The security of financial assets is the top priority of every organization. In the retail or insurance sectors, the security is provided by the terms of the agreement, however, in financial technology (FinTech) the software itself should include the tools and processes that mitigate the risk of financial fraud.

In this article we cover the bits and pieces that go into building a robust anti-money laundering system. Besides, we will take a look at when and why AML became so crucial for financial security and which institutions govern the AML laws.

KYC & AML – principles of customer identification

Today the world is shifting away from the anonymity of financial interactions. Any financial institution that cares about the security of the financial relations it has and respects the principles of AML should perform appropriate Customer Due Diligence (CDD). It is usually done by identifying customers and assessing how likely they may (or may not) commit financial crime.

The reasons for creating a robust CDD process are simple:

1. Companies don’t want to lose their money.

While it might seem to be expensive to create CDD, the risks that accompany the lack of this are usually more costly. In addition to more than $600 million, which are accounted for money laundering each year, banks and other financial institutions that do not follow proper regulations possess a risk of being penalised.

2. The global unified effort against money laundering and terrorist financing.

Financial institutions and governments are fighting illegal money flows and terrorist financing by joining forces. Organizations such as FATF are creating a safe financial environment. However, it’s only achievable if enough governments and businesses agree to follow certain regulations. Even a small business that doesn’t follow regulations might become a loophole for criminals, therefore compromising global security, and ruining their own reputation.

That’s why abbreviations Know Your Customer (KYC) and Anti Money Laundering (AML) have appeared in the common business vocabulary.

What is KYC?

KYC – Know Your Customer or Know Your Client is the principle for the operation of financial institutions. It consists of the identification of the natural person or a legal entity, before engaging into financial operations. The goal is to identify clients and monitor their behavior and financial transactions to mitigate the risks as well as fight bribery and corruption.

The first cases of money laundering and tax evasion were recorded more than 4000 years ago in China where merchants would hide their wealth from rulers and, therefore, avoid payments. The modern term “money laundering” was invented in the 1920s when Italian mafia in the US was purchasing laundromats to make their illegal proceeds look like legal profit. You have probably heard the infamous name Al Capone, who was behind this literal laundering. The modern KYC laws started appearing in the 1950s.

What is KYC?

4 steps of KYC

1. Customer profiling

Organizations have the right to have customer acceptance criteria and reject certain groups of people. The risk of the client may be determined by such factors as his or her geographical location or past records of criminal activity.

2. Customer identification

Obtaining personal data such as copies of valid identity documents, birth certificates, proof of address, and income documents to verify the identity of a customer.

3. Transaction monitoring

Tracking the transactions of the customers while registering the source of income and ultimate beneficiary owners. Reporting customers to proper authorities if suspicious transactions are found.

4. Risk-management

Assessing customers and assigning them a risk score based on their profiles, background information, and transaction data. Refusing service and reporting customers with abnormal or suspicious activities.

What Is A KYC/AML?

Newest tools to perform KYC

KYC technology is ever-developing. One of the newest tools used in modern KYC is biometric identification.

  • Fingerprint

Nowadays fingerprint technology is more accessible than ever. Most of the flagship smartphones have fingerprint scanners. While many of the internet banks and e-wallets such as Apple Pay are using this technology for customer verification instead of string passwords. Fingerprint scanners are by far the most accurate and the fastest authentification method.

  • Facial recognition

Facial recognition technology is used by many eKYC providers to match a video or a photo of a person with their picture in the document. Facial recognition is also used for unlocking your phone and some of the financial services. This technology is developing rapidly especially among top-tier smartphone manufacturers.

  • Voice recognition

Voice recognition is yet to see its wide use among KYC providers and FinTechs. It is not as secure just yet, however, solutions such as automatic video call interview can benefit from such technology.

What is AML?

AML – Anti Money Laundering. To be more specific, this abbreviation should be written as AML CTF CWMDF – Anti Money Laundering and Counter-Terrorist Financing and Counter-Weapon of Mass Destruction Financing. Its task and function are clearly defined by the very name.

Customer identification (KYC) is the key to performing effective counter-measures to laundering of dirty money, avoiding taxes, financing terrorism, and various fraud, yet it’s just one of the parts of AML.

KYC can be considered as a set of  tools and procedures, one of the features of a complex global AML/CTF policy, just like CDD – Customer Due Diligence, EDD – Enhanced Due Diligence and KYCC – Know Your Customer’s Customer.

The EDD was first introduced with the US Patriot Act back in 2001. It was implemented in order to minimize risks and the cost of the KYC, by expanding the information stored about a customer and keeping it up to date.

What is AML?

The percentages show how many institutions collect this data from the total amount of institutions participating in the study.

The data was provided by the Association of Certified Anti-Money Laundering Specialists (ACAMS).

Principles of KYC and AML are applicable to all financial institutions no matter how big or small they are.

What’s in common?

Often, KYC and AML are used as synonyms, but it’s not quite correct and sometimes brings confusion in business conversations.

  • Governmental and international regulatory authorities are more often using AML/CTF when talking about the subject.
  • Merchants, vendors, service providers, and financial institutions more often use the term “KYC obligations”.

At the same time, when you perform customer identification, therefore, follow the principles of  KYC, you may find information that will reveal fraud, which will allow you to restrict this client from using your service and comply with the AML policy.

Who creates policies and controls their practical implementation?

On the international level, the regulatory authority that issues cornerstone policies is the Financial Action Task Force (FATF).

Who creates policies and controls?

On a regular basis FATF issues directives, circulars, and acts that aim to prevent the ever-evolving fraud and money-laundering, as well as keeps track of how effectively they are being followed on the local level.

The FATF currently comprises of 37 member jurisdictions and 2 regional organizations, representing most major financial centers in all parts of the globe.

There are also some other organizations that create and enforce AML policies. Here are a few major examples.

  • International Monetary Fund

The International Monetary Fund (IMF) is an organization that fosters global monetary cooperation, secures financial stability, facilitates international trade, promotes high employment and sustainable economic growth, and reduces poverty around the world. It was created in 1945 and has 189 member countries. Its primary functions are keeping track of the global economy, lending to countries, and giving practical help to members, which also includes AML.

  • The Wolfsberg Group

The Wolfsberg Group is an association of 13 major banks: Banco Santander, Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, J.P. Morgan Chase, MUFG Bank, Société Générale, Standard Chartered Bank, UBS. Its goal is to create a framework for managing risks related to financial crimes. Their focus is KYC, AML, and CTF.

  • Basel Committee on Banking Supervision

The Basel Committee on Banking Supervision (BCBS) is a global standard setter for bank regulations. It has 45 members from 28 jurisdictions that include banks and bank supervisors. It has published such documents as sound management of risks related to money laundering and financing of terrorism, and its amendment guidelines on cooperation between prudential and AML/CFT supervision.

FATF and all of the above-mentioned organizations contribute to creating effective international policies such as:

●    5AMLD

Fifth Anti-Money Laundering Directive (5AMLD) has come into force on January 10, 2020. In the European Union Anti-Money Laundering Directives (AMLDs) are currently the primary documents that banks and FinTechs should refer to while creating their CDD policies. 5AMLD has 6 major changes compared to 4AMLD, which are related to virtual currencies and exchanges, prepaid cards, high-value transactions, Beneficial Ownership (BO) registry, high-risk third countries, Politically Exposed Persons (PEPs).

●    6AMLD

6AMLD will come in force on December 3, 2020 for EU members and on June 3, 2021 for entities that operate outside the EU. The main changes that 6AMLD tackles are increased jail sentences for money laundering, a single definition for predicate offenses, the criminal penalty for aiding and abetting, inciting, and attempting money laundering, extended liability for legal persons and cross border cooperation in regards to money laundering crimes.

●    PSD2

The Second Payment Services Directive (PSD2) is a set of regulations created by the EU with the goal to create a more integrated payment system in the EU and make payments safer while protecting consumers.

●    FATF 40 Recommendations

Forty recommendations on money laundering is a document released by FATF in 1990, which is constantly revised and includes global standards for AML and CTF. It covers criminal justice, law enforcement, cross-border cooperation, and the financial system with its regulations.

●    Eight Special Recommendations on Terrorism Financing

Eight Special Recommendations on Terrorism Financing is another document by FATF, which was released in 2001 following 9/11 terrorist attack in the US. There was a follow-up document  International Best Practices Combating the Abuse of Non-Profit Organizations released in 2002. There was a ninth recommendation added later as well.

On a local level, the control over the KYC and AML policies lies on the country’s national bank and local financial regulatory authority, such as:

●      Financial Conduct Authority (FCA) in the UK

●      Financial Crimes Enforcement Network (FinCEN) in the USA

●      Hong Kong Monetary Authority (HKMA) in Hong Kong

●      Monetary Authority of Singapore (MAS) in Singapore

●      Australian Transaction Reports and Analysis Centre (AUSTRAC) in Australia

Are you feeling lost?
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