What Is Know Your Customer (KYC)?
What Is Anti-Money Laundering (AML)?
The term Know Your Customer (KYC) refers to the process of verifying the identity of a customer. The KYC compliance process requires each client to provide credentials (ID documents, for example), before they are allowed to use the products or services offered by the company.
Investors, for example, must be verified before they can participate in an initial coin offering (ICO). Any person attempting to open a new bank account must also undergo KYC.
The term Anti-Money Laundering (AML) refers to any measures applied by governments and financial institutions for the purpose of preventing and combating financial crimes, such as terrorism financing and money laundering .
Institutions typically implement an AML compliance program that is developed to comply with local and any applicable AML regulations. It also involves the use of AML policies that help enforce these requirements.
In this article:
- How Is KYC Related to AML?
- What Is the Difference Between AML and KYC?
- Automated KYC with BlueCheck
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How Is KYC Related to AML?
AML is implemented as a compliance program that includes a variety of steps. KYC serves as the first step, used to verify the identity of a customer. It also helps understand the risk profile of the customer and monitor accounts.
KYC is generally considered the most critical step in an AML policy, because it provides a deeper understanding of customers and the risk they pose. This information helps set up the necessary measures that can catch anomalous behavior and block fraudulent actions.
The Three Components of KYC
Here are the three core components of KYC compliance:
Customer Due Diligence (CDD)
CDD is a process that collects all credentials needed to verify the identity of customers and evaluate their risk profile. CDD consists of two tiers:
- Simplified due diligence (SDD)—applies to accounts at low risk for terrorism funding or money laundering, such as standard bank accounts and low-value bank accounts.
- Enhanced due diligence (EDD)—applies to customers that are at a high risk of terrorism financing, infiltration, or money laundering. Once a customer gets assigned a high risk, EDD requires the collection of additional information. EDD also involves transaction monitoring.
Financial institutions are responsible for determining the risk profile or each profile, to understand whether they should apply SDD or EDD. To detect irregularities, institutions need to track the normal amount and frequency of the transactions performed by each client.
This program is required by the USA Patriot Act in 2001, which was created to improve the protection of financial systems worldwide. It was created in response to the 9/11 attack. The Patriot Act stipulates that all banks must implement written CIPs, created according to the size of the bank as well as its customer base.
Additionally, the act requires all banks to implement CIPs into their overall AML policies. CIPs use credentials, such as names, dates of birth, addresses, social security numbers, and other documentation to verify identity.
It is not sufficient to check a customer only once. To ensure security, institutions need to understand what constitutes normal account activity within each account and then monitor all activity. By establishing baselines and monitoring anomalous behavior, institutions can catch irregularities and then eliminate risks as they occur.
Learn more in our detailed guide to KYC requirements (coming soon)
What Is the Difference Between AML and KYC?
AML is a comprehensive program that includes all regulatory processes that firms must implement to ensure they conduct legitimate business.
KYC is a small component of AML—it is the first step in the AML compliance program, and is responsible for verifying customer identity. The main goal of KYC is to understand the customer and their financial transactions on a deep level. This information helps firms manage risks effectively.
AML and KYC must not be used interchangeably. Firms that blur the lines between AML and KYC may be subject to disciplinary action by regulatory bodies. Depending on the severity of the offence, legal violations may result in fines or even prison time.
The main components of an AML compliance program are:
- Risk-based AML policies
- Ongoing risk assessment and ongoing monitoring
- AML compliance training programs for staff
- Internal controls and internal audits
Core Aspects that Differentiate AML
- Process—involves the implementation of laws and regulations that help combat suspicious activities, as well as illegal transactions like money laundering.
- Purpose—preventing financial crime such as terrorist financing and money laundering.
- Elements—involves KYC, risk assessment, AML regulations, AML compliance program, monitoring, detection, reporting and money laundering prevention.
- Features—must be comprehensive, well-planned, detailed and current.
Core Aspects that Differentiate KYC
- Process—involves verifying the identity of customers, assessing the risk of the customer and gathering all available information.
- Purpose—making sure that suspicious criminal elements cannot participate in legitimate financial institutions.
- Elements—involves collecting data, verifying identity, risk assessment and management.
- Features—must be credible, thorough, efficient and intelligent.
Automated KYC with BlueCheck
BlueCheck’s industry leading identity verification infrastructure enables merchants to grow their business faster. Serving a wide variety of industries, our solutions are custom tailored to the unique needs of our customers, including PACT Act and eCommerce compliant offerings.