Know Your Customer (KYC) procedures are becoming essential for protecting financial institutions in an increasingly complicated and digitized financial environment. KYC is a legal mandate that aims to confirm clients' identities and evaluate any hazards.
Financial crimes like fraud, money laundering, and financing of terrorism are prevented in part by these procedures. In addition to being required by law, financial institutions must use KYC processes to preserve operational integrity, promote client confidence, and reduce risks.

Here’s how KYC procedures can protect financial institutions from fraud and risk.
The Foundation of KYC: Ensuring Customer Authenticity
Fundamentally, KYC involves confirming that a consumer is who they say they are. While this may seem straightforward, it can be difficult to verify identity validity in a world where financial transactions are increasingly being done online.
According to a Forrester study, the number of online transactions has surpassed traditional cash payments in the USA. In 2023, around 69% of US adults cited using a digital payment mode to make a purchase in the past three months. Comparatively, only around half of them said that they used cash or credit cards for a purchase.
Fraudsters frequently open bank accounts, obtain loans, and transfer illegal money using identities stolen or created. By implementing a strong KYC procedure, financial institutions may verify their clients' identities using various methods.
KYC procedures aim to examine and validate documentation, increasing the difficulty for dishonest individuals in getting financial services. In the current digital era, identity theft is becoming a more serious problem.
Up from 2023, the first half of 2024 witnessed around 552,000 incidents of identity theft. At this time, credit card fraud emerged as the most prevalent kind of identity theft. The age group of 30 to 39 years old in America is the most susceptible to identity theft.
As stated by AU10TIX, the first stage of a KYC procedure is to establish document verification during onboarding. The documents collected from customers can be government-issued identity cards, biometric information, etc. These documents are then cross-checked with the government database to verify identity.
This first stage of customer onboarding with KYC docs verification creates a barrier against it. All other KYC steps, from customer due diligence and continuous monitoring to audit and review, are done based on these verified documents. If KYC standards weren't in place, financial institutions would be more susceptible to people and criminal organizations looking to perpetrate fraud.
How does KYC differ from Customer Due Diligence (CDD)?
Customer Due Diligence (CDD) entails evaluating the risk profile of the client once they have been identified. On the other hand, Know Your Customer (KYC) is the more comprehensive framework for confirming a customer's identification. KYC assures the legitimacy of the identity, whereas CDD assists in determining whether a customer is a possible danger.
Fighting Fraud through Continuous Monitoring
Ongoing surveillance is equally important as the first identification verification. Financial institutions can't depend just on one KYC check at a time. Con artists vary their strategies, and it's possible that their actions go undetected for a while.
Many financial institutions use ongoing monitoring as part of their KYC compliance to combat this. This entails monitoring consumer behaviors, transactions, and trends in order to identify any irregularities or questionable activity.
For instance, a customer's abrupt and abnormally significant transfers or deposits from several places may cause more scrutiny. Financial institutions employ software that monitors these transactions automatically and notifies compliance officers of any anomalies. By serving as an early warning system, this technology enables financial institutions to end fraudulent activity before it worsens.
However, the problem here is that the standard transaction monitoring systems are not very accurate. According to PwC, around 80% to 90% of the alerts by these systems can be false positives. In this case, you can leverage artificial intelligence on top of transaction monitoring.
All the alerts generated can be passed through an AI algorithm that can accurately differentiate between a genuine and false positive. It can work by collecting data from multiple sources, such as customers' digital footprints, behaviors, transaction histories, and profiles. By analyzing all this data instantly, AI systems can identify transaction monitoring alerts that are false positives.
Are financial institutions required to notify customers if their accounts are under review for fraud?
Financial institutions are not required to alert clients right away if their accounts are suspected of being fraudulent. Investigations are frequently conducted covertly to prevent disclosing the identities of those engaged in fraudulent activity. Notification may happen if action is taken about the account or if evidence has been acquired.
Reducing Money Laundering Risks
Money laundering is one of the biggest threats to financial institutions. Via the banking system, criminal groups frequently attempt to conceal the source of their illicit profits. The median loss for money laundering has also kept increasing since 2019.
Data from the United States Sentencing Commission shows that the median loss for these offenses was $257,200 in the financial year 2019. However, it more than doubled in the financial year 2023, reaching $554,353. Since it is a very severe crime, around 90.6% of the offenders were sentenced to prison, with the average sentence being 71 months.
By requiring institutions to identify both their clients and the origins of their cash, KYC helps to reduce this risk. Financial institutions can identify unusual trends pointing to money laundering by doing thorough due diligence on a customer's financial history.
A consumer may be flagged for money laundering if their income or transaction history does not match their financial profile. KYC requirements reinforce the barriers against this kind of financial crime by requiring financial institutions to notify authorities of any questionable activity.
Regulatory Compliance and Risk Management
KYC ensures adherence to local, state, federal, and international laws while assisting financial institutions in managing the risks of fraud and money laundering risks. Financial institutions must implement strict anti-money laundering (AML) and counter-terrorist financing (CTF) rules enacted by governments worldwide. Heavy penalties, reputational damage, and even legal repercussions may arise from breaking these rules.
For instance, several instances have surfaced in which banks were penalized millions of dollars for neglecting to implement sufficient KYC and AML procedures. Due to lax KYC procedures, a big bank was once fined for permitting money launderers to transfer money via their system without restriction.
One such recent example is that of the Goldman Sachs-backed Starling Bank. U.K. financial regulators have placed a fine of £29 million ($38.5 million) on the bank for the failure of its financial crime prevention system.
Such sentences can cause serious harm to the financial institution’s reputation, which took years to mend, in addition to monetary losses. These kinds of occurrences emphasize how important stringent KYC compliance is to risk management.
How can financial institutions stay on top of the ever-changing regulatory landscape?
Many organizations purchase automatically updating compliance software to take into account modifications to national and international laws. Additionally, they have compliance officers working for them who monitor modifications to regulations and make the required adjustments to internal policies.
In financial institutions, KYC is a key component of the fight against fraud, money laundering, and terrorism funding. Institutions may reduce many types of risks by confirming the identity of their customers, monitoring ongoing operations, and adhering to legal requirements. By guaranteeing security and transparency, KYC not only shields financial institutions from possible losses and harm to their reputation but also increases consumer trust.
The significance of KYC will only increase in the ever-changing financial sector as new risks and difficulties materialize. Financial institutions that invest in strong KYC procedures now are better able to manage risks in the future while upholding compliance.
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