Customer due diligence is a process used to assess the risk associated with potential customers. In the same way that you assess a potential business relationship, customer due diligence is the act of vetting and verifying a potential customer—whether an individual or organisation. The goal is to gain transparency into their identity and intent, and in the process, minimise the chance of working with criminals who intend to launder money or commit other financial crimes.
Customer due diligence, also known as CDD, is a legal requirement for financial institutions. These are the businesses that money launderers target, to transfer their cash into clean money. When performingdue diligencechecks, these businesses collect, evaluate and record relevant information about their potential customers, including their identity, financial history and background.
The information that can be used to verify customers comes from a mixture of resources, including:
- Customers providing the required information to use the financial service
- Sanctions lists from authorities and governments
- Company listings and other public data
- Third-party sources that are used to provide private data
Why are Customer Due Diligence Measures Important?
Financial criminals rely on processes that don't check a customer’s identity or intent: which allows them to subtly exploit businesses in a range of ways, enabling them to make their ‘dirty’ money appear ‘clean’.
This is why a risk based approach is important. It protects your business, the economy and society from money laundering risks. During CDD, financial institutions perform specific procedures like Know Your Customer (KYC) policies to determine the risk of working with potential customers. These processes help to highlight high-risk individuals or groups such as politically exposed people (PEP) and prosecuted money launderers.
Suspected or guilty individuals or groups involved in some form of financial crime are typically givensanctions. CDD involves searching sanctions lists to help firms if they’re restricted or prohibited from working with their potential customers.
What Does the Customer Due Diligence Process Involve?
The process of performing thorough customer due diligence means collecting a range of different information to develop transparency of the potential customer.
Usually, financial organisations will analyse:
- Customers’ personal information:This will include the potential customer’s full name, approved photo identification, residential address, phone number, occupation, National Insurance Number, and email address to confirm that customers are who they say they are.
- Business information:This information includes their source of funds, what market they operate in, what activities they do, details of their business, their business model and ownership details.
- Customer risk profile:Potential customers can be sorted into groups with different levels of risk based on their identity, location and type of business. This will then determine how much due diligence is required for each customer, where those with a high risk of money laundering will need a more in-depth analysis.
- Ongoing monitoring:Once they begin working together, the financial business still needs to perform ongoing monitoring and due diligence, in case anything changes. This can involve flagging suspicious transactions and changes in customer profiles as they keep an eye on high-risk customers.
When is Customer Due Diligence Required?
Anti-money laundering (AML) activities don't always need to be applied, but they exist to combat risk in their most common places, including:
- New customer relationships:When a customer joins, banks and financial institutions must perform their CDD before the onboarding stage. The initial information collected can then guide the remainder of the CDD operation and risk assessment while ensuring the customer is who they say they are.
- Occasional transactions:In particular instances, occasional transactions can be a high-risk activity and call for CDD to take place. These include transactions that are much higher than usual or sent to foreign countries that are high risk from past money laundering cases.
- Customer suspicion:Customers can sometimes be flagged or be suspected of money laundering, which makes them high-risk customers and they need to have extra CDD performed on them.
- Inadequate documentation:Customers that provide unreliable identification or other documentation are a red flag. While these customers may not be laundering money and may have just supplied inadequate information, further CDD checks should be done here.
The Benefits of Customer Due Diligence
As CDD is a risk based approach used to prevent money laundering and other financial crimes, it begins to make a lot more sense why banks need and want to comply. Money laundering isn't just a crime committed by drug traffickers alone, but many different perpetrators that make cash through illicit activities. This ends up costing countries massive amounts of money per year, which has a knock-on effect on the economy and everyone within society.
As well as the greater social issues, customer and client due diligence prevents banks and financial institutes from becoming a victim, which has its own negative effects on their business. When banks are used to launder money, the leaders or directors can face major consequences, like significant fines or even prison sentences. The overall brand is likely to suffer from reputational damage by being linked to criminals laundering money.
Even when a financial institute isn't used for money launderers, they can still face penalties for not complying with CDD and risk having their products and services banned by the FCA. The benefits of complying with anti-money laundering (AML) include:
- Avoiding non-compliance fines:HMRC has recently reached new records in fines assigned for businesses not meeting the CDD requirements, totalling£23.8 million in one year alone.These fines are issued when relevant institutions can't provide the details of their CDD checks, so banks onboard this risk when they aren’t effectively managing their due diligence.
- Avoiding reputational risk:Financial firms that are found to not comply with their CDD requirements may be met with negative reputational risk from potential customers. On the other hand, businesses that consistently perform their CDD duties accurately are protected from fraudulent activity as well as building their reputation in the market.
- Transparent customer understanding:Following the regulations within a market and region helps firms remain aware of who they’re working with, so their business is transparent and avoids risk.
- Assisting authorities:Financial crime has huge consequences on the economy and the whole of society, so for major businesses like banks, helping law enforcement prevent money laundering is beneficial for not only them but the entire market.
Customer Due Diligence Checklist
Financial service providers will need to create an in-house process that streamlines the CDD of new and existing customers. Although it can be taxing on time and resources, this can be done by creating and implementing a checklist to help. The checklist can include the following.
Perform Basic CDD & Identification
For all new customers, the first step is basic identity verification and investigation. This step is a requirement in the KYC regulations to ensure the data a person uploads is legitimate.
Identity and background verification can be done in many ways, but it usually involves an online document verifications process to assess the validity of their identity files as part of a standard onboarding process.
Identify if Enhanced Due Diligence is Necessary
Once the identity and financial position of new customers is confirmed, businesses can then assess whether the customer presents a high risk. If so, enhanced due diligence (EDD) is the next necessary step. As discussed earlier, EDD is required if the customer is from a high-risk country, is a PEP or presents a risk of money laundering.
Maintain Updated Records
CDD requires ongoing monitoring; if customers’ circ*mstances change, it's essential to update their records, amend the risk assessment and perform EDD if necessary. This often happens when businesses change owners, or their organisational structure.
Store & Secure Records
It’s a legal duty to store and record financial transactions for a particular amount of years, which also includes CDD information. Financial institutions should make sure they keep records of their CDD measures, business communications and account files to prove they're compliant.
Consider Using a Third Party
Most financial service firms onboard an influx of new customers while managing a large number of existing customers. This can present challenges in ensuring CDD is performed effectively and complies with their requirements. Often, companies use a third party for their due diligence to streamline the process of verifications, sanctions search and other responsibilities.
Nexis Diligenceoffers this advanced service managed by our specialists who can streamline your new and existing CDD. This allows our clients to focus their resources on growing their business and handling customer relationships.
