Know Your Customer (KYC) in Banking Explained

What is Know Your Customer in banking? Get advice on the process, top KYC challenges, and how financial institutions can speed up while managing risk.

Know Your Customer (KYC) procedures are a legal requirement for banks and financial institutions to know who they’re doing business with. They are a critical part of anti-money laundering (AML) legislation, required by virtually every country around the globe.

Know Your Customer (KYC) in banking: Key parts.

While specific KYC requirements may vary by country, KYC programs typically include three parts: identity verification, customer due diligence, and ongoing monitoring.

  • Identity verification: Confirming that the individual or business customer is who they say they are by checking names, addresses, and social security numbers on government-issued IDs against government and third-party databases.
  • Customer due diligence: Ensuring that the customer doesn’t engage in illegal activities by screening them against sanctions and terrorist watchlists, reviewing executive bios, company reports, and media press, and analyzing past transactions and behavior. Banks also need to identify politically exposed persons (PEP) who are in positions of power and therefore at higher risk of corruption and people and companies doing business in regions that are known to have more money laundering violations, such as Iraq or North Korea. Customers determined to be at higher risk of involvement in financial crime undergo enhanced due diligence screening.
  • Ongoing monitoring: Continuously reviewing customers and their transactions to detect any changes in risk, suspicious activity, or fraud.

KYC is part of overall customer lifecycle management (CLM), which begins at customer onboarding and follows the customer throughout their entire association with the bank. CLM also includes account maintenance, marketing, product openings, tax declarations, and more.

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Why is KYC important in banking right now?

Money laundering is a big business, and growing. About 2.7% of the global GDP gets laundered each year, according to research from The Financial Accountability, Transparency and Integrity (FACTI) Panel, a UN-affiliated group. Money laundering costs US banks more than $2 billion per year in fines.

Many cases of money laundering are connected to fraud and drug trafficking, and recently, identity theft has become a major strategy in money laundering schemes—increasing the importance of Know Your Customer (KYC). Given the amount of money laundering that slips through the cracks, stronger KYC processes have become a necessity for many organizations.

Bad actors may use stolen identities in several ways:

  • Account takeover (ATO): Account takeover occurs when bad actors use victims’ funds, and then continue to use victims’ bank accounts to hide illegally gained funds and transfer them to other accounts.
  • Identity theft: Identity theft occurs when bad actors don’t steal victims’ funds, but they use their stolen identity to open accounts, take out loans, and establish corporations.
  • Synthetic identity: Synthetic identity is when bad actors create a new identity by using nonexistent social security numbers, names, and addresses. Since the identity is not real, it is not flagged on any watchlists.

Why is KYC a challenge for banks?

Imagine placing your items at a store checkout, only to be told by the cashier that they need to decide whether they’ll agree to sell to you. That’s the situation today for banks and their prospective clients—both individuals and business customers–at onboarding: The bank must conduct a thorough KYC verification before they can agree to create an account for a client. This obstacle can create friction in the customer experience, and to make matters worse, KYC verification takes a long time—often more than three weeks.

Why does the KYC process typically take so long? Banks and financial institutions face several speed challenges:

First, the sheer volume of information a bank needs to collect for KYC is staggering, both in paper and digital forms, such as emails. For business customers, banks need to collect identifying materials and photos for each individual connected to the business, as well as business documentation such as tax certificates or articles of incorporation. They also need to review executive bios, press releases, annual reports, and other materials.

Process automation can play a key role here, speeding up previously manual tasks. For example, robotic process automation (RPA), just one part of a holistic automation strategy, handles repetitive data entry tasks. Intelligent document processing (IDP), another tool that’s part of a complete automation approach, pulls data from digital documents.

Data silos and disparate systems across the organization are also a big speed bump in the KYC process. Today’s banks and financial institutions have some of the world’s most complex technology stacks—legacy systems and all. With B2B customers, banks can use strategy and technology to balance the customer’s desire for speed and the bank’s need to manage risk of financial crime. Data strategy proves critical in all four stages of the financial crime lifecycle:

  • Compliance - Governance structures and crime strategies.
  • Prevention and detection - Fraud management, including advanced analytics.
  • Investigation and remediation - Evaluating allegations, responding to regulatory requests, addressing issues.
  • Monitoring and reporting - Ongoing monitoring for signals of AML risk.

Banks also need to contend with an ever-changing regulatory environment. As bad actors invent novel ways to commit financial crime, regulators amend AML/BSA and other laws to stem the attacks. Banks must adapt their workflows to conform.

Customer onboarding speed: Tips to improve safely.

Banks report that long KYC processes negatively impact their customer acquisition rates. Banks that succeed in shortening their KYC times while remaining AML compliant will differentiate themselves in the marketplace.

They will also save money. According to McKinsey, around 10% of a bank’s workforce is assigned to financial crime–related activities, with KYC reviews typically being the costliest of these. During the current economic downturn, leaders are looking to save costs. Streamlining their KYC processes will enable banks to allocate resources to other tasks and help them remain competitive. Gaining that speed represents an important part of a financial company’s digital transformation effort.

So how can banks speed up the KYC process while rigorously enforcing AML regulations, even with a shifting regulatory landscape? To be successful, digital transformation must conform to your culture and how people work and interact, according to Deloitte research.

Addressing friction in KYC and CLM is a common industry problem leading investment managers are looking to tackle. These problems are being compounded as organizations continue to scale and grow into new geographies and issue new products. As we’ve discussed, the involvement of so many teams, platforms, and processes involved throughout the client lifecycle have historically resulted in disparate operating models and data silos—meaning increased resource constraints and negative client experience. Addressing these inefficiencies in the operating model is paramount for investment managers to continue to scale in an efficient manner. Here are three tips shared by leading organizations for addressing these issues:

  • Adopt a “data first'' approach: Sort the underlying data models within the organization to better harness the power of automation and new technologies. Focus on key integrations with leading data providers to complement internal data and ensure a robust document tracking workflow. Use intelligent document processing (IDP) and implement strict document approval and review processes to ensure accuracy and reduce errors. Analyze the benefits of tools that include a data fabric capability and examine centralizing your data strategy. For more on what it means to take a “data first” approach, read our related article: KYC Verification Process and Requirements: 3 Tips to Improve.
  • Integrate KYC into your CLM service model: Use customer-centric dashboards to keep track of upcoming and historical KYC investigations, tasks, and risk scores and more quickly and easily identify issues at the customer-level. For best continuous monitoring practices, configure alerts to notify the compliance team of any changes to a customer’s data and automatically open new KYC investigations accordingly.
  • Control increasing compliance costs: The compliance officer should focus on automatic routing of KYC policies to reduce manual reviews and unnecessary workload. They should use configurable KYC processes to fully manage rules, tasks, documents, and questionnaires and introduce standardized procedures for handling certain types of customers.

Improving the KYC process will be a key differentiator for banks and other financial institutions in 2023 and beyond—to unleash digital innovation, drive business efficiency, and ensure compliance.

[ Learn more about how to optimize KYC compliance strategies. Get the eBook: Powering Seamless KYC Operations. ]