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In the banking and financial sector, where many financial transactions take place every day, trust is paramount. Institutions need to ensure that their customers really are who they say they are. As such, the KYC process is essential to guarantee regular monitoring, ensuring that customers' activities are legal and compliant with current regulations. To this end, merchant banks worldwide spend an average of $2,598 on each KYC review*.
KYC, or "Know Your Customer" in French, encompasses a set of mandatory measures to identify and verify the identity of a company's of a company's customers. This process is crucial in the banking sector, as it helps prevent fraud, money laundering and other illegal activities.
But what exactly is KYC, why is it so important and what are the legal obligations that banks must meet?
KYC in banking
Why was KYC introduced in the banking sector?
KYC, or "Know Your Customer", is a process used in many organizations, such as banks, to verify the identity of their customers. It involves collecting information on new customers when they open an account, and ensuring that the funds used do not come from illicit activities. This process enables banks to know exactly who their customers are, and to monitor transactions for any suspicious activity.
KYC was born out of the need to combat illegal practices such as money laundering and terrorist financing. Governments and regulators have tightened requirements on banks to prevent criminals from taking advantage of financial services to conceal funds of dubious origin.
International regulations such as the recommendations of the FATF (Financial Action Task Force) and national legislation such as the Patriot Act in the USA, the LCB-FT (fight against money laundering and the financing of terrorism) in France, and the European AML (Anti-Money Laundering) directives, have made KYC mandatory for all financial institutions. The aim is to guarantee total transparency in financial transactions, and to protect both banks and customers against the associated risks.
The importance of KYC for banks
Combating money laundering and the financing of terrorism
The main purpose of KYC in the banking sector is to prevent money laundering (AML) and the financing of terrorism. By requiring detailed information when opening accounts, banks can trace the origin of funds and ensure that customers are not involved in illicit activities. Unusual or suspicious transactions can thus be detected and reported to the relevant authorities.
For example, people trying to transfer large sums of money from high-risk countries or shell companies can be identified through the careful monitoring of transactions enabled by KYC. This procedure is essential to maintaining the integrity of the global financial system.
Protecting banks and customers
In addition to preventing illegal activity, KYC protects the banks themselves. By verifying the identity and financial history of each customer, banks reduce their exposure to the risks of fraud, misrepresentation or identity theft. This ensures that only legitimate customers access banking services.
For customers, KYC provides an extra layer of protection. Sensitive information is held securely, and verification processes reduce the risk of their financial information being hacked or used for fraudulent purposes.
In short, KYC builds trust and security for both parties: the bank and the customer. Customers know that their money is handled in a secure environment, and that banks apply strict compliance standards. This enhances banks' reputation in the market and helps them stand out as trusted and reliable institutions.
KYC compliance: legal and regulatory obligations
European regulations
Banks, whatever their size or geographical area, are subject to strict KYC obligations. National and international regulatory bodies require banks to implement rigorous KYC processes in order to comply with anti-money laundering laws.
As mentioned earlier, European anti-money laundering directives (notably the 4th and 5th AML directives) impose precise requirements on banks in the European Union to identify customers and monitor their transactions.
They must constantly check that their customers' activities comply with anti-money laundering laws, on pain of significant sanctions, including heavy fines and even restrictions on their activities. Failure to comply with AML/KYC requirements exposes banks to major legal and financial risks.
To comply with these regulations, banks must collect a specific set of documents to verify the identity and legitimacy of their customers. For individuals, this may include proof of address or identity document. For companies, specific documents such as a certificate of registration or a list of beneficial owners are required.
Continuous verification process
KYC is not just a one-off process carried out when an account is opened. In addition to the initial collection of documents for account opening, AML regulations impose ongoing vigilance, known as Customer Due Diligence (CDD). This means that banks must constantly monitor customer activity and regularly update their information. Higher-risk customers (e.g. politically exposed persons, or PEPs) are subject to enhanced monitoring via Enhanced Due Diligence (EDD).
Thus, KYC and AML regulations are deeply interconnected, and AML is one of the essential pillars of the global banking system, requiring banks to adopt rigorous compliance processes to avoid exploitation by criminal networks.
KYC challenges for banks
Increasing regulatory burden
Although KYC is essential, it also represents a major challenge for banks. Compliance with KYC regulations requires considerable investment in terms of technology, personnel and training. Every bank must not only collect information, but also ensure that this data is secure and compliant with legal requirements, on pain of heavy fines.
Impact on customer experience
48% of financial institutions have lost customers due to an inefficient integration process*.
KYC processes can sometimes be perceived as an obstacle for new customers, especially if the procedure is lengthy or complicated. Poor KYC management can lead to delays in account opening, generating frustration among customers. Banks therefore need to strike the right balance between compliance with regulations and a smooth customer experience.
Non-compliance risks
Failure to comply with KYC obligations can result in severe penalties for banks, including massive fines and even the loss of their operating license.
In 2022, the ACPR's Enforcement Committee handed down 7 decisions: in total, over 14 million euros in fines were imposed on financial institutions for failure to comply with their regulatory obligations. Among the breaches identified in the 39 grievances upheld in 2022, we find recurring themes such as KYC in 33% of cases.
Conclusion
KYC in the banking sector is much more than a legal requirement: it's an essential measure for preventing fraud and ensuring that financial institutions operate in a secure and compliant environment. However, traditional KYC processes pose challenges, particularly in terms of high costs, data management and customer experience, as evidenced by the loss of customers due to inefficient onboarding procedures.
To meet these challenges, technology now offers a future-proof solution: the digital identity wallet. It not only reduces the costs associated with multiple KYC examinations, but also simplifies and streamlines onboarding and ensures regulatory compliance, while enhancing the customer experience.
The adoption of the digital identity wallet could thus revolutionize the way banks manage their KYC processes, offering a faster, more secure and more transparent alternative. Against a backdrop of increasing digitalization, these solutions appear to be the future of banking compliance.
Closely related to KYC is the KYS process, for example, which verifies the legitimacy of a company or supplier. To find out more, read our blog post.
*Source: Global KYC trends in 2023 (Fenergo)
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