KYC – A Genie in a Bottle

 

The adoption of effective know-your-customer (KYC) standards is an essential part of any banks’ risk management practices. Banks with an inadequate KYC risk management program may be subject to significant risks, especially legal and reputational risks.

Regulators appear to have increasingly high expectations for banks regarding their Know Your Customer (KYC) and Anti-Money Laundering (AML) policies and tools, and financial institutions are struggling to keep up with the pressure of those raised expectations. A key challenge in implementing sound KYC policies and procedures is how to put in place an effective, group-wide approach.

As such, it is essential that each group develops a global risk management program supported by policies that incorporate group-wide KYC standards. Policies and procedures at the branch- or subsidiary-level must be consistent with and supportive of the group KYC standards, even when, for local or business reasons, such policies and procedures are not identical to the different business units within that group.

The ideal process framework is derived from the following regulatory guidelines adopted around the world:

1. International Money Laundering Abatement and Anti-Terrorist Financing Act
2. USA PATRIOT Act
3. UK Proceeds of Crime Act 2002
4. JMLSG Guidance
5. Third European Money Laundering Directive

While KYC and AML regulations have been around for a long time, new laws across different jurisdictions are complicating what some might think is a straightforward data aggregation issue. The KYC data required for suitability includes the client’s investment objectives, risk appetite, capacity for loss, financial knowledge and experience. This information is generally summarized using a few key indicators, typically a resulting risk profile such as “conservative”, “balanced”, or “dynamic”.

As many regulations require firms to follow a special surveillance process for higher-risk clients, KYC data such as country of residence, country of activity or sector of activity is critical. Even if a firm does not get fined, the reputational damage of mishandling KYC can be significant, in particular if the client is a Politically Exposed Person (PEP). Last but not least, recent tax regulations have shed new light on the operational cost of a defective KYC process, e.g. when implementing the FATCA electronic search for US based markets.

The automatic exchange of tax information is imminent. Therefore the accuracy of KYC data will not be a question of operational cost or fulfilling regulatory requirements, it will also impact clients’ privacy. Many organizations are still implementing tactical solutions, reacting to each new piece of regulation on a case-by-case basis. Not only does this becomes very costly as time goes by, but adding on applications, processes, and repositories for every new requirement makes systems complex, redundant and difficult to maintain.

Taking reference from my recent experiences of working with 87 banks using our Predict360™ platform, I must give you the best trick to trap this genie in a bottle. 360Factors’ enterprise risk management software uses advanced algorithms to calculate compliance risk scores of new as well as existing customers on the basis of customer profile; financial products & services subscribed, countries of their operations, types of transactions performed, and their deviation from the expected behavior. These compliance risk scores are constantly recalculated based on customer profile changes including discovered association with high risk categories such as PEPs, Money Services Businesses and Casinos, etc. Because if you don’t manage you KYC functions up front, you will NEVER be able to get the Genie back in the bottle.

 

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