Definition of KYC & AML
KYC can be thought of as a set of regulatory rules, a collection of steps taken to avoid committing offense related to business. It stands for Know Your Customer, which started out as one of the significant parts of the Patriot Act. AML, short for Anti Money Laundering is part of this regulation. Its goal is to stop generating illicit income through illegal actions. The goal of these regulations is quite simple, to verify customers or business subsidiaries to avoid mingling with potentially illegitimate entities. In short, you can think of KYC as an institution's way of verifying whom customers say they are. AML is placed to stop occurrences of illegal money laundering.
History of KYC & AML
Money laundering became a prevalent problem for finance organizations during the 70's. Nations were losing billions of revenues due to the tax frauds committed by illegal businessmen and political entities. As a response to increasing concerns, a task force called the Financial Action Task Force on Money Laundering (FATF) was created in Paris by the G-7 summit in 1989. Its responsibility was to examine the existing techniques and trends in money laundering and to assess necessary measurements needed to stop such actions. In 1990, the task force published its first report, which contained a set of 40 recommendations, providing a thorough plan of action required to thwart off the threats posed by money laundering. All countries were called upon to ensure necessary steps following the new recommendations, and implement those in business. This became the primary source of KYC.
The Goals of KYC & AML
KYC aims at enabling organizations the guarantee that they're working lawfully with legitimate clients. Institutions need to gather documents necessary for customer verifications and match them against known databases like PEP(Politically Exposed Persons). If organizations don't have enough verifiable information on a client, they could try to scam the organization or even launder money. This can bring potential legal troubles and massive fines to the company. KYC gives organizations the facility to determine a risk factor for any particular client. Establishing a bias-free risk assessment opens a secure door to future business relationships. AML is a dedicated set of regulations designed explicitly for stopping customers from using financial organizations from unlawful behaviors.
How KYC & AML work?
As you might've guessed already, it's no easy task fulfilling the requirements needed by the KYC and AML regulations. It tends to be a massively complex task, in need of many resources. The process begins right from the moment a customer opens an account. Organizations will start to collect necessary documents to verify the account. They'll mostly want some of the following documents.
Documents such as name, birthplace and date, nationality, residential address, permanent address, spouse information, and others.
- Political Involvement
It's collected as a mandatory part of the AML, which helps organizations assess a client's risk factor. Clients with political influences are checked for cases of money laundering.
- Criminal History
Any history of previous illegal activities is reviewed carefully. Connections with terror-financing and illicit businesses are evaluated.
A legal source for future funds needs to be shown.
- Volume of Transaction
In the case of substantially large transactions, organizations want to be sure the source of income is legal. Different companies use different types of documents for verifications. However, the documents mentioned above are almost universal for every organization. Companies may require additional materials to verify a customer depending on a change of law or potential criminal investigations.
KYC processes can be significantly complex and time-consuming. The need for requiring and verifying an array of different documents tends to delay customer onboarding. Organizations need to understand the corporate structures and jurisdictions. They expect information about the directors, shareholders, and associates. Sourcing all these information and utilizing a risk factor based upon them can pose many challenges. Analyzing lots of data in real-time delays customer onboarding to a great extent. As the number of customer starts to grow, companies face a much larger problem verifying customer IDs.
- Lack of Consistency
The lack of consistency across different banks is primarily due to the lack of universal requirements. As there is no standard on what documents qualify for a valid verification, banks often ask for excess information. Each bank calculates its risk factor differently and thus require different proceedings. A significant inconsistency is stemmed from these differences in internal policies. Clients may need to provide passports, utility bills and income statements of all signatories for a particular account. The information needed to comply with KYC and AML regulations vary between organizations and country to country.
- Hard to Scale
As KYC is performed manually, it soon becomes unrealistic to scale it efficiently. It's often tough to keep a consistent workflow due to the vast number of different analysts. The demand for professional analysts with requisite skills has seen a massive rise due to the scarcity of qualified professionals. Manual analysis introduces the scope of errors in the identity verification process. In such cases, analysts need to re-contact customers, have them provide the latest information and start processing them again. This disrupts the total process. Imagine, thousands of employees working with millions of customers, then you'll get the idea of how fast this could happen.
- Increased Cost
It is estimated that the introduction of policies like KYC and AML has contributed around 20-25% to the total cost of a bank's "operational costs." According to a survey conducted by Thomson Reuters, financial organizations are spending over $60 million per year behind KYC processes. This increase in cost has been reported to promote selectiveness in financial institutions. Selecting not to collaborate with a business solely for the KYC costs associated with them might hurt small to medium-sized companies significantly.
- Negative impact on Customer-Bank Relationship
Different types of complex issues with KYC policies can hurt the relationship between banks and customers. Many customers do not want to comply with banks' KYC requirements by providing every personal and business detail. Some recent breach of personal information in different organizations has also contributed to the growing mistrust of customers in the banks. Often customers find the initiation with a new organization to be too bureaucratic. This results in customers seeking out services from organizations that are associated with their parent companies.
Suggested Solutions to Such Challenges
As you can see, the presence of complex procedures and complicated policies has become a significant threat to KYC and AML regulations. They are losing the purpose behind them due to practical extremes and inefficiency in identity verification. We're suggesting some carefully curated solutions to overcome these barriers in a diverse way.
- Standardized Verification Process
Although seemingly obvious, the lack of standard proceedings for verifying KYC & AML policies is the number one reason customers have to face a hard time during identity verifications. The requirements for these regulations differ among organizations. There's no one single verification method employed by every institute, which leads to redundancies when opening an account. Differing standards among different organization makes it impossible for the verification process to be portable. If standard procedures were maintained, customers would be able to use the same documents for verifying their identity to different institutes. A standalone verification method will ensure customers a complexity free, easy confirmation method. This, in turn, will earn the trust of customers and help organizations achieve a unified KYC & AML verification system. Whether it be a government-issued document or notarized records, a standard procedure is a must for the stable integration of KYC policies into the corporate world.
- Incorporating Blockchain Technology
Many people think of blockchain only regarding cryptocurrency. However, it's a technology that can be very well suited to the KYC and AML regulations. Incorporating this innovative technology to these policies will get rid of dependencies on human analysts. This, in turn, will lead to much efficient and error-free identity verification. Right now this technology is utilized in diverse areas of different businesses. Blockchains are able to process KYC and AML regulations in an anchored and verified way. It doesn't pose any security threats due to human actions. The idea behind this is, a customer would create a "block" by entering his personalized data, required by the KYC & AML verification policies. This information would be encoded and stored in a blockchain. Different organizations would be able to utilize these data without any need for extra information from the customer.
- Unified SaaS API
Software as a Service or SaaS has become the latest trend in the software world. These are mostly websites that provide an API endpoint to organizations, employing these APIs companies can check and verify customer data quite easily. The inner mechanism of how these checkings are done remains hidden from the outside world, and companies don't need to be familiarized with those. Many organizations use different types of SaaS services. It's one of the most common ways private organizations are verifying their clients nowadays. However, as different providers use unique algorithms to employ their identity verification services, it promotes ambiguity and hinders user experience. If every SaaS provider used a unified API, then despite the service a company chooses to opt-in for, customers wouldn't have to fulfill different requirements. They could supply the same set of documents to verify their identity on different platforms.
- Distributed Ledger Technology (DLT)
As banks' are looking for efficient solutions to reduce the cost and complexities associated with KYC & AML regulations, DLT has caught the eye of experts. It has some of the essential attributes needed for eliminating the complications of a KYC verification process. DLT is a type of decentralized database that allows third parties to directly share in the database without the need of any intermediary. The concept of digital identity used by this system eliminates the redundancies currently faced by organizations. Although a significant investment is needed when incorporating this technology, it's guaranteed to repay these in the long-term. Although specific challenges lie ahead of this technology, if employed correctly, organizations will be free from many burdens possessed by the manual identity verification.
KYC and AML verifications are an expensive part of the corporate world. They are a pricey procedure and may cause sky-high fines if not implemented correctly. However, they are a crucial weapon against fighting terror-financing and money laundering. The current verification process has many potential scopes for error and is bundled with redundancy. Customers have to face hazardous situations often, due to the inconsistency in different types of identity verification. Hopefully, with standard proceedings in place and employing technology the right way, organizations would be able to overcome these problems associated with KYC and AML regulations.