Business, Finance

Know Your Customer (KYC) in Financial Institutions: Is it my Right or Duty to introduce KYC Documentation?

August 21, 2017

The financial industry is more sophisticated today compared to ten years ago. The challenges facing financial services providers have led to the adoption of rules and regulations like KYC, which have attracted scrutiny of various stakeholders. To ensure legality of all client transactions, financial institutions need to acquire precise disclosure of their clients’ activities.

Know Your Customer (KYC) therefore plays a very important role in banks for this purpose. Before processing any transactions with clients, the first step for financial services organizations is to establish the client’s identity. At first glance, this seems to contradict the bank secrecy traditions. However, on deeper analysis, we realize that this step is necessary and is in fact in line with the interests of bank’s clients.

KYC is essential for several reasons.

It enables financial institutions to maintain market transparency and execute their supervisory functions at the same time. This helps to reduce risk of financial fraud, terrorism financing transactions, money laundry - a serious threat to the stability and integrity of financial system, and protects the sovereignty and security of nations globally.

In summary, the aim of KYC is to:

- Enhance opportunities to banks to establish long-term relations with their customers,

- Be aware of their financial deals, and

- Assist them consistently not to be exposed to money laundering activities.

The Requirements of KYC - Understanding the Forms and Documentation

The “know your customer” form is a standard application form in the banking industry, which gives investment advisers detailed understanding about their 

- Customers’ residence eligibility,

- Risk tolerance,

- Investment perspectives, and

- Financial status.

Submitting all the necessary documents is a mandatory procedure nowadays for any reputable bank. Banks will risk incurring huge fines, if they do not comply with the standard requirements. In 2014, Standard Bank was fined £7.6m for its failure to implement sufficient money laundering control.  

Within the scope of KYC, it is necessary to:

- Identify the client on the basis of the personal documentation presented and verify all the information from the third independent and trustful source;

- Verify consistently the position of the client and the true intention of the financial deal (investment or another) during all the period of the collaboration.

Despite the cumbersome processes, in most cases the policy plays into the hands of the client. By submitting all the requested information, clients also assist their personal investment advisers to select the best investment schemes which ideally suits their needs. Hence, KYC helps to protect the client and reduces the risk of a wrong investment choices for the client.

The Risks and Challenges of KYC

Unfortunately, due to the complicated requirements, KYC has garnered negative feedback among the customers. The main complaint given is the complicated paperwork and repetitive processes, resulting in transaction delays and in some cases, even suspensions on customer accounts.

Recently in 2016, Thomson Reuters conducted a large-scale study on the global changes in the KYC policy.  In the survey, 772 respondents from financial institutions and 822 respondents from corporations in leading regional markets of Europe, USA, South Africa and the Asia-Pacific regions were asked about their views on how KYC was affecting their businesses. The survey revealed a global trend: the cost and complexity of KYC procedures are negatively affecting businesses around the world.

Due to the numerous complaints, various service providers have stepped in to ease the burden for financial institutions and corporations. In 2014, Thomson Reuters Org ID launched a KYC solution, maintaining a database that stores over 350,000 updated records and 1.25 million legal entity profiles in over 140 countries to help customers with KYC. To date, Thomson Reuters has served over 50 financial organizations and asset management companies worldwide with this solution. 

Examples of KYC in Action in Different Countries

It is in each country’s interest to maintain the good name and reputation of its financial institutions. So, different countries may have unique requirements for customer data collection. But generally, the key aspects are standard and common across countries and jurisdictions.

Regulators around the world are constantly improving and changing KYC policies, in response to global events and changes. For instance, the Swiss Bankers Association’s Due Diligence Agreement, which has been in existence since 1977, is revised regularly. In the US, after the Sep 11 terrorist attacks in 2001, KYC laws were integrated into the Patriot Act to identify and hopefully, curb terrorist behavior. The Reserve Bank of India (RBI) is also constantly considering various stakeholder interests and coming up with new KYC rules. In the recent two decades, the urgency to fight against illegally-acquired assets has caught the eye of governments and gained greater emphasis among regulators.

Going forward, we can most likely expect tougher regulations around the world. In the US, banks can expect even more requirements for KYC and AML in 2018.  Financial institutions will be obliged to establish their customers’ identity throughout all stages of collaboration. New terms like “beneficial ownership”, which will require consideration of both direct and indirect ownership of company shares, will be introduced to improve visibility of who is in control of funds.  

The Bottom Line

It is unfair to criticize KYC for all the extra documentation and effort required from financial institutions and their clients. To be fair, KYC protects both the client and the advisor by establishing clear boundaries between acceptable and unacceptable transactions. But we must acknowledge that this protection comes at a cost. Financial institutions bear the cost of implementing KYC procedures, as compliance will often demand extra duties and greater competence of staff.

Ultimately, the bottom line is KYC is going to stay in the long term. Despite the pain of compliance, KYC helps banks in their long-term strategies, improves compliance and customer service. Hopefully, this could lead to higher profitability for both sides in the long term. 

about author

Ani is a PhD Candidate and has worked as a Business Consultant and Financial Analyst. She has facilitated training sessions for Chartered Accountants (in her homeland country Armenia) throughout last 5 years. Ani has an academic type of personality with passion for research in the areas of Investing and Asset Management worldwide.