Why Financial Institutions Must Perform Due Diligence

These days, most people practice due diligence without even thinking about it. It’s rare that someone would make a major purchase like buying a car without performing some research beforehand.

Just as we evaluate big decisions before we make them, banks and financial institutions need to know who their prospective clients are before allowing them to open an account. This is where customer due diligence comes into play.

What is Due Diligence?

Customer due diligence (CDD) is the process of identifying your customers and checking they are exactly who they say they are, ensuring that they are properly risk-assessed before being onboarded. In practice, this means obtaining a customer’s details and cross referencing them with those of an official document which confirms their identity. 

Customer due diligence (CDD) is at the heart of Anti-Money Laundering (AML) and Know Your Customer (KYC) initiatives, and is designed to help banks and financial institutions verify their customers, confirm they’re not on any prohibited lists and assess their risk factors. 

There are three levels of due diligence: simplified, standard and enhanced.

Simplified Due Diligence (SDD) is used in situations where the risk of money laundering or terrorist funding is low and full CDD is not necessary. 

For example, in accounts which are low-transaction/value, the opportunity is limited to perform illegal activity. Therefore these small value accounts can be exempt from stringent CDD to help reduce onboarding friction for customers and financial institutions.

Customer Due Diligence (CDD) is information obtained on customers to verify their identity and assess the risks associated with that customer.

These are the checks most typically taken out on customers when opening a financial account in some form.

Enhanced Due Diligence (EDD) is additional information collected on higher-risk customers to provide a deeper understanding of activity to mitigate associated risks.

For example, most jurisdictions require politically exposed people (PEPs) to go through the EDD process. Other factors that might trigger EDD are high-transaction/value accounts, accounts that deal with high-risk countries, or accounts that deal with high risk activities.

Why is Due Diligence important?

Due diligence is important, not only to comply with regulation and avoid hefty fines & sanctions, but as smart business strategy – not knowing your customer in today’s financial world is a non-starter.

Here are a few reasons to take CDD seriously:

• Big Compliance Fines: Enforcement actions related to money laundering have been on the rise. The United Nations Office on Drugs and Crime (UNODC) estimates the market for global money laundering is worth up to $2 trillion per year.
• Sophisticated Cyber Threats: Criminals are using more sophisticated means to remain undetected, including globally coordinated technology, insider information, the dark web and e-commerce schemes.
• Reputational Risk: AML incidents put a financial institution’s reputation on the line.
• Rising Costs: Most AML compliance activities require significant manual effort, making them inefficient and difficult to scale. Regulators imposed bigger fines for anti-money laundering failures in the first half of 2020 ($706m) than they did in the whole of 2019 ($444m).
• Poor Customer Experience: Compliance staff must have multiple touch points with a customer to gather and verify information. According to American Banker, adding just 5 minutes to the onboarding process can increase drop off rates by 200%.

International standards require that a risk-based approach is applied to customer due diligence. Companies should assess the money laundering/terrorist financing risk each client poses and adjust their due diligence scrutiny accordingly. ‘Where ML/TF risks are higher, banks should always apply enhanced due diligence, although national law or regulation might not prescribe exactly how these higher risks are to be mitigated,’ says the FATF.

The application of customer due diligence is required when companies with AML processes enter a business relationship with a customer or a potential customer to assess their risk profile and verify their identity. Financial institutions must carry out CDD measures in the following circumstances:

• New business relationship: Companies must perform due diligence measures prior to establishing a business relationship to ensure the customer matches their risk profile and isn’t using a fake identity.
• Occasional transactions: Certain occasional transactions warrant CDD measures. These might involve amounts of money over a certain threshold or entities in high-risk foreign countries.
• Money laundering suspicion: If a customer is suspected of money laundering or financing terrorism, companies must implement CDD checks.
• Unreliable documentation: When the identification documents that customers have provided are unreliable or inadequate, companies should apply further CDD scrutiny.

How we can help

At Acuant we offer a suite of KYC solutions that satisfy all of the above requirements. We also help onboard your customers faster and more efficiently with more accurate results.

Onboard up to 68% more customers than with traditional identity verification methods, using our single universal API, Sodium. One simple integration; a flexible 360° solution which is scalable and secure.

Book a demo today and see for yourself how powerful our suite of solutions are.