Enhanced Due Diligence (EDD) is a risk-based approach to KYC procedures. It was developed in response to the increasingly complex financial crime environment. Banks have always been required to know their customers before providing them with banking services, but financial crime risk has increased substantially since 9/11 and other related events. As a result, banks are under pressure from regulators and governments worldwide to adopt stricter customer identification and due diligence standards. EDD, thus, was born of necessity.
EDD is used to verify customers’ identity, business activities, and products to reduce the risk of financial crimes such as money laundering and terrorist financing. It is a more rigorous process than other KYC processes. Banks view the EDD as a safety net to ensure that high-risk, high-net-worth individuals and large transactions are legitimate. That’s why EDD often includes enhanced verification countermeasures like electronic checks against BSA/AML requirements, physical checks on customer documents, on-site visits or other methods based on risk assessment.
Difference Between Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD)
Although Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) can be counted among the KYC procedures, they have their focuses. For a customer judged to be low risk, a simplified customer due diligence may be acceptable. The only requirement is to identify the customer and not verify their identity.
EDD is a more rigorous process than CDD, and it’s typically used for high-risk customers and involves more detailed checks.
For example, for a $1 million loan or credit limit, CDD may involve looking at the borrower’s last five years of tax returns and verifying the source of all income. EDD checks are more exhaustive. It may require going through those years, plus looking at ten years back. It may also include any of the following:
-Third-party background checks, including public records and court records
-Identity verification, including proof of residence and employment, plus credit history checks
-In-person interviews, including with family members and friends
-Financial checks, which may include: trade references, bank records, business, and commercial documents
When is EDD Needed?
Enhanced Due Diligence (EDD) is a legal requirement in some countries and for specific customers. This could be because there’s a high risk of money laundering, terrorism financing or tax evasion or because it’s an emerging market where fraud risks are higher than normal due to a lack of regulation or weak governance structures.
For instance, UK regulations require businesses to adhere to EDD standards when dealing with customers from countries they consider “high-risk third countries“. In the US, it is necessary to conduct EDD for individuals or businesses in High-Risk Jurisdictions. Countries with these designations require EDD because they have strategic AML/CFT deficiencies or have been subjected to sanctions by international organizations.
When conducting financial transactions with certain types of customers, such as politically exposed persons (PEPs) or Special Interest Persons (SIPs), EDD may also be required by law.
Importance of EDD in Banking
- Risk Identification: The purpose of EDD is to identify risks early and mitigate them before they threaten a financial institution’s reputation or stability. EDD helps banks avoid transactions with criminals or terrorists by increasing their knowledge about customers and business activities. The systems of EDD can improve the detection and reporting of criminal activities.
- BSA/AML Compliance: Enhanced due diligence is essential for financial institutions because of their role in combatting money laundering and terrorist financing. Financial institutions are required by law to have effective EDD programs in place as part of their compliance with laws such as the Bank Secrecy Act (BSA) and the Anti-Money Laundry Act (AML). BSA/AML requires financial institutions to identify, prevent and report suspicious activity for each customer relationship or account. As a result, banks that fail to comply with EDD requirements will be fined by BSA/AML regulators.
How to Perform EDD
Financial institutions must have tools to identify, assess, monitor, and report suspicious activities to conduct an effective EDD program.
EDD can be conducted either manually or automatically using software tools. Manual EDD typically involves a team of BSA analysts researching each high-risk customer. They look for information about the customer on several databases and then analyze this information for suspicious activity. This analysis could be based on risk rating methodologies.
Automated EDD uses algorithms to search for red flags that could indicate illegal activity, such as money laundering or terrorism financing. The software then generates a risk score based on risk rating methodologies (data such as transaction history, business activities, income, and spending habits are included) for each customer.
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