KYC vs. AML: What is the Difference?

Some professionals use “KYC” (Know Your Customer) and “AML” (Anti-Money Laundering) interchangeably, thinking that they mean the same thing. But, in a regulatory context, the terms have very different meanings, and KYC is actually a component of the more broadly based AML transaction monitoring rules.

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What is similar about the two terms is that both are regulatory practices that financial institutions worldwide must adhere to in order to avoid potential fraud.

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This article is designed to serve as an overview for early-stage startups and as a refresher for already established risk, fraud, and compliance departments. In order to properly manage risk in financial relationships, you need to know what KYC and AML are and why they’re important.

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Let's jump in.

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KYC vs. AML

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What is KYC?

A critical thing to note is that KYC is specifically about customer verification.

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Know Your Customer, or KYC, is a process that organizations undertake when onboarding a new business relationship. KYC has also been expanded to include KYB, or Know Your Business. While it’s mandatory for financial institutions, KYC and KYB are practiced by other institutions as well, including insurance companies, nonprofits, Fintechs, and other technology companies. KYC and KYB guidelines help to verify a customer’s identity to determine whether there is any risk associated with bringing on the business as a customer.

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Because illegal activities can damage an institution's reputation and increase its legal liability, understanding who they're dealing with is essential knowledge for challenger and sponsor banks, lending institutions, brokerages, exchanges, and payments organizations. These identity verification processes protect against fraudsters gaining private information with the intent of committing fraud.

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The objectives of gathering KYC or KYB information are to:‍

• Identify the customer - Find out who they are, the nature of the business they are involved in, their location, their interests, principals, business formation, or incorporation documents‍
• Ensure the customer is who they say they are - Verify their identity through credit reports, media coverage, annual financial statements, and reports to avoid relationships with any known watchlist bad actors‍
• Determine funding sources and main activities - Identify the business entity’s main source of funds and relationships to other individuals/businesses‍
• Assess and monitor ongoing risk - Perform subsequent ongoing risk-assessment to ensure that the customer is not engaged in risk-adverse activities

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Once this data is collected and analyzed, it’s compared to national and international databases that list individuals who are known to be affiliated with organized crime or other types of criminal activity. This helps to identify individuals or businesses that have an increased risk for engaging in money laundering or other illicit activities.

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Types of KYC Due Diligence

As not all potential customers pose the same risk for money laundering or other illegal activities, there are two different types (tiers) of due diligence that can be performed based on perceived level of risk:

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Customer Due Diligence (CDD), the basic process of gathering potential customer data to establish a clear picture of the customer’s identity and risk category.

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Enhanced Due Diligence (EDD), an additional level of scrutiny that is performed when a customer is classified as high-risk under CDD. EDD looks more carefully at potential customers who, due to the nature of their business dealings, are at greater risk of being involved in financial criminal activity, such as money laundering or terrorist financing.

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To ensure that your KYC processes are thorough and comprehensive, it's important to note the key differences between CDD and EDD.

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• EDD processes are more reliable because they are more detailed and require greater data analysis
• EDD requires specialists who are experienced and highly analytical
• The EDD process needs to be carefully recorded and documented so regulators have access to all collected data
• EDD source information must be deemed reputable and trustworthy
• If any data is determined to be suspicious, it must immediately be turned over to regulatory agencies

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In the case of both CDD and EDD, you need to have a secure system in which to store your data.

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What is AML?

Anti-Money Laundering (AML) is an umbrella term for the broad framework of rules and processes that financial institutions and others must comply with to prevent financial criminal activity, like money laundering and terrorist financing.

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AML rose to the global level in 1989, when the G-7 Summit established the Financial Action Task Force (FATF), a worldwide watchdog agency that monitors money laundering and terrorist financing. Now with the participation of more than 200 countries, the FATF has developed international standards to prevent organized crime and terrorism, going after money generated by criminals involved with illegal drugs, human trafficking and other crimes.

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In addition to KYC, the main elements of AML include:

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• A dedicated AML Compliance Officer with a team who is committed to enforcing AML procedures and policing activity. This activity may include large cash transactions (inbound or outbound), increased number of deposits/withdrawals, transactions that are often associated with mainly cash, high-risk businesses (e.g., gambling, professional services providers, convenience stores, liquor stores, restaurants, etc.)‍
• Transaction Monitoring - ongoing real-time monitoring of business transactions, not just including monetary deposits and withdrawals, but also any kind of anomalous behavior that may be deemed to be suspicious ‍
• Suspicious Activity Reports (SAR) - records of suspicious activity, that are sent to regulatory authorities. Suspicious activity may be anything flagged from the transaction monitoring system or KYC processes. In the U.S., this is the Financial Crimes Enforcement Network (FinCEN), a division of the U.S. Department of the Treasury, that analyzes and disseminates financial transaction data for law enforcement purposes.

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Failure to adhere to AML regulations can result in hundreds of millions of dollars in penalties, as well as loss of reputation.

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In fact, in 2020, financial institutions were hit with $10.4 billion in global fines and penalties associated with AML, KYC, data privacy and MiFID (Markets in Financial Instruments Directive) regulations in 2020, representing a 141% increase over 2019. Fortunately, regulatory technology is dedicated to keeping you on top of all regulatory changes, and helping you update your tech stack accordingly.

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Identity Verification and Transaction Monitoring With Unit21

If you try to do identity verification and transaction monitoring processes manually, AML and KYC processes can be time-consuming and resource-draining.

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Identity verification

Unit21 collects a variety of data signals from companies like Socure and Middesk to verify in real time the identities of any potential customer, including a comprehensive, holistic view of the customer to help with KYC verification and risk analysis.

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With Unit21, you can:

• Write rules and automation logic to enable your best users to go through a frictionless onboarding experience and the riskiest users with a more friction-filled pathway
• Manage identity and document verification, watchlist and sanctions screening, adverse media monitoring and more
  

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Transaction Monitoring

With Unit21’s state-of-the-art RegTech, your risk and compliance teams can customize rules and create complex statistical AML models without engineering resources.

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Our transaction monitoring product allows you to:

• Apply complex machine learning in an understandable and approachable way
• Choose from 100s of out-of-the-box scenarios that you can easily deploy with several clicks
• Apply unique monitoring logic and thresholds to different customer segments

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Unit21 for AML Compliance

With Unit21 you can make data-driven decisions with our no-code platform to transform risk, fraud, and compliance into a competitive advantage. Even more importantly, you can reduce the overall cost of AML compliance on your financial institution. Find out how you can build a comprehensive fraud and AML program that leverages transaction monitoring and reduces your reliance on engineering support.

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The Difference Between KYC and AML: Key Takeaways

While Know Your Customer (KYC) and Anti-Money Laundering (AML) are both crucial components of compliance programs, they serve different purposes. KYC is focused on identifying and verifying the identity of customers, while AML is focused on detecting, preventing, and reporting suspicious financial activities that may be linked to money laundering or other financial crimes.

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KYC and AML work together to create a comprehensive compliance program that helps financial institutions reduce their risk of exposure to financial crimes. By performing thorough KYC checks and maintaining accurate customer records, financial institutions can better monitor their customers' activities and identify any unusual or suspicious behavior that may warrant further investigation. AML compliance officers can then use this information to investigate and report suspicious activities to the relevant authorities.

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It's worth noting that the distinction between KYC and AML is not always clear-cut, and the two concepts are often intertwined. However, understanding the difference between KYC and AML is essential for financial institutions and compliance officers to design effective compliance programs that meet regulatory requirements and protect against financial crimes.

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‍Schedule a demo to learn more about how Unit21 can help improve your AML compliance program.