KYC, or Know Your Customer verification, is a commonly used method to identify, verify, onboard, assess, and monitor customers — which doesn’t necessarily involve only standard IDs or end when the user is accepted to a platform after opening their account. It’s a detailed process that protects financial institutions and other regulated sectors from fraud and unwanted business relationships that can lead to major non-compliance fines.
So, it’s safe to say that throughout the years, KYC verification, or identity verification, together with anti-money laundering (AML) regulations, have been a universal approach to ensure that companies engage with legitimate individuals and entities. Standard requirements include measures like government-issued ID verification, biometric checks, address verification, database checks, AML screening — and more — which we’ll discuss in more detail below.
What is KYC Verification?
Know Your Customer (KYC), or KYC verification, is the process of verifying a customer’s identity during the onboarding and assessing potential risks, such as ties to money laundering, before agreeing to do business with them and allowing them to open an account. Banks, fintech platforms, real estate firms, e-commerce companies, and similar entities are required by law to implement KYC checks. These regulations also extend to certain cryptocurrency exchanges and money service businesses (MSBs).
There’s a standard for verifying identities for KYC, but it still depends on the use case and industry. For example, if it’s an age-restricted item seller online, the platform has to adapt its KYC flow to meet age verification requirements (and check if the buyer is of legal age). In crypto, extra verification checks before withdrawals, such as Proof of Address (PoA) and providing a document like a utility bill, are standard KYC practices.
The Main Goal of KYC
KYC requires companies to implement an identity verification flow that’s built around these steps:
- Confirming a customer’s identity
- Understanding their activities, focusing on verifying the legitimacy of their funds
- Assessing money laundering risks through continuous monitoring
Ultimately, KYC verification helps companies guarantee that the user who’s completing the process is genuine: they aren’t using forged or altered ID documents, stolen source of funds documents (for example, to manipulate the institution into securing a bigger loan), outdated proof of address (for instance, to get their account back after it’s been breached and blocked on an online marketplace), and so on.
However, the biggest issue today is that KYC checks based on only a single layer of verification, for example, document checks, where IDs (passports, driver’s licenses, or ID cards) are verified, aren’t enough. High-risk, regulated entities, such as payment service providers, combine multiple ID verification methods (for example: document verification + selfie verification + address verification) to build a solid KYC verification process that doesn’t allow fraudsters to bypass and manipulate the system to create multiple accounts and conduct unauthorized purchases, or worse, launder funds under a stolen identity or a money mule using schemes like structuring.
Related: KYC Challenges and How You Can Overcome Them
What are the 3 Components of KYC Verification?
The Financial Crimes Enforcement Network (FinCEN) mandates KYC requirements in the US. FinCEN serves as a connection that bridges the law enforcement, financial, and regulatory sectors together. FinCEN operates under the Bank Secrecy Act (BSA), which is the primary AML and counter-terrorism financing (CTF) law. It requires regulated companies mandating to implement measures, such as KYC verification, AML screening, monitoring, and reporting when suspicious activity is detected.
Ultimately, this all boils down to the main three components of KYC verification, which are:
1. Customer Identification Program (CIP)
As part of the KYC framework, regulated entities need to implement Customer Identification Programs (CIP) to verify customers’ identities and confirm the legitimacy of their business activities. CIP requires all financial institutions under the BSA to comply with its regulations. This includes companies like banks, lenders, credit unions, brokerage firms, savings associations, cryptocurrency exchanges, and gambling platforms.
Section 326 of the USA PATRIOT Act outlines these steps for developing a CIP:
- Identifying and verifying users who are opening an account (collecting essential data, like the user’s ID document, name, etc.).
- Maintaining detailed records (assessing customer risk levels by verifying identities, creating risk profiles, and screening AML lists).
- Cross-referencing customer information with government databases (detecting any changes in the customer’s risk profile and overall activity, ensuring timely identification and reporting of suspicious behavior).
While CIP establishes the minimum requirements for onboarding clients, its implementation varies based on factors like the company’s size, operating industry, and location. For example, some financial institutions might ask the customer to provide identification details (not only IDs), such as their Social Security number (SSN) or Taxpayer Identification Number (TIN). It helps companies confirm who their customers are.
After the onboarding, the CIP program consists of verifying whether a customer appears on any government-issued lists. This step involves screening customers against AML databases, including Politically Exposed Person (PEP) lists, sanctions, adverse media, and global watchlists. Individuals flagged in these databases pose a higher risk of fraud or financial crime, often requiring enhanced due diligence (EDD) measures.
For compliance officers, this means applying simplified due diligence to low-risk users, while high-risk customers — such as foreign PEPs or those identified through AML risk assessments — undergo EDD for extra scrutiny.
Related: What is the Difference Between CDD and EDD?
➡️ CIP Data Collection Requirements for KYC Verification
At a minimum, the Final CIP Rule requires companies to collect vital details about the customer, including their:
- Name
- Date of birth
- Address
- Identification number
If the company is onboarding another business (not an individual client), similar requirements are applied. That means they must collect the company’s name, business address, Ultimate Beneficial Ownership (UBO) information, the company registration number (CRN), as well as the corporation date and issuance documents. This is part of KYC for corporate clients, also known as the Know Your Business (KYB) verification process.
Related: What is the Difference Between CIP and KYC?
2. Transaction Monitoring
Transaction monitoring is the process of tracking transactions (such as deposits, transfers, and withdrawals) to detect potential illegal activities like money laundering or terrorist financing. Since this is a complex process, some sort of automation is needed. Suspicious transactions are flagged for further investigation, making ongoing monitoring essential to prevent money laundering and other financial crimes. Regulated entities often implement AI-powered third-party transaction monitoring solutions to maintain a risk-based approach to AML compliance easier (since a large volume of customers and their transactions need to be monitored).
This is mandatory for staying KYC/AML compliant, as it enables the real-time detection of suspicious transactions. The software automatically flags these transactions, helping the company’s internal compliance teams better determine whether the match or flag that was found in the system is a false positive or if it needs to be reported to regulatory authorities. In general, when it comes to EDD and the risk-based approach, it can’t be fully automated, and manual human insight is required to stay accurate. This means combining automation with manual assessment and adjusting transaction monitoring based on the user’s risk profile.
➡️ Transaction Monitoring Requirements for a Risk-Based Approach
Companies use transaction monitoring in different ways, depending on their risk appetite and other factors like their industry, company size, geographical reach, as well as operating markets, customer profiles, and their partners or intermediaries. This is also recommended by the Financial Action Task Force (FATF), which stresses the importance of aligning the scope of transaction monitoring with their institutional risk assessments and individual customer profiles.
The FATF advises that ongoing monitoring should be conducted either continuously or triggered by specific transactions. That’s why most transaction monitoring solutions are built on a rule-based system, which is designed to flag suspicious transactions based on custom settings defined by the institution that’s using the software.
For example, the transaction monitoring process could be customized by following these steps:
- Determining a risk value based on several risk factors, such as industry, location, and transaction history.
- Creating custom rules based on each defined risk value and customer category.
- Setting up alerts, which are triggered when a “rule” is breached so that a further review can be conducted.
- Assigning transactions for further investigation to internal compliance officers responsible for analyzing triggered alerts.
- Filing a Suspicious Activity Report (SAR) if suspicious activity is actually detected and the financial transaction must be reported to the adequate regulatory authority.
For instance, such an automated system can show a real-time alert if a customer spends more than $10,000, which is considered an AML red flag. With such alerts, compliance officers can monitor and audit users’ transactions more efficiently and focus on high-risk transactions instead of all transactions, even those that don’t require extra scrutiny.
3. Risk Management
In this part of the KYC verification framework, companies focus on three things: identifying, assessing, and mitigating risks linked to potential illicit transactions, money laundering, and other financial crimes. So, risk management, also known as AML risk assessment, involves implementing internal controls to minimize the chances of getting involved with a potential client, for example, another business that’s non-compliant or, worse, has ties to sanctioned regions, suspicious ownership structures, or shell companies tied to money laundering. For this reason, risk management practices should be ongoing, as both AML measures and money laundering tactics change over time.
For example, accepting crypto payments introduces more money laundering risks than standard transactions. As a result, companies need to monitor their internal controls and transactions to assess internal and external risks. For bigger companies, this means bigger compliance risks due to factors like extensive networks of partners, third-party providers, or suppliers, some of whom may operate in high-risk jurisdictions where money laundering risks are higher. This sort of exposure increases the company’s overall vulnerability to financial crime.
➡️ Risk Categorization in Risk Management
Another important factor in AML risk management and screening is the quality of data and the scope of official databases, which can be internal or external. Risk assessments should also reference official documents from authorities, such as the UK Treasury’s publicly available list.
In general, key risk factors that can indicate potential money laundering during a company’s risk management processes include:
- The types of customers you serve (B2C or B2B) are based on the entity’s operating industry.
- The size and complexity of the business, including employee and customer count, as well as operations in high-risk jurisdictions.
- The distribution channels for their products or services, including KYC processes for third-party vendors and suppliers.
- The transaction sizes that the business handles, such as larger transactions, which can be used to evade reporting requirements.
- Findings from the company’s most recent AML audit, which helps inform the business about the next steps in their risk management strategy.
Related: What is an AML Risk Assessment? [With Examples]
How is KYC Verification Linked to AML?
Anti-money laundering, or AML compliance, is part of a broader regulatory framework designed to safeguard companies from various financial crimes. KYC is part of this framework, serving as a key component in AML. Authorities like FinCEN mandate that companies implement both KYC verification and AML measures to stay compliant.
These include AML screening and other AML processes, such as:
- Assessing the nature and purpose of customer relationships.
- Creating risk profiles that help identify suspicious activities.
- Keeping customer information up to date.
- Continuously monitoring accounts for potential risks.
- Reporting any detected illegal activity.
However, this means that not only ID verification during user onboarding is required but ongoing due diligence throughout their whole user journey and business relationship, which is particularly why KYC consists of the three key components that we’ve discussed, not one, and is tied along AML measures that correlate with KYC risk assessment (linked to each user, not overall AML assessment for determining the company’s internal risks).
Related: KYC and AML Compliance — Key Differences and Best Practices
Who Uses KYC Verification?
All regulated entities that are subject to KYC compliance need to implement KYC verification. This includes all sorts of companies, both traditional financial institutions and other non-financial entities or online businesses.
For example:
- Mortgage companies
- Real estate firms
- Crypto platforms
- Credit unions
- Travel businesses
- iGaming and gambling establishments
- Forex exchanges
- Art and luxury item dealers
- Music and production companies
- Telecommunication firms
- Healthcare businesses
- Proxy service providers
- Loan and investment companies
That’s because even on an e-commerce marketplace, which is also subject to KYC, users need to create an account and start purchasing/selling items. This automatically increases the risk of fraud since there’s money involved. On top of that, online payments are more convenient, which makes it more attractive to bad actors looking to breach data, steal identities, or conduct unauthorized transactions after account takeovers.
Without KYC verification, this results in costly chargebacks and losses for merchants. By verifying identities and checking users’ ID documents, companies can approve and onboard only genuine users. Of course, ongoing monitoring is vital since they can change and switch to developing fraudulent intentions.
Benefits of KYC Verification
The main reasons why companies find KYC verification beneficial are for ensuring regulatory compliance and improving fraud prevention. Naturally, when done right, a good KYC process will help the company scale faster, accept more users from different jurisdictions, increase conversions, improve the brand’s image, etc.
By verifying that the user’s personal information is legitimate, companies can effectively prevent various types of fraud, such as:
- Financial Fraud. KYC verification blocks bad actors from using stolen IDs or creating fake accounts for unauthorized transactions. This is especially relevant in sectors like fintech and e-commerce.
- Identity Theft. Requiring ID uploads or biometric checks ensures that stolen identities cannot be used to gain access to networks or commit fraud. A common example is loan fraud, where criminals exploit stolen SSNs or personal details to secure financial benefits.
- Money Laundering. Combined with ongoing due diligence, such as transaction monitoring, KYC verification helps detect and prevent money laundering by flagging individuals linked to suspicious transactions for further investigation and reporting.
Good news! iDenfy can help you choose the right building blocks for your identity verification process, tailored to any unique case, risk appetite, or industry, helping you access those benefits and forget about compliance-related headaches.
We specialize in streamlining different types of KYC processes, automating due diligence, and minimizing the workload of your compliance officers. Whether you require AI-powered risk assessment, document or biometric verification, AML checks (including PEPs, sanctions, watchlists, and adverse media), or PoA checks with fully automated utility bill verification, we have all these tools on a single platform, plus KYB for corporate identity verification.
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