Know Your Customer (KYC) is a practice done by companies and other financial institutions to identify and verify their customers in compliance with the laws, regulations, and other legal requirements. KYC is the first step in establishing a relationship between a business and its clients and maintaining that relationship.
It ensures that company owners and other stakeholders acquire detailed information about their customers’ investment knowledge, financial position, and risk tolerance. Knowing your customer is ideal before or during the time you start doing business with them, especially before making a crucial financial transaction involving a large sum of money.
The COVID-19 pandemic prompted companies and other financial institutions to perform KYC processes digitally, enabling them to carry on with their operations despite the restrictions put in place. KYC has become more popular in banks, credit companies, insurance agencies, and other businesses, avoiding cases of bribery, money laundering, corruption, and other illegal transactions.
History of KYC
In recent years, KYC laws and regulations have been raised to higher standards to suit banks and other established institutions. Every business that carries out financial transactions has been affected by the regulation implications, limiting cases of money laundering and fraud.
The Patriot Act of 2001 that was passed after the 9/11 terrorist attacks in the U.S led to the introduction of KYC laws to the nation. The laws were introduced as a move to detect and stop terrorist activities in the country. Enforcement policies and other requirements were added to the pre-existing Bank Secrecy Act of 1970 that served regulatory functions to banks and other institutions. The Patriot Act was undergoing scrutiny for many years before the terrorist attacks but was pushed into law after the politicians saw its importance and role in preventing such attacks.
Components of KYC
The Patriot Act of 2001 laid emphasis on the delivery of two components from financial institutions.
The first component, known as the Customer Identification Program (CIP), is straightforward and familiar. In CIP, the customer or client presents their personal identification information, depending on what the institution or bank requests. The information requested may include the client’s name, address, date of birth, identification number, driver’s license, or passport, along with other documents.
The second component is the Customer Due Diligence (CDD) that aids the bank in predicting the transactions a client will make, hence detecting any suspicious behavior. The bank can assign a risk rating to the client to determine how often their account can be monitored and identify clients who bear the risk of conducting business.