Financial institutions employ a number of different standards, regulations, and practices to ensure that customers and their accounts are protected. Know Your Customer (KYC) and Anti-Money Laundering (AML) both operate and exist in similar contexts, so people often confuse them or even use them interchangeably. It is important to underline the differences between these two concepts so that the customer and their financial representative can communicate with a mutual understanding.
What is AML?
Anti-Money Laundering (AML) encompasses any laws, standards, regulations, or mechanisms used to catch and control possible money laundering schemes in a financial institution. Money laundering is a process used by criminals to convert illegally gained profits into untraceable money that has been filtered through a registered cash business. A wide variety of institutions may experience money laundering. Therefore, AML can include a number of different procedures, which are usually specific to the institution’s type of business. AML transaction monitoring is one of the most common methods for catching money laundering.
What is KYC?
Within the realm of AML lies the Know Your Customer (KYC) standard. KYC is an industry requirement for financial institutions to go beyond verifying customer identity to identify high-risk customers. It protects the best interests of both the customer and the business. KYC procedures include creating a comprehensive client profile with personal information such as date of birth, employment history, annual income, investment intentions, and other identifying factors.
Customer Due Diligence (CDD) is essentially the same as KYC. These terms both refer to the process of understanding and screening a client’s personal information to judge their risk of money laundering. This requirement comes from the Financial Industry Regulatory Authority Rule 2090.
In specific situations where KYC has identified that a client is of high risk for money laundering, firms must exercise the Enhanced Due Diligence (EDD) standard. This standard verifies various aspects of the client’s information, such as sources of funds, additional identification, and previous financial history. In this risk-based approach, a firm must assess, understand, and manage the client’s money laundering risk before business proceeds.
Why does KYC matter?
Money laundering and terrorist financing are criminal activities that often fly under the radar of governments and financial institutions. Criminals use illegal money that funnels through the financial system to finance crimes like the drug trade, human trafficking, and terrorist activities. Thus, it is imperative to catch illegally obtained money when it travels through financial institutions during the laundering process.
In order to detect suspicious financial activity, financial institutions must verify the identities of their customers. By knowing their identities and their transaction patterns, banks can easily weed out the money laundering transactions from the system.
In 2013, regulations involving KYC and other AML standards became stricter through a large fine increase for financial institutions that do not comply with AML regulations. Between the years 2013 to 2014, the government collected $4.3 billion in fines from financial institutions, demonstrating the increase in fines issued for not complying with regulations. Following these fine increases, in 2014, businesses filed more than 1.7 million suspicious activity reports with the Financial Crimes Enforcement Network, which is 35% more than in 2013.
The stricter regulations and hefty fines led to the detection of more suspicious activity, and therefore to uncovering more money laundering transactions as well. The end result of anti-money laundering laws and standards like KYC is greater difficulty for criminals to finance illegal activities through their money laundering practices.
How do KYC and AML differ?
In summary, KYC is a financial risk assessment of a potential client, whereas AML is a broad set of laws and regulations that mitigate and prevent the risk of financial institutions doing business with money laundering clients. From this perspective, the information obtained from the client during the KYC process can be critical for further AML evaluation, such as EDD.