Anti-money laundering (AML) regulations are mandated by both national and international authorities around the world and place a wide variety of screening and monitoring obligations on financial institutions. Those AML obligations include the Know Your Customer (KYC) process, however, given the proximity of the terms ‘AML’ and ‘KYC’ and the fact that they are often used interchangeably, it can be difficult to understand how they differ in a regulatory context.
The importance of the compliance function means that firms must be familiar with the difference between AML and KYC and, similarly, understand how both relate to each other during the regulatory process.
What is AML?
AML is an umbrella term, referring to the range of processes which firms must put in place to meet their regulatory obligations. The general goal of AML is to ensure that firms are able to detect and prevent money laundering, and so protect themselves and the financial systems in which they operate from the damage it causes.
In most jurisdictions, AML regulations require firms to develop and implement an AML program that is tailored to their own business needs and is capable of managing the specific risks that their customers or sectors present. A firm’s AML program should facilitate the practical screening and monitoring processes required by the AML legislation under which it operates.
The regulatory requirements and screening processes associated with AML may change depending on prevalent trends in financial crime and the legislative needs of financial authorities.
What is KYC?
While AML refers to an umbrella framework made up of a range of processes, Know Your Customer is a component part of that framework — specifically, the process of verifying customer identities.
Sometimes referred to as Customer Due Diligence (CDD), KYC is so important because the risk-based approach to AML is predicated upon firms knowing who their customers are and what level of money laundering risk they present. In more detail, the KYC identity verification process requires that firms:
- Establish basic information about their customers: name, address, birthdate, etc.
- Obtain information about the nature of the customer’s business in order to understand the business relationship into which they are entering.
- Establish the beneficial ownership of companies (if this is not the customer).
The KYC process should take place during onboarding in order to ensure that customers are being truthful about who they are and the business in which they are involved. KYC should also take place throughout the business relationship to establish that a customer’s risk profile continues to match the firm’s information on them.
In situations where a customer presents a particularly high risk of money laundering, the KYC process should involve Enhanced Due Diligence (EDD), which may involve:
- Collecting additional customer identification materials
- Verifying the source of customer funds
- Scrutinizing the purpose of transactions or the nature of business relationships more closely
- Implementing ongoing monitoring procedures
The relationship between AML programs and the KYC process should be one of continuous feedback. As a subset of AML, KYC can be used to tailor an AML program to a business’ unique needs, refining customer risk profiles and enhancing compliance performance. Specialized KYC software is available to help firms manage the identity verification process, allowing them to automatically prioritize high-risk customers, while reducing human error and false positives.