KYC & AML – What Is The Difference?

By: Liubomyr Maievskyi, Solution Engineer
17 May. 2023
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Massive money laundering has devastating consequences for businesses and disrupts national economies. Every financial institution may face hefty fines, sanctions, and potential reputational damage. And Know Your Customer (KYC) procedure is a significant element in the fight against financial crime. It is caring out under the of Anti-Money Laundering (AML) requirements.

KYC and AML complement one another. They are compulsory across national and international authorities worldwide, as they prevent and limit various types of financial crimes. Although these terms are similar, they are mistakenly used synonymously. The main difference between KYC and AML is that the first term is one of the mechanisms used in the Anti-Money Laundering framework.

But for successful optimization of both processes, it is necessary to know their important distinctions. This article will look at key aspects that differentiate these two abbreviations and what’s behind them.

What is AML?

Before diving into the Know Your Customer procedure details, let’s familiarize ourselves with the Anti-Money Laundering definition. AML is a set of measures, rules, and laws for the financial sector aimed at the prevention of actions of money laundering and uncovering efforts to disguise illicit funds as legitimate income. In particular, AML regulations are designed to avoid corruption and financing of such crimes as human and drug trafficking, gambling, and terrorism.

AML should be considered as a framework rather than a separate procedure. It includes multiple methods and tools which help uncover and prevent financial crime at the time of their commission or before it. Within these rules, financial institutions must obtain and verify customers’ data, monitor their activity and sources of customers’ funds, and report all suspicious transactions to the appropriate authorities. In particular, this applies to banks, law firms, casinos, tax advisors, forex brokers, etc.

History of Anti-Money Laundering (AML)

For the first time, AML legislation was passed in the United States in the 1930s. It aimed to stop the growth of organized crime during the times of Prohibition. The next time the U.S. government returned to the discussion of money laundering rules at the height of the war against drugs. Thus, in the 1980s, law enforcers tried to trace the proceeds of crime and catch organizers.

After the Terroristic Act of 11 September 2001, it became necessary to strengthen the laws. And after a year, governments worldwide updated AML laws. Today, the Financial Action Task Force (FATF) is responsible for global AML guidance. It works with more than 200 countries and jurisdictions, training government agencies and financial service providers to prevent money laundering.

Key Components of AML Compliance Programs

Below are five elements of an effective Anti-Money Laundering compliance program.

  • Designation of AML compliance officer (AMLCO). The responsibilities include settling all the issues related to the program: internal audits management, analysis, guideline development, employee training, etc. A compliance officer must have vast experience working in the financial sector and appropriate certification.
  • Regular and relevant staff training. The main purpose of such programs is to keep employees updated with regulations, processes, and tools. They should also be scheduled after serious incidents when employees were involved in money laundering. Repeating such incidents indicates that the existing policy is ineffective and must be adjusted.
  • Development of internal policies and procedures. Each financial institute work with different products, services, and customers. That’s why it is so important to keep AML policies in accordance with the specifics of doing business. Internal AML guidelines address how a business runs, stays compliant, and ensures all implemented policies. They include Customer Due Diligence (CDD) and monitoring procedures for both natural and legal persons.
  • Risk assessment. The risk-based approach is of central importance in effectively implementing the FATF standards. Financial entities must perform risk assessments to identify and understand the money laundering and terrorist financing risks they are exposed to.
  • Independent audits. The organization’s risk assessment and compliance program also require review. The process should be conducted by an independent auditor, which cannot be the compliance officer or by another employee who directly reports to him. One of the main purposes of this testing is to identify gaps in processes and check how successfully the company prevents money-laundering crimes.

What is KYC?

The KYC process is s key part and critical function of the overall AML framework. It means the procedure of verifying the identity of new clients. The main goal of checks is to ensure customers are who they say they are. Effective KYC also involves knowing clients’ financial activities and the risks they present. KYC processes are aimed at preventing money laundering, terrorism funding, corruption schemes, and other types of financial crime. This is the backbone of any successful compliance and risk management program.

Main Steps of KYC Procedures

To clearly explain the KYC process, let’s look at its stages.

  1. Registration of a new user.
  2. Request for a full name, address, and ID document.
  3. Verification of identity and other customer information.
  4. Identity confirmation and permission to finish the registration.

Although all these steps may seem simple, manual verification can’t be scaled for large companies. In addition, criminals always intend to cheat the KYC process. That’s why many financial institutions rely on third-party software to perform identity verification.

Elemets of KYC program

Know Your Customer processes are made up of three critical components.

Customer Identification Program

Financial institutions must know their customers. Today, identity theft is widespread, bringing financial risk and a real threat to banks, lenders, credit unions, insurers, and other businesses. A customer identification program (CIP) is a crucial part of KYC. It protects companies from identity thieves by verifying that customers are who they say they are.

The customer identification procedure consists of several stages. And one of them is collecting identifying information required to open an individual financial account. This includes such data as name, address, date of birth, and identification number. This customer’s data is a minimum requirement, and companies can collect additional information depending on risk factors and specific needs.

The next step of the process is identity verification procedures. For example, for documentary verification, financial organizations may request from their new customers a driver’s license, birth certificate, military card, etc. During database verification, there is a comparison between user-supplied information and authoritative databases from mobile operators, credit unions, and other financial institutions. And the last form of identity verification procedure is biometrics. It can be facial and fingerprint scans or selfie authentication.

Customer Due Diligence

Before companies cooperate with new clients, they must ensure they are KT

Customer Due Diligence (CDD) is crucial to effective risk management and protection against financial criminals. There are three types of due diligence.

  • Simplified Due Diligence is carried out on low and medium-risk customers. This brief process is performed when full CDD is unnecessary, as the risk for money laundering or terrorist financing is low.
  • Regular or Basic Customer Due Diligence is a level that provides greater scrutiny of potential business partnerships or customers. These are generally situations with potential risks, but they are unlikely to be realized.
  • Enhanced Due Diligence is conducted for higher-risk customers to understand client activity better, ensure they are not criminals, and mitigate risk levels.

In addition to basic Customer Due Diligence, including identity verification, conducting ongoing monitoring is recommended. This is due to the fact that existing customers may transit into higher-risk categories with time. In this case, periodic CDD can benefit financial institutions and ascertain whether EDD is necessary.

Some of the criteria to take into account to determine whether Enhanced Due Diligence is required:

  • client address and occupation;
  • type of transactions and most often used payment methods;
  • expected model of customer activity.

Ongoing Monitoring

The one-time identity verification process, as mentioned above, is not enough. Banks and other financial entities should have a special program to monitor clients continuously. This feature contains accounts and transaction monitoring based on thresholds from the customer’s risk profile. A set of criteria to monitor may vary according to risk mitigation strategy and type of clients. It can include the following factors:

  • bursts of financial activity;
  • suspicious activity;
  • inclusion in the sanctions lists;
  • a negative mention in the media;
  • status of an account record;
  • compliance of transactions with the stated purpose, etc.

A suspicious Activity Report may be required in case of revealing unusual account activity.

Now, you see that KYC and AML are similar terms and can’t be positioned against one another. These are legal requirements that governments monitor. AML and KYC regulations call for financial institutions to examine their customers to comply closely. Both processes require different types of verifications, including – documents, addresses, and customer’s identity.

KYC procedures are primarily focused on the last mentioned point and risk assessment. AML program relates to the whole scope of Anti-Money Laundering techniques employed to help protect and report financial crimes. It refers to understanding where customers’ money comes from. Ultimately, KYC is just one component of the AML compliance program.

Importance of KYC and AML Regulations

According to the United Nations, money laundering represents up to 5% of the global GDP. This is around 800 billion to 2 trillion U.S. dollars. Therefore, AML and KYC compliance is fundamental for businesses and the economy, protecting financial service providers against fraudsters and money launderers.

The presence of robust AML and KYC checks is the best way for financial entities to protect their businesses from improper use and maintain a good business reputation. The above-described procedures of the new customer identity verification, risk level determination, and ongoing monitoring throughout the cooperation are not only important for protection against fraud but also are a legal requirement.

Moreover, processes associated with AML regulations form an essential part of the customer experience, including the impression of the onboarding stage. Customers want simplicity, ease of cooperation, and a sense of safety. Implementing intuitive processes of KYC and AML helps provide this, improves conversion rate, and creates the right first impression.

How Automation Improves AML and KYC Compliance

KYC and AML are mandatory for banks, creditors, insurance companies, and other organizations. But increasingly strict regulations are extremely costly and time intensive. Firms must involve independent third-party verifiers and compliance teams, which requires a lot of money. Additionally, businesses could face identity theft and data breaches. That’s why more and more companies are moving to automation and integrating automated identity verification into their onboarding process.

Automated KYC checks allow financial institutions to get client identity data through online verification. The procedure is available via mobile version and website and usually involves five steps. For example, a new user, who wants to register, selects an ID document type and uploads photos of it and a photo of himself holding the document. After this, the KYC platform screens and validates the document and then verifies that a user is a real person. Automated KYC process can also include biometric checks, such as Face Match verification.

Automated AML screening is cost-efficient, as it reduces manual checks. AML solutions protect businesses from crime by working with trustworthy sources, such as sanctions and Politically Exposed Person (PEP) lists.

Wrapping Up

The distinction between AML and KYC is essential to know and understand. If a financial institution mistakenly thinks these abbreviations have the same meaning, it can’t fully implement them. Such a firm can become a target of money laundering and terrorism financing, which lead to severe economic consequences. Such an approach to KYC and AML compliance can also result in heavy fines imposed by regulatory authorities.

Although many businesses from the financial services sector continue to rely on proven methods of performing KYC, integrating new technologies is gaining momentum. Today, advanced data analysis and AI gain a deeper understanding of customer behavior. Such innovations positively affect the KYC process and enhance decision-making in increasingly complex AML laws. Despite the effectiveness of traditional measures, more firms will transition to specialized software to reduce human error and enhance compliance performance.

By: Liubomyr Maievskyi, Solution Engineer
17 May. 2023
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