How to Build an Effective Know Your Customer (KYC) Strategy

Why KYC is important

Banks and other financial institutions are entitled to the responsibility to verify the identity of their customers and their genuinity. Therefore, operating an effective and successful Know Your Customer (KYC) process has the utmost importance in today’s financial world because it is one of the most powerful tools in the battle against financial crimes, especially money laundering as the identification of a customer is the initial step in each process. The financial institutions apply KYC checks on new account openings and a regular basis for the ID verification of a customer. In the event of a failure in meeting the KYC requirements, the FIs can terminate the business relationship and refuse to open an account for that specific customer.

In the digital era, it is becoming more challenging to control financial payment systems.  Following that, the regulatory requirements are getting more demanding and challenging to guarantee a more safe financial environment. The financial institutions are expected to detect and prevent potential financial criminal activity while at the same time remaining compliant with the regulations. That is why it is dramatically crucial for financial institutions to employ a successfully working KYC strategy.

Main features of a KYC system

The KYC procedures are aimed to help prevent and detect illegal activities like money laundering or financing of terrorism via assessment and monitoring of the risks. There are 3 main components of a KYC system:

    1. Customer Identification Program (CIP):

A customer identification program (CIP) aims to support financial institutions in ensuring their customers are genuine. One of the most important elements of a successfully working CIP is risk assessment. The role of the CIP is an advisory one as it is in the institution’s judgment to decide what is the level of the risk and which policy to apply for that specific level. Financial institutions must at least collect four types of data from their potential customers to open an account which are name, date of birth, address, and ID number.

    2. Customer Due Diligence (CDD):

Customer Due Diligence (CDD) is one of the important steps in achieving Know Your Customer (KYC) requirements. It is defined as the set of processes the banks, FinTechs, and other financial institutions operate to obtain and analyze data about a potential customer. By evaluating information collected from different sources (provided by the customers themselves, sanction lists, and public or private data sources), the main purpose is to detect any suspicious activity or potential risks that threaten the financial institution’s way of doing business.

    3. Ongoing Monitoring:

Customer behavior and financial activities require continuous monitoring as the nature of the financial transactions is highly dynamic. Therefore, the FIs need to operate effective monitoring systems to check the unusual activities of their customers regularly and keep track of the risk profiles of their customers.

How to build an effective KYC strategy

The KYC procedures are striving to prevent institutions from being abused by money laundering or other financial crime activities, therefore they are highly beneficial in minimizing the risks of fraud thanks to the possibility of detecting any suspicious factors in advance at the level of client-business relationship. With the help of digital automated systems,  it has become easier for FIs to take precautions and get into action in case of a risk related to KYC compliance.

Before deciding on which path to follow for building a KYC strategy, the FIs need to go over these main steps:

  1. Identify where and why they need KYC: Is it necessary to implement KYC for all transactions to streamline the process, or is it more logical to implement KYC only to align with compliance obligations?
  2. Determine their preferred KYC method(s): In-person KYC methods used to be effective before the pandemic. On the other hand, digital verification tools require an investment in a software system to ensure effective data collection and security.
  3. Apply all three KYC components: To ensure an effective working KYC system, the CIP or CDD by themselves is not enough. All three of the components need to be working at the same time.
  4. Operate an effective risk mitigation strategy: Risks are not a hindrance in the flow of a financial transaction system necessarily; however, if they are not addressed and mitigated, they might impact the institution negatively.
  5. Partner with an identity verification company: To refrain from extra costs and time, it is more efficient for the FIs to partner with an ID verification provider to streamline the process.

With the support of technological enhancements, intelligent KYC systems can offer additional benefits to financial businesses. The improved ID verification ensures a smoother onboarding process for the customers as it gives the possibility to banks and financial institutions to easily skip the frustrating part of the onboarding system. Secondly, the operational efficiency within the institution is increased because an automated KYC system can analyze and process big volumes of data in less time with more accuracy. Finally, a computer-based KYC system eliminates risks related to human error, therefore, minimizes the overall risks. Additionally, the specific KYC-related needs of an institution can be configured to the system which reduces the risk of non-compliance with the challenging regulatory requirements and saves the FIs from paying high penalties.

To sum up, for building an effective KYC program, financial institutions need to be aware of the dynamics of the digital financial industry, strive for minimizing the complexity, and remain compliant with the regulations at the same time. Identity verification is the core of a successfully working KYC system which is the key factor in preventing fraud and money laundering crimes. Ongoing monitoring and risk evaluation are also essential to build a functioning KYC strategy. To achieve all of them in a more cost and time-friendly way and comply with the AML regulations, the most strategic step for the FIs would be to adopt an intelligent, automated KYC system.

Burçin Güney, Account Manager