With the increasing demand for financial services, along with the need for protection and security against financial criminal activities, KYC and AML came to the surface. These procedures are vital for the protection of the customers and the financial institution itself.
What exactly do KYC and AML mean? What is the purpose of these processes?
Know Your Customer (KYC) and Anti-Money Laundering (AML) are procedures established to minimize the risk of having companies and banks get used for financial criminal activities. These two procedures are mandatory verification, cross-checking, and monitoring procedures, which are used to avoid malicious activities from slipping through the law.
Although these two— KYC and AML— are frequently mistaken to be used interchangeably, they are two different things. While KYC is a procedure, AML is a complete framework.
Know Your Customer indicates identity verification, ensuring that the “customers” are really the person they say they are. On the other hand, Anti-Money Laundering consists of complete mechanisms implemented for protection against money laundering and any financial crimes.
What is Know Your Customer (KYC)?
KYC, short for Know Your Customer, is a process of authenticating a customer’s identity. It is one of the several AML mechanisms that is implemented in order to measure up to regulatory compliance.
In KYC, every single client has to give credentials like ID documents to use a financial institution’s service. This is often asked during application processes like when an individual wants to open a bank account or join Initial Coin Offering (ICO).
In a sense, KYC is a predominant process of identification, a kind of an identity risk assessment that is often, yet not exclusively applied in the course of the customer onboarding process.
The procedure includes a multi-staged operation of collecting and analyzing customers ‘ personally identifiable information. Typically, this is called a Customer Identification Program (CIP).
Technically, there is no really given standardization when it comes to this step, and various institutions may ask for various types of personal information. The most commonly asked personal information is, of course, the customer’s full name, address, birth date, and perhaps you know the rest.
To verify the customer’s given information, they are obliged to submit valid government identification in order to verify the information they have given. Valid government identification documents including driver’s license, proof of address, and passport.
After gathering the data needed, the institution will send your information and government documents to third-party verifiers, then those verifiers will run it on official databases to validate if the information is legitimate.
There’s also a verification run-through against global watchlists. This verification procedure will show if you are a Politically Exposed Person (PEP), or if you have ever been identified as a risk.
The PEPs are individuals who possess prominent public positions like politicians. For financial institutions, the people who are in politics constitute a higher risk because of the possibility of corruption.
Every financial entity and provider has the right to measure and allocate the risk of every applicant. The level of risk and record of the behavior of transactions are highlighted in the customer profile.
If there’s any unusual activity against the profile, there will be future monitoring against it.
The KYC process varies for every financial institution.
KYC in Banks
Anti-money laundering and Know Your Customer is a regulation that every bank should follow.
Negligence or failure to act in accordance with these laws may result in hefty penalties by regulators, as well as damage to the offending financial establishment.
KYC in Blockchain
Know Your Customer is getting standardized in various token crowd sales and cryptocurrency exchanges. However, because cryptocurrencies are famous for the anonymity of transactions, making KYC a standard might appear to defeat its purpose.
Customer identification is mandatory on some cryptocurrency platforms because many countries have forbidden having anonymous trading accounts. Hence, having KYC implemented on blockchain helps in combating online finance criminal acts and other legal and reputational issues.
KYC also helps in ensuring the security of investor’s digital assets.
What is Anti-Money Laundering (AML)?
AML or Anti-Money Laundering is way broader than KYC. It is the measure that is often used by the government and financial institutions to battle against crimes such as terrorism financing and money laundering.
Instead of a procedure, AML is more of a framework that is made up of various protective levels to seize financial crimes before it even happens. Know Your Customer procedure is part of Anti-Money Laundering.
The compliance to Anti-Money laundering is trumped up by external and internal systems that utilize risk assessment upon application process, the KYC, manage internal risk controls, submit independent audits, training for staff, and detect apprehensive activities.
By combining these said systems, every financial establishment will have a greater opportunity of getting detected and reported. With this being said, prevention of illegal activities is in greater prospect.
However, the financial product demands are meeting the profound AML regulation, and currently, financial institutions and providers are having difficulties in keeping up.
Money laundering is skyrocketing in countries like the United Kingdom. The anticipated amount of criminal funds ripping within the United States of America is around $300 billion, including the enormous amount coming from drug cartels connected to Mexico.
Extreme money laundering brings forth average ripple effects on countries, and a huge amount of money fosters the expansion of terrorist cells, illegal arms dealers, human trafficking, and other criminal cartels.
Moreover, the contrived flood of money is unfavorable for the economy, especially when it’s siphoned from illegal businesses and dealings.
Money laundering can extort a threat to the country’s national security. This is the very reason why a strong AML framework is implemented among various sectors— to protect the customers, the institution, and even the economy of the entire country.
KYC vs. AML: What’s the Difference?
KYC and AML are frequently used synonymously. However, that is not the case.
KYC focuses more on verification and assessment of risks, while AML is the complete system of anti-money laundering techniques that are implemented for security against, report, and flag financial crimes.
There are numerous entities that interchange these two, hence, fail to incorporate one, or both of these aspects by assuming that they are one and the same task.
Failure to execute strong KYC and AML processes can lead to a higher possibility of financial crime that may affect even the whole country. However, this kind of slip-up brings institutions a huge number of fines exploited by regulatory bodies.
The KYC process and AML programs should have continuous feedback. As a subgroup of Anti-Money Laundering, Know Your Customer should devise an AML program that will suit the needs of the business, enhance the performance of compliance, and refine the customer risk profiles.
