What You Should Be Aware of About KYC Compliance Requirements

Graph visualizing KYC compliance requirements for customers

Despite the challenges of compliance, well-prepared banks can thrive

Anti-money laundering (AML) and know your customer (KYC) services cost businesses 1.4 billion, with AML and KYC compliance issues costing banks alone millions of dollars in 2021. The total amount of fines in certain cases was in the hundreds of millions. These penalties are merely the cost of using poor compliance procedures. Losing customers is probable due to the damage penalties have done to a brand’s reputation. This is especially true if KYC introduced extra friction to an already unpleasant procedure for customers. In addition to the first fine, the opportunity cost of customer churn may total millions of dollars.

Banks and other businesses cannot afford the expense of noncompliance with AML and KYC standards. Unfortunately, compliance is also challenging, particularly in regions like Europe or the United States where there are numerous authorities, each with its own set of regulations.

The intricate and shifting compliance environment

Because KYC and AML processes are governed by a patchwork of regulations governing fintech identity verification, and a collection of laws, directives, decisions, and recommendations in the European Union, compliance with these laws is extremely difficult to achieve.

Identity verification procedures for KYC and AML compliance are governed in the United States by the Patriot Act, Bank Secrecy Act, CFR Chapter X, FIDO Alliance Certification, and numerous state-level regulations. These laws, along with upcoming proposed regulations, guarantee that financial institutions follow a reasonable approach to customer identification verification.

Directives provide guidance to member states when they enact their own legislation in Europe. They are made to set and uphold a standard for product quality and safety throughout all member states. The European Commission and Parliament’s most potent tool is regulation. Every member state must abide by the regulations exactly as worded.

Member states are directed by Directive (EU) 2015/849 to enact laws “for the purposes of money laundering or terrorist financing.” Countries have passed their own anti-money laundering and KYC legislation under this general heading. Therefore, every financial institution has to deal with a variety of regulators, identity verification processes, and requirements in each jurisdiction.

The federal laws in the U.S. and EU-wide directives have the advantage of somewhat standardizing KYC and AML compliance procedures. The drawback of such a complex web of regulations is that they could hinder innovation in addition to burdening regulated entities with major compliance costs.

Increased regulatory inspection of third-party service providers may shortly be implemented

With each new regulation, the potential of impending consequences for banks and other financial institutions increases. They have a responsibility to do a risk analysis and modify AML compliance strategies in accordance with each rule. For assistance in fulfilling know your customer requirements and AML policy considerations to reduce risk and stay out of trouble, banks could seek out third-party providers. A fresh draft regulation, though, might make matters much more difficult.

The Digital Operational Resilience Act (DORA) marks a significant shift in how AML and KYC standards are implemented in the EU. DORA proposes a regulatory structure for “critical third parties which provide ICT (Information Communication Technologies)-related services” to banks and financial institutions. Vendors who offer services for risk assessment, monitoring of criminal or suspicious conduct, and AML or KYC compliance are included in this group.

Despite how complicated the regulatory environment is now, it is constantly changing, so banks must take the appropriate precautions to make sure both they and their third-party partners are compliant.

Three techniques that banks can use to develop robust, scalable compliance programs

Financial institutions are already well-protected against activities such as money laundering and financing terrorism. They must, however, programmatically plan for any and all future changes to KYC rules and AML laws due to the dynamic regulatory environment. Unfortunately, overhead expenses are necessary for even this preparation.

However, initial expenses to strengthen customer identification programs and improve due diligence procedures are insignificant in light of possible penalties, reputational damage, and customer loss in the event of a breach. The following activities are involved in creating a strong program:

Digitize customer experience, audit trails, and identity verification processes

Banks have made significant investments to digitize their identity verification procedures. However, if digital technologies indicate a high-risk transaction or account, many institutions still fall back on human procedures. Financial companies should keep modernizing customer identification technology because it should have several advantages.

The amount of in-branch customer identity verifications is decreased and, when necessary, improved through digital operations. Utilizing intelligent platforms reduces the possibility of human error and frees up bank staff to concentrate on the customer experience. Banks are able to convert their actual paper trail into a digital one by using digital audit techniques. Compared to manual audits, this transformation is more reliable against errors and helps eliminate inefficiencies.

The customer experience is streamlined as a result of digital processes. Banks, financial institutions, and financial services companies can position the KYC process at advantageous points in the customer journey regarding the use of digital identity verification technologies. In addition to lowering customer churn, this strengthens anti-money laundering security measures.

Educate staff members on how to adhere to KYC standards

Despite the strength of digital identity verification and other AML techniques, some situations will still require physical intervention. For instance, it is common for students, immigrants, and those with various temporary visas to be unable to present legally acceptable proof of long-term in-country residency. Employees at bank branches must personally perform KYC procedures in these particular circumstances. Although keeping meticulous records of these checks might be expensive, doing so is essential for ensuring compliance.

Bank staff must be properly trained in order for these manual procedures to fit into a programmable AML compliance program. The pillars of training programs will probably be making sure that training is uniform throughout branch networks and keeping staff informed of changes to compliance requirements.

Financial institutions and other regulated companies are required to maintain strengthened customer due diligence procedures, such as transaction monitoring for suspicious activity and reacting to changes in the conditions of customers. These procedures can be made scalable and adaptable in a changing regulatory environment by combining trained personnel with digitalized processes.

Utilize external resources to strengthen KYC verification procedures

Banks can use outside resources to supplement digitized procedures and personnel training. For the purpose of creating reference points for every customer’s identity verification procedure, they will require anything from credit bureau information to background data sources. External resources present a barrier since, like rules, their accessibility differs among countries.

Credit bureaus are frequently a source of information that can be used to locate customers in order to meet KYC and AML regulations in a particular area. The market coverage of bureaus varies by location, and they frequently ignore younger or inactive credit users, leaving them with a sizable blind spot.

Financial institutions need to develop scalable compliance programs nowadays

Banks and other financial institutions are caught between a rock and a hard place as a result of an increase in money laundering instances and tightened restrictions. A complicated and ever-changing regulatory environment that will likely have an impact on third-party KYC service providers will only increase their burden soon. The positive aspect is that banks have a wide range of resources available to them to create effective customer identity verification and anti-money laundering programs.

Banks can strengthen their AML and KYC strategies by digitizing procedures like risk assessment, internal audit, and illegal activity monitoring, stepping up employee training, and utilizing outside resources. More crucially, institutions can create compliance programs that grow and react to future regulatory changes with the correct mix of these resources. In this context, it can be difficult to organize compliance and risk procedures, but businesses that do so today will find it much simpler in the future.

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