Automated KYC workflows, representing KYC meaning in action, act as the financial world’s gatekeepers, facilitating seamless onboarding for customers and institutions alike.

Know Your Customer protocols, often referred to as KYC Know Your Client, are just one facet of AML, or Anti-Money Laundering. Part of customer due diligence (CDD) requirements, KYC is a verification process that helps bring a company into AML compliance at onboarding, embodying the principle of what does KYC stand for.

Traditionally, KYC involved in-person meetings, but now many companies are transitioning to electronic Know Your Customer (eKYC) processes, offering convenience for both businesses and customers. However, KYC compliance is no walk in the park, demanding meticulous data assessment and collaboration across teams.

How Does KYC Work?

A large part of KYC, particularly customer KYC, involves identifying and verifying the correct relationships between companies, a key aspect of the customer identification program (CIP). This information is subject to frequent change due to the increase or decrease of control or ownership stakes. 

KYC information can be linked to the digital identity of the customer and shared through the system. The amount of information stored and shared is regulated through the customer's settings.

Across borders, KYC requirements, as outlined by the financial action task force (FATF), may differ, but most programs encompass three fundamental components:

1. Identity verification: Verifying the identity of individuals or business customers involves cross-checking names, addresses, and social security numbers on government-issued IDs with data from government and third-party databases—an essential process in preventing money laundering and terrorism financing.
2. Customer due diligence: Ensuring customer compliance, through enhanced due diligence (EDD), involves screening for illegal activities, sanctions, and terrorist watchlists, reviewing executive bios, company reports, and media press, analyzing past transactions and behavior. Banks, for example, must also identify politically exposed persons and those doing business in regions with higher money laundering risks, adopting a risk-based approach.
3. Ongoing monitoring: Consistently monitoring customers and their transactions to identify shifts in risk, suspicious behavior, or potential fraud.

Examples of KYC in Practice

• KYC Registries and Utilities: Created to comply with rising regulatory requirements, KYC registries and utilities are now being utilized for more than just customer KYC, finding additional uses across various business lines.
• Integration into Customer Lifecycle: KYC, essential in preventing money laundering and complying with anti-money laundering (AML) regulations, is integrated into the entire customer lifecycle, covering aspects from onboarding to account maintenance, marketing, product openings, tax declarations, and more.
• Third-Party Verification and International Mandates: Recognizing the challenges of KYC, international mandates, including the Patriot Act, allow for at least some form of third-party verification, especially in cases involving politically exposed persons (PEPs) or high financial crime risk factors.
• Hard KYC Checks by Companies: Companies perform hard KYC checks, requiring users to submit genuine, physically present IDs to confirm their name, age, and address. This process may include photo uploads or video streaming for ongoing monitoring and may require digitally notarized identification documents.
• Due Diligence Team Analysis: Involves interpreting screening outcomes and assessing risk based on captured information. The intensity of these check-ups depends on the customer's inherent risk, with criteria prescribed by regulators and further specified by banks' policies, aligning with customer due diligence (CDD) and KYC requirements.

Benefits of KYC 

Benefits of a Robust KYC Process: A company with a strong KYC process, encompassing pre-KYC checks, tends to have lower losses to fraud and contributes positively to a safe financial ecosystem.

International KYC mandates, including those under the Patriot Act, are designed not just as regulatory measures for financial institutions, but to protect a healthy economy and prevent financing of crime and terrorism.

A well-executed KYC process aids in ensuring clients enjoy a smooth and rapid on-boarding process and relationship management. It also bolsters confidence in a bank's ability to manage risk, including risk factors related to illegal activities.

KYC Drawbacks

• Compliance Demands and Customer Burden: KYC and other regulations in the financial services sector demand strenuous customer identification procedures, which can burden customers seeking speed and simplicity in financial innovations, often leading to customer abandonment and lost revenue.
• Efficiency vs. Expense: While KYC is generally efficient in preventing money laundering and closing opportunities for fraud, it presents significant expenses to companies. Manual document reviews, necessary for ongoing monitoring and part of comprehensive KYC processes, can become costly when scaled to cover an entire customer base.
• Increased Friction in Onboarding: Any onboarding process that includes KYC compliance inevitably increases friction. Lengthy legally-mandated due diligence can lead to higher customer abandonment rates and increased opportunity costs.
• Challenges in Fighting Cybercrime and Fraud: As cybercriminal enterprises evolve, legislation and security measures, including pre-KYC checks, must constantly advance to combat new forms of illegal activity and fraud.
• Struggles with Modernizing KYC: Many banks face challenges in modernizing their KYC processes due to outdated technology architectures, leading to reliance on manual processes, high costs, and operational risks.

Key Components of KYC

Customer Due Diligence (CDD) is a critical element of effectively managing risk and protecting you (and your business) against potential association or involvement with bad actors and financial crimes. CDD processes are crucial for KYC, and while they vary around the world, in most cases, they involve identifying your customer and understanding their activities. This then allows you to assess their risk profile.

KYC also encompasses determining reportable accounts to government authorities of various countries, requiring banks to classify the tax status of clients, who are beneficial owners, toward their country of fiscal residency. This classification is part of the customer information declared by the client during the KYC process.

How Companies Can Effectively Integrate KYC

• Optimized Onboarding System: The best KYC-compliant onboarding system allows customers to input the minimum necessary information without compromising organizational safety. Nubank, a Brazilian digital banking giant, emphasizes simplicity, convenience, and intuitiveness, which are essential for low-friction onboarding.
• Balancing Friction and Security: Low friction in onboarding is beneficial for good customers, and advancements in fraud detection technology ensure that this doesn't necessarily ease access for fraudsters.
• Leveraging Pre-KYC Checks: By implementing pre-KYC checks, companies can avoid subjecting all customers to high-security, high-cost gateways. A dynamic friction system provides a balanced experience for legitimate users and prevents fraud.
• Challenges of Current Fraud Climate: Currently, identities are easily stolen and misused, enabling bad actors to bypass light KYC checks, especially without anti-fraud pre-KYC measures.
• Role of Third-Party Tools: Third-party tools have become crucial in exchanging and verifying KYC data in a cost-effective manner and using data analytics for monitoring transaction flows, thus ensuring ongoing compliance.

KYC in a Nutshell

• What does KYC stand for? Know Your Customer (KYC) compliance is an integral part of financial services operations, helping to ensure a stable and trustworthy financial framework in the face of emerging and evolving risks such as fraud, money laundering and other types of financial crime.
• From the late 1980s, the US introduced KYC policies that have obliged banks to collect and store information about their customers and monitor their transaction flows in order to inform authorities of suspicious behavior.
• At its core, KYC means companies like financial institutions must take the necessary steps to understand the risks inherent in the payment flows of not only their own clients, but also their clients' clients. 
• Challenges involve vast data collection requirements that KYC inevitably demands.

Frequently Asked Questions About KYC

What is KYC (Know Your Client) and why is it important?

• Know Your Customer (KYC) procedures have become a legal necessity for banks and financial institutions worldwide to ensure they know their customers and comply with anti-money laundering (AML) regulations.

What information is typically collected during the KYC process?

• KYC input consists of information provided by the customer and analysis performed by an employer, or in the future eventually a computer.

What are the potential risks of not conducting proper KYC due diligence?

• Failure not only increases the risk of fraud, cybersecurity attacks and other operational hazards, but it also lays companies open to steep fines. This is especially true as regulators raise the bar in protecting consumers, increasing transparency and tackling financial crime.