• The Know Your Customer (KYC) rule requires financial institutions to verify the identity of customers to prevent fraud and terrorism.
  • Establishing a risk profile for each client from the start of the business relationship with him is a key element.
  • Continuous monitoring of customer transaction standards helps detect suspicious activity.

The United Nations estimates that criminals around the world use legitimate banking systems to launder up to $2 trillion a year. To combat the use of illicit funds, US regulators require financial institutions to verify the identity of their customers, develop a risk profile for each, and continuously monitor transaction activity.

Commonly known as the “know your customer” (KYC) rule, this practice allows banks, brokers and other financial institutions to detect suspicious activity and prevent criminals and terrorists from transferring money. money in the financial system.

What is the Know Your Customer rule?

Know Your Customer (KYC) is part of the due diligence required by law for financial institutions to verify the identity of customers and monitor their transactions. The rule was established by the Financial Industry Regulatory Authority (FINRA).

It requires financial institutions to authenticate the personal information of each individual customer or beneficial owner of a business, including documenting their names, dates of birth and addresses. They must also develop risk profiles for each client and continuously monitor their transactions for signs of illegal activity.

The KYC rule was designed to ensure compliance with anti-money laundering laws, detect suspicious activity, and prevent criminals and terrorists from using the financial system. This helps protect customers, investors, the bank’s reputation and the integrity of global markets.

How does KYC work?

A KYC compliance program has three main parts:

  1. Verify customer information
  2. Create a customer profile
  3. Continuously monitor activity

Verify customer information

Financial institutions are required to verify a customer’s information at the start of a business relationship.

“In its simplest form, when someone opens a bank account, they are required to provide the bank with multiple identifying information,” says Brandon Koeser, principal financial services analyst at RSM US LLP. “This information will also be used for ongoing bank account monitoring purposes to identify and report suspicious banking transactions or activities to the relevant regulatory authorities.”

Create a customer profile

A key part of KYC is building a customer profile, also known as a customer risk assessment. This helps the financial institution better understand the customer’s preferences and behavior in their relationship with the bank. When the bank understands the nature and purpose of a customer’s relationship with the bank, it can help the bank understand what types of transactions the customer is most likely to perform. This allows them to spot suspicious activity that does not correspond to the customer’s usual activity.

Constantly monitor

“Continuous monitoring is an important part of KYC,” says Terry Monteith, senior vice president of product at the payment software provider. BlueSnap. “After the initial identity verification and risk assessment is complete, criminal activity may still occur. Monitoring unusual activity such as spikes in spending, unusual cross-border activity, or transactions involving people or sanctioned institutions help to combat nefarious activities.”

Who uses the KYC standard?

Financial institutions that must comply with the KYC rule include:

  • American banks
  • Mutual fund
  • Securities brokers or dealers
  • Futures Commissions
  • Introducing commodity brokers

These are institutions that closely deal with your money and its management.

Why is KYC important?

KYC helps prevent crimes such as:

  • Identity theft
  • money laundering
  • Financial fraud
  • Financing of terrorism
  • Other Financial Crimes

“KYC is designed to prevent the banking system from being used as a means by criminal organizations or enterprises to fund and conduct illicit activities,” Koeser said.

By creating a customer risk profile, a bank can determine what type of transaction pattern would be normal for them and be able to easily detect suspicious activity.

“As an example, if someone opens an account and is determined to be a low risk customer (thus low dollar transactions and low transaction frequency) and the activity in the customer account switches from day overnight to high value transactions and high transaction frequency, the bank’s ongoing monitoring activities would flag this change in activity,” he says. “As a result, the bank could review transaction activity and , if found to be unusual or suspicious, notify the appropriate regulatory authority.”

An example of KYC in banking

KYC standards affect every consumer whether they know it or not. For example, when you open a current account, the bank will take steps to verify your identity, establish a risk profile for you, and continuously monitor your transactions. This protects both the consumer and the bank.

Here’s what it would look like in practice:

  1. You want to open a current account. You submit an application.
  2. The bank asks for documents to support the personal identification details. You can present an official document such as a driver’s license or passport to verify your name and date of birth, and a utility bill to verify your address. Once these have been provided and verified, the bank can open an account for you.
  3. The bank builds a customer risk profile. Behind the scenes, the bank gathers the information it has about you to create a customer profile or customer risk assessment. This data is used to predict your behavior based on your transaction history. For example, if you typically have a payroll deposit of $2,000 every two weeks, the bank will expect a similar amount to be deposited at the next interval. A large deposit of $10,000 or more that does not conform to the client’s typical transactions would trigger red flags.
  4. The bank monitors transaction activity. If anything appears to be inconsistent with your transactions, the bank may report it to the appropriate regulatory body. For example, if you started moving large sums of money outside of your usual banking operations, the bank would point this out and take a closer look.

It’s not uncommon to receive calls about suspicious activity on your account that you weren’t aware of. This is how the system works for consumers as well as for the financial institutions charged with safeguarding the money. When the KYC rule is followed, participants can have more confidence in the financial institutions and markets that are affected.