Intelligence (AI) and Machine Learning (ML) are gaining prominence in AML screening. In conclusion, by letting go of legacy systems, manual approaches, and tech advancements, financial institutions can elevate their KYC and AML efforts and overcome the most common hurdles.

AML Solution

Conclusion

To conclude, KYC and AML are critical components in building an effective fraud detection and prevention system. As we’ve seen, non-compliance with these processes can result in exorbitant fines and damage to a brand’s reputation. In today’s complex financial landscape, understanding and implementing robust KYC and AML practices is not just a regulatory requirement, but a business imperative.

For more insights into the world of financial compliance and how your organization can navigate the challenges of KYC and AML, contact our team of experts today. We’re here to help you understand the complexities of these processes and provide solutions tailored to your needs. Don’t let compliance be a stumbling block – let us help you turn it into a stepping stone for success.”

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