Know Your Customer (KYC) | B2B Finance Glossary

What is Know Your Customer?

Know Your Customer (KYC) is a standard designed for the financial services industry that requires financial companies to identify and verify their customers’ identities when they open new accounts; KYC can also be used to periodically check in on customers to repeatedly verify their identities so that businesses can make sure that these customers are who they say they are.

This standard was set to fight against money laundering, the funding of terrorist organizations, and other financial crimes. Essentially, KYC allows financial institutions to confirm that their clients are who they claim to be so that funds are not going to illicit causes.

KYC involves several steps to verify a potential customer’s identity, understand the nature of the customer’s activities, qualify that the source of the customer’s funds is legitimate, and evaluate any money laundering risks that might be related to a potential customer.

KYC checks are done through independent, reliable documents, data, or information sources. These processes require customers to provide credentials such as government ID verification, facial recognition and verification, biometric verification, and document verification for proof of address.

What is the Difference Between AML and KYC?

AML stands for anti-money laundering. The biggest difference between AML and KYC is that AML refers to the legislation and regulations that financial institutions need to follow to prevent money laundering, while KYC is a specific component of the AML framework: KYC requires corporations to verify customer identities so that they can know exactly who they are doing business with.

AML legislation can vary by location, and because financial institutions are responsible for developing their own KYC processes, these institutions must create KYC procedures that comply with AML legislation according to each of their corresponding jurisdictions. Therefore, KYC is an important component of AML procedures that are in place to prevent money laundering and terrorism financing, all while establishing each customer’s independent risk factors and preventing fraud across the board.

Why is KYC Important?

Financial institutions can more accurately detect suspicious or criminal activities when they verify a customer’s identity through KYC and continue monitoring transaction patterns.

AML regulations were first introduced in 1970 to combat money laundering. After 9/11, the US passed the Patriot Act. Title III of this act specifically outlined measures that could be taken to fight the funding of terrorist organizations, including two core KYC components: the Customer Identification Program (CIP) and Customer Due Diligence (CDD).

More specifically, KYC frameworks take a risk-based approach to fight money laundering, financial fraud, and identity theft:

• Money laundering. Criminals have used bank dummy accounts to store funds for drug and sex trafficking and other illicit activities. KYC limits these criminals from spreading funds across several accounts, preventing them from more easily being able to hide illegal acts such as money laundering.
• Financial fraud. KYC is instrumental in stopping fraudsters from using fake or stolen IDs to apply for car loans, personal loans, and other loans. KYC is also helpful in reducing other forms of financial fraud, such as businesses that pretend to be charitable organizations when they aren’t really operating in this way
• Identity theft. KYC procedures allow banks and other financial institutions to obtain different customers’ true legal identities before they create accounts. In this way, KYC prevents fake accounts from being created – inevitably preventing fraud, the creation of forged documents, and other illegal activity.

What Kind of Institutions Are Required to Have KYC Processes?

KYC is mandatory for financial institutions that offer customers financial accounts. KYC standards usually apply when businesses onboard new clients and when current ones acquire regulated products.

KYC is crucial for any institution that interacts with money, so while banks must comply with KYC, they must also pass along KYC requirements to organizations they do business with. Financial institutions that need to implement KYC include, but are not limited to, the following:

• Banks
• Wealth management firms
• Broker-dealers
• Credit unions
• Fintech apps
• Private lenders
• Lending platforms

What Happens if a Customer Fails KYC?

If a particular customer fails to meet KYC requirements, the bank or financial institution may refuse to open an account for the individual or halt the working relationship if the customer in question is a business. This is in the interest of preventing money laundering and other financial crimes. However, sometimes KYC fails because documents were uploaded incorrectly or because of another clerical error.

The KYC process is designed to be easy for innocent people and businesses, so if customers are who they say they are, overcoming any issues that keep someone from passing a KYC process should be able to be fixed relatively simply.