KYC/AML Compliance Checklist for Fintechs

The success of Fintech companies is primarily predicated on their ability to challenge conventional banking models through technology. Still, they must also remain vigilant in ensuring that their products and operations do not cross the line of KYC/AML protocols. 

Implementing a robust KYC/AML framework is imperative to avoid fines and regulatory penalties. It is also needed to establish successful third-party relationships with trusted partners, such as banks, who require compliance with KYC/AML regulations as a prerequisite for doing business.

Are you confident that your company is fully compliant with all necessary regulations? Have you established processes to ensure ongoing adherence? Read on to learn more about some of the major compliance checklists Fintech firms need to adhere to in order to ensure robust KYC/AML practices.

Key Facts About Know Your Customer (KYC)

Know Your Customer (KYC) refers to policies and procedures for gathering customer information and monitoring transactions throughout the entire customer relationship. In other words, KYC is not a singular step confined to the customer onboarding phase.

In the US, companies providing financial services are required by the Financial Industry Regulatory Authority (FINRA) to implement KYC checks. Non-compliance with KYC requirements can lead to severe consequences such as fines, legal actions, or reputational damage.

Following the growing risk of financial crimes, KYC processes are now streamlined and enhanced through technological systems, including digital identity verification and automated risk assessment tools.

Key Facts about Anti-money Laundering (AML)

Anti-money laundering (AML) refers to a series of processes, policies, and controls used to prevent, detect and report any activity that could be used for money laundering or terrorist financing. Global standards and guidance for AML measures are set by the Financial Action Task Force (FATF). Its latest guidance is on Beneficial Ownership Reporting.

In the US, financial institutions are obligated by the AML Act of 2020 to implement risk-based programs to prevent money laundering and terrorist financing. The 50% spike in global AML fines in 2022 shows that regulators are tightening the noose on AML compliance, and Fintechs are not excluded.

What Is The Correlation Between KYC/AML?

KYC and AML are two separate regulatory requirements. AML is the process of identifying and verifying suspicious transactions, whereas KYC is the process of verifying the identity of a customer. When considered separately, KYC can be categorized as a component of AML.

The reason why these two concepts are used together is that, in some cases, they share many similar processes. For example, both KYC and AML require customer identification, due diligence, and ongoing monitoring.

KYC/AML Compliance Checklist for Fintech 

This checklist summarizes good practices in managing AML and KYC compliance for Fintech companies. But, again, KYC/AML compliance is a process, not an event. Therefore, you must always be certain that you’re following best practices and putting the necessary control for verifying customers and monitoring their activities against potential money laundering and terrorist financing risks. Here are a few checklists to consider.

1. Create Policies and Procedures for KYC/AML compliance

Fintechs must establish well-spelled-out policies and procedures for KYC/AML compliance. What are the criteria for determining the risk level of customers? What should be done if a suspicious activity is detected? How often should customer due diligence be conducted? These are some of the questions that a comprehensive KYC/AML policy should address. It should be designed to comply with all applicable laws and regulations and follow industry best practices.

For example, Fintech companies operating in the Decentralized Finance (DeFi) arena must be cognizant of the potential impact of OFAC sanctions. To avoid non-compliance, the sanctions watchdog recommended “five essential components of a sanctions compliance program.” They are: 

  • Management Commitment
  • Risk Assessment
  • Internal Controls
  • Testing and Auditing 
  • Training

2. Establish Risk Assessment for KYC/AML compliance

Fintech firms must use risk assessment factors throughout customer relationship management to determine the overall money laundering and terrorist financing risk associated with each customer. This is where conducting customer due diligence (CDD) measures come in. 

Customer Due Diligence is the process of identifying, verifying, and managing the risks associated with each customer based on certain risk factors. This includes but is not limited to 

customer name and country analysis, category of customer and business sector evaluation, account category, customer’s reputation, ultimate beneficial ownership, and account activities. 

The common practice is to weigh each risk factor against established risk thresholds or scoring tools to determine the overall risk level associated with customers. That’s why CDD is often categorized into three: regular CDD, simplified CDD and enhanced CDD.

Fintechs that want to provide seamless customer experience without leaving gaps for financial crime should take a leaf from members of the Fintech Financial Crime Exchange in the UK. To manage risks associated with their services, members of this “global network of Fintechs” were observed to be implementing the following standard procedures:

  • Streamlined but robust applications for identification and verification (ID&V)
  • Document scanning and validation
  • Interactive interfaces for additional validation
  • Online behavior analysis
  • An appropriate, risk-based balance between manual and automated verification.
  • Frictionless customer experience while remaining compliant.

Furthermore, Fintechs were urged to consider the optimal mix of in-house and third-party solutions and conduct thorough assurance testing (including AML compliance testing) to mitigate risks. As they scale, adequate governance arrangements should also be in place to effectively manage the risks associated with changes to their CDD systems and controls.

If you want more detailed examples of CDD approaches for Fintechs, FINTRAIL’s report is a valuable resource.

3. Facilitate Ongoing Monitoring 

There must be measures to regularly inspect and track transactions and adopt necessary steps to reduce the risks. This is known as ongoing monitoring. A fundamental measure to monitor transactions is Suspicious Activity Reporting.

Suspicious Activity Reporting is required for all financial institutions and other businesses subject to the US Bank Secrecy Act (BSA). Therefore, Fintech companies that operate as money services businesses (MSBs) or in the virtual currency industry, as defined by the BSA, are subject to SAR filing requirements. 

For efficiency, OFAC recommends that you implement sanctions screening and investigation software. This should include geolocation tools and IP address-blocking controls to prevent individuals from sanctioned areas. When there is a suspicion of money laundering, terrorism financing, fraud, or other illegal activity, a Suspicious Activity Report (SAR) must be filed with the Treasury Department’s Financial Crimes Enforcement Network (FinCEN). 

4. Measure KPIs for KYC/AML compliance

To check against potential AML violations, Fintech firms should have a standard for measuring their AML efforts. This can be facilitated by KYC/AML analysts and implemented through AML monitoring systems. The results of these KPIs should form the foundation for developing and refining AML policies and procedures.

Authorities suggest that typical AML KPIs involve a combination of AML and KYC metrics. At the same time, these metrics will vary depending on the type and size of the company and the products offered. Regardless, a KYC/AML compliance program should measure the following KPIs:

SAR disclosure rates: Tracking the number of suspicious activity reports (SARs) submitted to regulatory authorities can be a valuable KPI. It helps gain insights into important risk areas, such as locations with high-risk customers.

False positive ratio: This measures the number of alerts generated by an AML system to those confirmed as true positive cases of suspicious activity. 

Operational costs of AML compliance: This may involve tracking and reporting on denominators such as the cost per transaction, cost per customer due diligence, and cost per SAR reports filed.

The number of monitoring scenarios/rules: This will provide insights into the AML systems’ complexity and help identify opportunities for streamlining and simplification.

5.  Audit for KYC/AML Compliance

To make the compliance process more efficient, a digital audit trail must be automated and integrated into the KYC/AML compliance program and tested regularly. This is needed to test the effectiveness of Fintech’s KYC/AML compliance program. It’s an attempt to gain valuable insights into the compliance program, recognizing the strengths and weaknesses and identifying areas where improvements may be necessary.

The auditing process must also include reviewing and assessing policies, procedures, and other internal controls to ensure they align with all the KYC/AML requirements.

6. Train employees on the best practices for KYC/AML compliance

KYC/AML compliance training is especially important when Fintechs expand their operations. Although automation can assist with many aspects of KYC/AML compliance, it cannot replace the need for trained employees who can recognize and respond to potential risks and suspicious activities.

7. Establishing oversight functions

A KYC/AML analyst or compliance officer should be designated to frequently monitor the implementation of the KYC/AML compliance policies and programs. In addition, regular communication and reporting to senior management should be established to ensure that any compliance issues or concerns are promptly addressed.

Talk to us

With our extensive experience in Fintech regulatory compliance, RADD LLC can be your trusted partner in navigating the complex world of compliance. Do you need a KYC/AML analyst or advice on the best transaction monitoring tool/software? We are equipped to help you ensure compliance with KYC/AML rules and regulations as they evolve. Contact us today to learn more about how we can assist your organization in achieving compliance in the dynamic Fintech landscape.

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