KYC Regulations: What Are They?

Over time, the number and type of fraudulent activities have increased significantly. As a result, governments and regulatory bodies have started pushing more stringent KYC/Know Your Customer regulations. Unfortunately, many businesses view such KYC regulations as added expenses in their income statements. However, these regulations are more than just a necessary evil. A considerable number of companies suffer significant losses due to online fraud yearly. The implementation of KYC processes can go a long way in mitigating the risk of fraud and other online dangers.

Non-compliance with online KYC regulations leads to some heavy penalties for businesses. Apart from that, companies that don't comply risk their reputations and losing the trust of their customers. As a result, there are a lot of questions regarding KYC regulations. For instance, one of the popular questions is, "what is KYC verification?". Read on for answers to this and other KYC-related questions.

Why is KYC Important?

The main aim of KYC is to clarify the legitimacy of a customer's identity. Apart from that, KYC processes also help to spot potential risk factors like Politically Exposed Persons, financial crimes, and fraudulent incidences like identity theft and money laundering. Furthermore, there has been an increase in money laundering activities globally. According to data from the United Nations, money laundering transactions amount to about US$800 billion to US$2 trillion. Banks and financial institutions can restrict criminals' ability to operate through KYC processes. Apart from stopping crime, KYC processes also help businesses better understand their customers' operations, enabling them to manage risk in a well-judged manner.

Who Needs KYC?

Any time a business lands a new or existing client acquires a regulated product, they apply standard KYC procedures. These regulations are needed by almost every institution, especially those that deal with money. This includes firms in the banking and financial services sectors. Examples of businesses that should implement KYC processes include banks, credit unions, fintech apps, asset management firms, and private lenders. Any criminal activity in the banking and financial services sectors not only affects the institution in question but its customers, broader markets, and economies. Besides companies in the financial services sector, KYC checks are also required for Politically Exposed Persons, helping to reduce the risk of bribery and corruption.

Who is a Customer?

Regarding KYC policies, a customer may be an entity or person who maintains an account or performs business transactions with the reporting entity. A beneficiary of transactions conducted by a professional intermediary is also classified as a customer. Intermediaries include stockbrokers, solicitors, and chartered accounts. KYC regulations also apply to entities or persons connected with financial transactions that pose significant reputational or other risks to the reporting entity, which can be a bank or financial institution.

How Does KYC Work?

Governments have established specific laws and regulations that outline the basic requirements for the KYC process. It's important to note that these laws and rules are industry specific. As such, you will find that banks and financial services providers must implement the strictest KYC process for obvious reasons. Over time, there is now digitization of KYC processes. Most KYC verifications and procedures are now carried out over the internet, using different methods, KYC documents, and technologies. Institutions use biometrics, holograms, liveness, and even AI to carry out KYC checks. Verifications usually comprise the following KYC process steps:

Verification of government-issued ID documents.
Liveness checks or face verification to verify the live presence of the customer.
Verification of address or proof of address.

Apart from standard KYC checks that are part of online security, several events can trigger KYC. This includes unusual transaction activity and new information changes to the client. For instance, if the customer wants to change the name on their account. In addition, a change in the client's occupation or nature of their business can also trigger KYC. Lastly, adding new parties to an existing account will also trigger KYC.

Components of KYC Regulations

The Financial Action Task Force introduced KYC regulations in the 1990s. Over time, there have been a lot of changes to these regulations. If you have encountered these regulations before, you have probably heard about the three pillars of KYC, which refer to the three components required for a complete KYC program. While the technical implementation of the processes is at the institution level, companies are required to adopt the general KYC framework.

Customer Identification Program

A customer ID program is the first and most fundamental pillar of KYC processes. Institutions are required to verify the identity of the customers, whether the customer is an individual or a corporation. The customer identification program aims to confirm that the customer is who they claim to be.

Customer Due Diligence

Customer Due Diligence is the second component of KYC processes. Customer due diligence involves the collection of further customer data.

This data helps to establish a risk profile. Thus, enhanced checks are performed on high-risk customers.

Continuous Monitoring

The third and final component of KYC is continuous monitoring. It's important to understand that KYC isn't just about one time check to verify customer identity. Companies should continuously monitor customer activity and status, ensuring there haven't been changes to the relationship between a business and a customer that increases risk. The extent and frequency of continuous monitoring checks depend on the customer's risk profile. Companies generally have to monitor transactions, media coverage, and sanction lists.

KYC Regulations and Associated Costs

According to a 2017 study by Consult Hyperion, some financial institutions spend up to $60 million annually on KYC. Some are even spending upwards of $500 million each year on KYC. That's according to data from a 2016 Thomson Reuters survey. Besides the immediate costs associated with implementing processes, KYC has other costs associated with customer churn and time. For instance, customer onboarding can take up to three months. Some businesses even report changing banks because of KYC issues.

If a company fails to comply with KYC regulations, it could face steep fines. From 2013 to 2014, up to $4.3 billion in fines against financial institutions. That amount quadrupled the penalties of the nine previous years combined. For instance, JP Morgan had to pay more than $2 billion because it failed to report suspicious activities.

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