Centralizing Compliance Processes with AML and KYC in FinTech

Imagine opening a new bank account entirely online without visiting a branch. This convenience stems from fintech innovations that use KYC (Know Your Customer) and AML (Anti-Money Laundering) processes to ensure security and regulatory compliance. As embedded finance seamlessly integrates these financial services into non-financial platforms, the importance of AML and KYC in fintech is growing at a fast pace. By centralizing and streamlining these protocols, companies meet regulatory demands and enhance customer experience, making everyday financial operations safer and more accessible.

In this article, we explore the concept of centralized KYC platforms, their implementation in embedded finance, and their potential benefits and challenges.

The history, importance, and technologies driving AML and KYC in FinTech

Anti-Money Laundering (AML) and Know Your Customer (KYC) are foundational elements in the financial services industry, designed to prevent fraud and ensure compliance with global regulations. 

• AML refers to a set of procedures, laws, and regulations designed to halt the practice of generating income through illegal actions. It involves monitoring customer behavior to detect and report suspicious activities to the relevant authorities. 
• KYC is a component of AML, focusing specifically on verifying the identity of customers, understanding their financial activities, and assessing the risks they may pose.

Diving into AML and KYC’s history

The history of AML traces back to the Bank Secrecy Act (BSA) of 1970 in the United States, which required financial institutions to report certain transactions. The importance of AML has significantly increased after major financial scandals and terrorist activities, leading to stronger regulations worldwide, such as the USA PATRIOT Act of 2001. KYC became prominent as part of AML directives to further enforce due diligence to verify clients’ identities and risk profiles.

Notable KYC and AML regulations in the European Union and the United States

• Bank Secrecy Act (BSA): Enacted in 1970, this primary piece of anti-money laundering legislation in the US requires fintech firms to establish Customer Due Diligence (CDD) procedures, report suspicious transactions, and maintain transaction records.
• USA PATRIOT Act: This law expanded AML regulations in the US, mandating KYC programs, enhanced due diligence for high-risk customers, and strict reporting requirements.
• Corporate Transparency Act (CTA): The most recent modernization of the US AML regulatory regime, requiring companies to file beneficial ownership disclosures to combat money laundering.
• Sixth Anti-Money Laundering Directive (6AMLD): In the EU, this directive builds on existing AML frameworks, enhancing efforts to combat money laundering and terrorist financing.

Technologies powering AML and KYC & the benefits they offer

Technological advancements have been pivotal in the evolution and implementation of AML and KYC in fintech applications development and ensuring seamless financial procedures. These include:

AML and KYC in practice – Use cases, challenges, and addition of RegTech in the mix

Practical examples of KYC and AML in FinTech

As banks and financial institutions (BFSIs) prioritize regulatory adherence, they can learn from the use cases of AML and KYC in financial services listed below.

HSBC 

• Issue: HSBC faced allegations of inadequate AML controls, allowing illicit funds to flow through its systems.
• Impact: The bank was fined a staggering $1.9 billion in 2012 by US authorities for facilitating money laundering by drug cartels and terrorist organizations.
• Solution: A reliable AML framework is crucial to prevent such lapses.

Danske Bank

• Issue: Danske Bank’s Estonian branch faced a massive money laundering scandal. 
• Impact: Approximately €200 billion of suspicious transactions flowed through the bank between 2007 and 2015, raising serious AML concerns.
• Solution: Stringent KYC processes and ongoing monitoring are essential to detect and prevent illicit activities.

Standard Chartered

• Issue: Standard Chartered faced allegations of violating US sanctions against Iran, Sudan, and other countries.
• Impact: The bank paid hefty fines totaling $1.1 billion in 2012 for inadequate AML controls and sanctions breaches.
• Solution: Effective screening of sanctions lists and AML management are critical.

JPMorgan Chase

• Issue: JPMorgan Chase failed to detect and report suspicious transactions related to Bernie Madoff’s Ponzi scheme.
• Impact: The bank paid $2.6 billion in penalties in 2014 for AML deficiencies.
• Solution: AML diligence extends beyond routine checks; continuous monitoring is vital.

Deutsche Bank 

• Issue: Deutsche Bank faced scrutiny for inadequate KYC processes.
• Impact: The bank was fined $630 million in 2017 for failing to prevent money laundering.
• Solution: Rigorous customer due diligence and accurate identity verification are non-negotiable.

Challenges associated with ensuring compliance in FinTech & the solutions offered by RegTech

While the importance of AML and KYC cannot be overstated, their implementation often presents formidable challenges for BFSIs. Striking a delicate balance between stringent compliance and operational efficiency is difficult because the intricate web of regulations, voluminous data, and evolving risks demands robust solutions. 

This gap could be filled with RegTech. Short for Regulatory Technology-RegTech offers innovative tools and approaches to tackle AML and KYC complexities.

Integration with AML National Priorities

• Challenge: Financial institutions must align their AML programs with national priorities such as corruption, cybercrime, terrorist financing, and fraud.
• Solution: Organizations need to assess how each priority applies to them, adopt policies and procedures, and enhance AML/KYC processes to detect and report relevant criminal activities.

Ultimate Beneficial Ownership (UBO) requirements

• Challenge: It is often difficult to identify perpetrators in the financial world. Recent events like the Pandora Papers and EU criminal liability for non-compliance emphasize the need for vigorous UBO registries.
• Solution: RegTech solutions can automate UBO checks, ensuring transparency and preventing misuse of complex networks of shell companies.

High onboarding costs and low conversion rates

• Challenge: Cumbersome onboarding processes lead to high costs and low customer conversion rates.
• Solution: RegTech streamlines customer onboarding by automating identity verification, risk assessments, and compliance checks, enhancing efficiency and improving the customer experience through AI and ML technologies like chatbots in contact centers.

Lengthy onboarding processes

• Challenge: Manual KYC processes can be time-consuming, causing delays in customer onboarding.
• Solution: RegTech offers digital platforms and automated workflows that accelerate onboarding, reduce manual effort, and expedite account setup.

Poor record keeping

• Challenge: Inadequate record-keeping hinders audit trails and compliance monitoring.
• Solution: RegTech ensures proper documentation, maintaining accurate records for regulatory purposes.

Considerations for BFSIs aiming for compliance in FinTech

The world of financial services is changing every day, especially its regulatory environment and consumer preferences. Adhering to these regulations and ensuring seamless customer experiences requires reliable digital solutions, which poses a problem for institutions still using legacy solutions.

Collaborating with FinTech partners like VentureDive allows BFSIs to harness technological expertise, improve efficiency, and scale seamlessly. Together, they can navigate compliance complexities and foster innovation, ensuring a secure, agile future for embedded finance.