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Finding Opportunity in KYC

By Anne Sharkey, SVP Operations, First Internet Bank

Anne Sharkey, SVP Operations, First Internet Bank

KYC regulations revolve around the responsibility of banks to understand their customers and their financial transactions in order to discover and report any illegal or unusual activity regarding money laundering and terrorist financing activity. This challenge has been heightened in the era of digital banking, where customers are more often not physically present and where massive data breaches routinely compromise identifying information.

The obvious question, then, is how a bank can establish practices and procedures to know their customers. But another line of questions could also explore whether a financial institution might leverage technology to create opportunity from its KYC program.

Looking at four key elements to an effective KYC program reveals, in fact, that each may additionally present opportunities to leverage customer relationships, reduce the risk of fraud or other illegal activity, and create operational efficiencies. These components are:

• Customer Acceptance Policies
• Customer Identification Procedures
• Monitoring of Transactions
• Risk Management

Customer Acceptance Policies

A primary goal of any KYC program is to help banks define a customer. Most financial institutions define a customer as a person with whom a formal banking relationship has been established through a product or service offering. However, the Treasury Department’s Financial Crimes Enforcement Network, or FinCEN, recently amended the Customer Due Diligence (CDD) rules regarding the identification and verification of beneficial owners of legal entity customers, which will become effective on May 11, 2018.

“An effective KYC program allows financial institutions to gain insight into their customers to ensure compliance with regulatory requirements”

These requirements are designed to identify any beneficial owners of an account who own 25 percent or more of the equity interests of legal entity customers, as well as a single individual with significant responsibility to control, manage, or direct a legal entity customer. The rules compel financial institutions to know the actual customer, and eliminate the masking of true account owners through nominees or straw men. 

While this rule is designed to uncover any elusive owner of an account for illicit purposes, knowing the true customer can assist in identifying additional products and services that may support the customer relationship. Previously unknown beneficial owners may need products in wealth management, treasury management services, loans, and other services. Taking a deep dive into a relationship will not only assist in uncovering beneficial owners for regulatory purposes, but may also identify further potential relationships. 

Customer Identification Procedures (CIP)

CIP is the core of any KYC program, as it provides the means to verify the identity of a customer. It is during this process that banks ascertain a customer’s transactional behavior, and create a customer profile from a risk perspective. However, CIP can also be a means to provide a more efficient onboarding process for customers and the financial institution, as well as assist in identifying fraud and eliminating the associated losses. 

CIP allows banks to authenticate a customer through both documentary and non-documentary means. Many online systems and databases enhance KYC expectations for non-documentary methods of identification. They often include information compiled from internet sources and social media, which assist in identifying customers. Additionally, these systems have the ability to leverage biometric information, such as fingerprint and facial recognition technology, to verify identity. They can also assist in providing alerts or red flags for inconsistencies in documents for identity theft purposes.

These types of systems create a more seamless customer experience by enhancing the ability to easily scan and upload documents during the account opening process, and by integrating with mobile applications. They also integrate with various platforms to create efficiencies in the onboarding process, OFAC checks, and record retention.

It is important during the CIP process to gather expectations for a customer’s transactional activity, which allows financial institutions to understand customers from a risk perspective, and evaluate if an activity makes sense for any particular customer or business. While this information is useful for customer risk-rating purposes, it can also be utilized to analyze customer activity and determine what products may be useful for that customer. Will ACH transactions be less costly than wire transfers? Is a money market account more effective than a free checking account? Knowing your customer’s activity is key to strengthening customer relationships. 

Monitoring of Transactions

Most banks employ systems to assist with ongoing monitoring of customer transactions. While these systems can be very effective, financial institutions must ensure that system parameters, alerts, and output information are independently validated, and confirm that the system is working effectively and producing alerts as predicted. 

Another critical task in utilizing monitoring systems is to ensure there are trained analysts to review and investigate alerts, as well as to provide meaningful investigative summaries and results. Many alerts of unusual activity may be considered “false positives.” It takes skilled personnel to identify unusual trends, which may take place over a long period of time, that are indicative of actual money laundering or other illegal activity. Monitoring systems and the alerts that are produced provide opportunities to further understand customers.

Risk Management

Finally, an effective KYC program is designed to identify and manage risk. Customers must be continually evaluated for the risk they pose to the financial institution. Each customer has a different risk profile, based on the type of customer, the services or products utilized, or the geographic location where they operate and reside. Identifying the risk a customer poses up front allows financial institutions to more effectively monitor and manage higher risk accounts and report any suspicious activity or potential fraud. 

Overall, an effective KYC program allows financial institutions to gain insight into their customers to ensure compliance with regulatory requirements, and lead to new opportunities with customers and efficiencies in the customer onboarding process, as well as the identification of fraud and the reduction in associated losses.

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