If the Indian economy has taught us one thing, it’s that Know Your Customer (KYC) alone isn’t enough to prevent financial scams. Illegal activities such as money laundering and terrorist financing are quite notorious in the banking and corporate sectors, which indicates a growing need to find a holistic way to prevent such activities.
Enter Anti-Money Laundering (AML) compliance, the answer to combating financial crimes. While KYC effectively verifies customers' identities and filters out bad players, a recent study showed that 70% of frauds have occurred even after completing KYC processes. This is where AML strengthens the KYC process and deters criminals even further.
While both concepts are similar in objective, they have underlying differences. Let’s explore how KYC differs from AML and some of their best practices in fintech!
What is Know Your Customer (KYC)?
Know Your Customer refers to the mandatory process of verifying customers' identities. Organisations and financial institutions collect information about their customers in compliance with legal requirements for identity verification and risk assessment. As a critical component of anti-money laundering, KYC is primarily used to prevent financial crimes like fraud, identity theft, etc.
What is Anti-Money Laundering (AML)?
Anti-money laundering refers to the regulations and procedures organisations and financial institutions follow to detect and prevent financial crimes such as money laundering and terrorism. It involves performing extensive due diligence on customers, monitoring their transactions for suspicious activities, and reporting them if a crime is suspected. AML compliance is usually carried out to prevent illegal activities such as tax evasion, political corruption, money laundering, terrorist financing, etc.
What is the Difference Between KYC and AML?
Know Your Customer and Anti-Money Laundering are legal requirements for businesses to protect against financial crimes. However, they differ in the following ways:
Where and When are KYC and AML Required?
To prevent financial crimes, KYC and AML are required in various industries and circumstances. Following both are mandatory for all regulated entities, some of which include:
- Financial institutions: Before onboarding new customers, assess risks and detect suspicious activity.
- Payment service providers: KYC and AML are done before opening digital wallets or activating digital transactions.
- Cryptocurrency exchanges: Crypto and DeFi platforms implement KYC and AML before allowing users to trade or convert digital assets to prevent money laundering via cryptocurrencies.
- Gambling and casinos: They are done upon player registration, during large transactions, and withdrawal of funds.
- Corporate entities: Large corporations and venture capital firms conduct KYC and AML checks during mergers, acquisitions, or major investments to ensure legitimacy and prevent illicit financial activities.
What Does the AML Screening Process Look Like?
Organisations and financial institutions typically perform AML screening. They check potential customers against public lists to verify whether they are high-risk individuals or are involved with entities engaging in money laundering or terrorist financing. In other words, they analyse customer information and transactions to verify their legitimacy and identify suspicious behaviours.
While conducting an AML screening process, you should be on the lookout for a few red flags like usual transactions, use of anonymous entities, unexplained wealth increase, large cash transactions, etc.
There are a few types of screening processes your business can conduct:
- Sanctions screening: These lists are maintained by government agencies and contain information about individuals or entities deemed national security threats. These are individuals who are prohibited from certain financial dealings.
- Politically Exposed Persons (PEP) Checks: Under this process, individuals who hold high-profile positions in government or politics may be more likely to engage in financial crimes such as bribery or corruption, making them high-risk individuals.
- Adverse media sources: These sources include negative news stories that may be associated with the customer being verified. This check ensures that the individual does not portray the company negatively.
- Watchlist Screening: Companies check a customer’s information against specific databases containing data about known or suspected criminals. Watchlists are similar to sanction lists but are constantly updated and even employ real-time screening for adequate due diligence.
How does the KYC Process Work?
The KYC process can be carried out both offline and online. Regardless of the method, the following documents are essential:
- Identification proof: These documents verify your identity. Examples include an Aadhar card, passport, driver’s license, or voter ID card.
- Address proof: This is used to verify your current address. Utility bills, rental agreements, and even some ID proofs can be used to verify your address.
- Income proof: A few entities may require proof of income to assess your financial status. Such documents include salary slips, income tax returns, or bank statements.
- Photographs: One or two passport-size pictures are required as well.
- Additional documents: Depending on the entity you’re opening an account with, a few more documents, such as a PAN card or business registration documents, might be needed.
- Self-declaration form: In most cases, you’ll need to fill out and sign a self-declaration form confirming the accuracy of your KYC information, and they’ve been submitted in compliance with applicable laws.
The KYC process is conducted in the following order:
- Collection of information: The applicants first submit their personal information. After which, they are required to fill out an online KYC registration form.
- Uploading of evidence: Once their information is collected, the applicants have to validate it with relevant documents. These serve as evidence to prove they are who they say they are. Neokred’s ProfileX takes this a step further with its secure verification feature that implements facial recognition technology to prevent identity frauds.
- Verification: Once the forms and relevant documents have been uploaded, they undergo multiple checks to ensure they haven’t been tampered with. The verification process may take time, and the applicants will receive a notification from the entity if their application has been approved.
What are the Main AML Regulations?
AML regulations in India are primarily governed by the Prevention of Money Laundering Act (PMLA), which mandates businesses and financial institutions to implement robust measures to detect and prevent financial crimes.
Between 2014 and 2024, the Enforcement Directorate (ED) registered over 5,200 money laundering cases, with 40 convictions and three acquittals. This indicates the threat money laundering poses to the Indian economy, which has led to the necessity of regulatory bodies enforcing AML regulations.
The Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), and Insurance Regulatory and Development Authority of India (IRDAI) are key regulators that have been integral towards the development of robust AML frameworks. More regulations anchored by the PLMA were implemented to address the rising number of financial crimes and safeguard the nation’s economic system:
- PML (Maintenance of Records) Rules, 2005: Requires reporting entities to maintain transaction records and submit those deemed suspicious to the Financial Intelligence Unit - India (FIU-IND).
- PML (Amendment) Act, 2009: Introduced the concept of “corresponding law enforcement agencies” where information about reporting entities could also be shared with foreign agencies.
- PML (Amendment) Act, 2012: Introduced the concept of politically exposed persons, expanded the scope of reporting entities to NPOs and lowered the threshold for identifying beneficial owners.
- PML (Amendment) Act, 2015: This was made to align Indian AML laws with international standards by introducing the concepts of “reporting financial institution” and “reporting authority.”
- PML (Maintenance of Records) Amendment Rules, 2023: This amendment aimed to bolster AML compliance efforts by widening the scope for reporting entities and customer due diligence requirements. It imposed stricter KYC norms for company secretaries and chartered accountants, including cryptocurrency and virtual digital asset transactions under AML norms.
How Automation Improves KYC/AML Compliance
Automation has the power to streamline KYC and AML in the following ways:
Online Identity Verification
Businesses can automate KYC procedures and obtain customer identity data through online verification. The process begins with the user selecting their ID document type and uploading pictures. Once the KYC platform screens the documents, users are asked to send a photo of themselves holding the document to verify that they are real people. Biometric checks and facial authentications are done under automated KYCs to verify customers' identities.
For example, ProfileX makes digital identity verification easier with its top-of-the-line KYC API. The platform verifies customer identities in seconds with unparalleled accuracy and validates their information with automated document cross-checking with trusted sources.
Automated AML and Sanctions Screening
Automating AML and sanctions screening is also highly effective in reducing businesses' manual burden of conducting the verification processes themselves. Through automation, companies can build verification flows in compliance with AML/KYC regulations, maximising reliability and protecting them from financial crimes. PEP lists, sanctions lists, watchlists, and adverse media lists are a few sources that automation can use to screen customers for possible risks.
Transaction Monitoring and Digital Wallets
KYC/AML automation facilitates real-time monitoring of customer transactions and detection of illegal or suspicious activities. Since many users also create digital wallets for online payments, automation tools can verify their identities and continuously monitor their transactions.
Consequences of Poor AML & KYC Compliance
Here’s a brief overview of some of the consequences companies and financial institutions can face due to poor AML and KYC compliance:
Facilitating Criminal Activities Unknowingly
Poor AML and KYC policies can cause financial institutions to unknowingly facilitate illegal activities such as money laundering and terrorist financing on behalf of criminals. This can expose the entity to risks, so robust identity verification and monitoring procedures are required.
Regulatory Fines and Penalties
Did you know that the number of penalties imposed by the RBI on financial institutions grew 88% over the last three years? What’s worse is that AML and KYC non-compliances contributed to that growth. Regulatory bodies impose strict guidelines that companies must follow to maintain AML and KYC compliance. Failure to adhere to these guidelines will result in fines, sanctions, and legal penalties.
Reputational Damage and Loss of Customer Confidence
Breaching AML and KYC compliance erodes customer trust and confidence in the entity. Adverse publicity, media scrutiny, and loss of loyal customers are common results of such compliance breaches, which can persuade customers to switch to competitors perceived as more trustworthy.
Exposure to Greater Financial and Operational Risks
The consequences aren’t limited to the above three; there are more. The entities in question will become more vulnerable to financial scams. They will frequently be subjected to regulatory investigations and incur higher costs for remediation efforts. Loss of business partnerships and profitability are also long-term consequences they’ll have to face.
Best Practices for KYC/AML in Banking, Crypto, and Fintech
Since banking, cryptocurrency, and the fintech industries are more vulnerable to financial fraud, here are some of the best KYC/AML practices that can be followed to mitigate such risks:
- Ensuring compliance with AML laws: Properly complying with AML laws and regulations will prevent businesses from incurring hefty fines and penalties for non-compliance. It will also ensure that their reputation and customer loyalty are preserved.
- Internal controls and audits: Businesses should conduct regular audits and reviews of their KYC/AML policies to ensure there are no weaknesses or loopholes that criminals can exploit to conduct illicit activities.
- Verified users: Fraudsters use fake IDs and various sophisticated schemes to conduct fraud. Financial institutions should ensure that only verified users can become customers, which can reduce innovative fraud attacks.
- Enhancing user experience: Financial institutions can optimize KYC/AML process workflows based on applicant risk profiles so they don’t have to pass extra checks. This motivates the customers to complete the process without dropping off in between, thus improving the overall user experience. Neokred makes this possible as the platform’s onboarding workflows ensure reduced customer drop-offs by 24%.
Conclusion
To sum up, KYC and AML compliance share the same goal of preventing financial crimes. However, while KYC focuses on verifying customer identities, AML aims to detect and prevent illegal activities such as money laundering and other financial crimes. Understanding the key differences between KYC and AML and implementing their best practices will help you streamline and strengthen your compliance efforts.
With Neokred’s KYC APIs, you can stay ahead of evolving regulations with constantly updated databases, real-time user identity and secure verifications, and more features that offer your customers a seamless onboarding experience. Contact us today to learn more about our KYC platform’s capabilities!
Conclusion
FAQs
KYC is a subset of AML requirements.
AML is a broad set of measures that includes KYC, customer due diligence, risk assessment, and suspicious activity monitoring. KYC verifies a customer’s identity and is critical to the AML process.
The four elements of KYC and AML are Customer identification, Ongoing due diligence, Risk management, and Customer acceptance policy.
KYC refers to obtaining customers’ information, such as name, date of birth, address, etc. and verifying their identities to ensure they are who they say they are.
AML refers to measures carried out by financial institutions and other entities to prevent financial crimes. It involves customer due diligence, ongoing monitoring, risk assessment, and suspicious activity reporting.
KYC primarily focuses on verifying customers' identities, whereas AML focuses on detecting and reporting suspicious activity and learning more about customers and their sources of funds.
