Since 2004, all Indian financial institutions have been required by the Reserve Bank of India to verify the identity and address of all customers who conduct financial transactions with them. As a result, the RBI mandated the KYC process as the sole mode of verification. In this blog post let’s know more about KYC.

What is KYC?

KYC or “know your customer” is a process banks and other financial institutions use to verify the identity of their customers. This helps to prevent fraud and money laundering. In order to comply with KYC regulations, financial institutions must collect certain information from their customers, such as name, address, date of birth, and identification number. They may also need to take measures to verify the customer’s identity, such as conducting a background check.

The importance of Know Your Customer

The purpose of KYC is to prevent fraud and money laundering. It’s important for businesses to know who their customers are, so that they can be sure that they are not doing business with criminals or terrorists. There are many different ways to verify the identity of your customer. The most common way is by asking for government-issued ID, such as a passport or driver’s license. You can also verify someone’s identity by checking their credit history or other public records. KYC is an important part of doing business, and it’s something that all businesses should take seriously.

KYC is an important tool because it protects financial institutions and prevents illegal activities. Non-individual customers make extensive use of financial services such as trading and mutual fund investing. Banks have the right under KYC to verify an entity’s legal status, which includes cross-checking customers’ operating addresses and verifying the identities of their beneficial owners and authorized signatories.

Furthermore, the KYC process requires the nature of the customer’s employment as well as the business conducted by the customer, which is useful in verifying the authenticity of an individual and/or company.

KYC Documents Required

Individuals and organizations are both subject to the KYC process. KYC authentication is based on identity and residence verification. The documents required for the KYC process for individuals include the typical documents that people use, such as:

• Driver’s license
• Social security card/number
• Passport
• Documents issued by the state or the federal government.

For proof of residence, the following documents can be furnished:

• Utility bills, such as telephone, electricity, gas, etc.
• Bank statements
• Employment documents
• Housing contracts and rent agreements

Three Components of Know Your Customer

There are three main parts of a KYC compliance framework: customer identification, customer due diligence, and enhanced due diligence. Each phase of the process gets more intensive according to the estimated risk that the potential client might pose.

Customer Identification Program (CIP)

Organizations must ensure that a potential customer’s ID is valid, genuine, and free of inconsistencies. The individual must also not be on any of the Office of Foreign Assets Control (OFAC) sanctions lists.

An organization must also determine whether or not a prospective customer is “politically exposed.” A politically exposed person (PEP), such as a public figure, is thought to be more susceptible to corruption than the average person and is thus considered high-risk, necessitating special care.

All financial institutions are required to keep records of their Customer Identification Program (CIP) as part of their AML/KYC compliance program, as mandated by the Financial Crimes Enforcement Network (FinCEN).

FinCEN works under the direction of the Department of Treasury and is tasked with protecting the financial system from illicit transactions.

The following information will satisfy the minimum KYC requirements for a Customer Identification Program:

• Customer name (or name of business)
• Address
• Date of birth (not required for businesses)
• Identification number

Customer Due Diligence (CDD)

Due diligence entails gathering all relevant information on a customer from reliable sources, determining why the customer will be using financial services, and maintaining ongoing monitoring of the situation to ensure that customer activity corresponds to recorded customer information.

The goal of this phase of the know your customer process is to assess the risks that a potential customer may pose and categorize them as low, medium, or high risk.

Several factors, such as the customer’s expected cash transactions, business type, source of income, and location, will help determine the customer’s risk level.

Other risk factors include the customer’s industry, whether they use a foreign or domestic account, and their financial history. The Customers are also checked against the lists of politically exposed persons (PEP) and the Office of Foreign Assets Control (OFAC).

Enhanced Due Diligence (EDD)

Enhanced due diligence (EDD) entails increased monitoring of high-risk customers. Customers from high-risk third countries, those with political exposure, or those with existing relationships with financial competitors may fall into this category.

When opening an account with a high-risk business entity, it is necessary to identify all beneficiaries of that entity. Customers who are legal entities have had legal documentation filed with a Secretary of State or other state office, and these customers, include:

• Limited liability companies (LLC)
• Corporations
• Business trusts
• General partnerships
• Limited partnerships
• Any other entity created via filing with a state office or formed under the laws of a jurisdiction outside of the US

A new AML/KYC requirement went into effect on May 11, 2018. According to this change in KYC laws, all banking and non-banking firms subject to the Bank Secrecy Act (BSA) must verify the identity of legal entity customers’ beneficiaries when they open an account.

Firms must also create risk profiles for their customers and constantly monitor them. This must be done regardless of the risk category of the customer. Due diligence is a continuous process that necessitates financial institutions continually updating customer profiles and monitoring account activity.

What Are the Steps Involved in KYC?

There are five main steps of complying with the know your customer rule. These include:

• Customer Identification Program (CIP)
• Customer due diligence (CDD)
• Enhanced due diligence (EDD)
• Account opening
• Annual review

After determining that a customer is eligible for financial services, an account is opened and an annual review is performed.

The higher a customer’s risk category, the more frequently their activities will be reviewed.

What Are the Four Key Elements of a KYC Policy?

There are four key elements of a KYC policy:

1. Identification and verification of the customer’s identity
2. Assessment of the customer’s risk profile
3. Monitoring of the customer’s transactions
4. Updating of the customer’s information

These elements work together to help financial institutions comply with KYC regulations and prevent money laundering and other financial crimes.

Benefits of KYC

To be mandated by the law, the Know Your Client (KYC) process also helps the financial institutions in several ways:

• Helps lenders perform risk assessment by identifying the previous financial history and assets owned
• Limits fraud that result mainly due to hiding of identity
• Prevents money laundering and other anti-social activities
• Brings stability and investment to the country, as it makes the financial framework more trustworthy and less risky
• Decreased uncertainty allows institutions to lend more to customers and increase their profits

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