KYC compliance, with KYC acting as an umbrella term for identity verification, refers to the regulatory obligations of institutions, whether financial or not, to identify their clients. There are a few main goals of the KYC process: identifying the customer, verifying their identity, recognition of their activities and funding and monitoring said activities.
“Red flags” for KYC may include unusual transactions, changes to the client (i.e., a new occupation), and adding other clients to the financial account. Initial due diligence, or determining the client’s level of risk, and ongoing monitoring should keep the client satisfied, account secure, and financial institution safe from liability. High-risk accounts are monitored more often, and clients may even be asked to provide explanations for particular transactions.
KYC is not free, and it does cost financial institutions millions of euros annually, but non-compliance to regulations results in fines and increased risk factors. In the past, some institutions have been fined billions.
The digital transformation has real-world consequences
In recent years, there have been significant developments in financial regulations throughout Europe. The Fourth, Fifth, and Sixth Anti-Money Laundering Directives (AMLDs) have all come into effect, in succession, since 2014. The newest AMLD will address such matters as customer due diligence and the implementation of a 10,000-euro EU-wide limit to cash payments. AMLD6 additionally introduced a minimum prison sentence of four years for money laundering offenses. The COVID-19 pandemic is further accelerating the “Know your customer” digital transformation, as remote client onboarding becomes a prevalent reality.
The KYC process has been officially recognized by regulatory authorities as an important stage in the prevention of money laundering. Nonetheless, some financial institutions have discovered that established clients may feel alienated by the demands, wherein the requirements of KYC may be disproportionate to the risk. KYC processes can also be time-consuming and expensive for institutions. Financial institutions can deny the opening of an account, as well as discontinue an existing client relationship, given KYC requirements are not met.
The elimination of physical paperwork poses new problems
Historically, sourcing KYC information has been challenging. KYC processes online eliminate the use of physical forms and documents. Instead, data can be provided digitally and compared to reliable sources, such as government databases. KYC verification can even involve biometrics, for example.
Financial criminals can take advantage of the speed and ease by which monetary transferences are possible globally. Criminals conduct money laundering so that “dirty money” becomes “clean money”, as in, they can make fake money appear legitimate. According to EUROPOL, it is estimated that over one percent of the annual EU GDP relates to suspect financial activities. This threat may weaken the reputation and soundness of banking institutions.
KYC assists financial institutions in preventing and catching cases of identity theft, wherein forged or stolen documents may be presented. Financial institutions depend in part on KYC processes to limit fraud. Overall, KYC regulations have implications on many levels, for clients and institutions alike, and are a necessary measure in the face of growing illegal financial activity in the digital age.