For this article, I’m going to suggest you put on your favorite jazz music, pour yourself a glass of your favorite red wine, and if you have a fireplace, light it up and get ready to be seduced by the sexy world of compliance. Just kidding, compliance might not be that sexy but it’s definitely important, and now that I have your full attention, I’m going to teach you once and for all what AML and KYC are.
Let’s begin with AML: AML stands for Anti-Money-Laundering. Money laundering is the process (crime) of making “dirty money” look “clean”, and it occurs when funds from illegal activities such as drug dealing, terrorist funding, prostitution, human trafficking, among others are integrated into the financial system to make it appear as though they belong to legitimate sources. Criminals do this by moving the money to a place where it is less likely to attract attention. This process involves 3 stages:
In the Placement stage, the money is placed into the financial system through banks, casinos, shops, etc. This phase involves different types of transactions like splitting up large amounts of cash, transporting the money across borders to deposit it in banks abroad, or buying precious goods such as art, gold & diamonds and reselling them for payments made by check or wire transfers.
The Layering phase can involve legitimate transactions—the most popular being investing in real estate, although there are many others such as using a shell company to hide the real owners of the business or investing in the stock market.
Finally, we have the integration stage; here, the funds are reintegrated into the economy, so they appear to belong to legitimate sources. This helps the criminal “clean the dirty money” to invest it and profit from it. As a result, it is extremely hard to distinguish between legal and illegal funds.
Alright, so that’s money laundering for you—after all we’re not writing a “how-to-tutorial” so let’s get to the ANTI part. Anti-money-laundering refers to the entire set of rules, laws, and regulations that are designed to prevent money laundering crimes. Most developed countries have laws or a set of regulations in place against money laundering and terrorist financing however, the enforcement of these laws really happened in the US only after 9/11. In the years following the attacks, a great deal of effort went into strategizing on how best to prevent future attacks. The most effective approach in fighting terrorism has been the efforts of the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) and its counterparts in countries around the world. In fact, Title III of the PATRIOT Act was all about securing the international financial system from terrorist financing.
Okay, but how is AML related to KYC?
Well, complete AML compliance includes KYC, ‘Know Your Customer’. These procedures are an initial step to:
- Verifying customers identity ✅
- Managing their risk factors ⚖️
- Monitoring their accounts 🔍
KYC is probably the most important step in an institution’s AML policy, not only because it helps to keep customers protected and satisfied and to reduce risk on a given platform, but also because, well, it’s the law in most countries.
Many financial institutions begin their KYC process by simply collecting basic data about their customers, ideally through electronic identity verification. Information such as full names, social security numbers, birthdays, and addresses can be very useful when determining whether or not an individual is involved in financial crime.
Once this information is collected, banks compare it to blacklists, watchlists, and lists of Politically Exposed Persons, aka PEPs. From there, the bank defines how much of a risk-factor their client appears to be, and how likely they are to engage in illegal activities. The bank will then plan what the account of that customer will look like in the near future. Once the planned account course has been identified, the bank can monitor the client’s account activity regularly to ensure that nothing looks suspicious.
KYC was first used exclusively by banks and financial institutions for AML purposes. But over the years, it has become more and more popular since it turned out to be super effective in 2 other areas: reducing fraud and reducing incidents. It has also proven to be useful for sharing economy platforms: You’re more likely to be a model Uber passenger if they have access to the ID you submitted when registering, right? Furthermore, the expansion of AML/KYC beyond financial services is creating an exciting evolution in ways to measure customer trust and authenticity for the likes of peer-to-peer lending and marketplaces—but we’ll save that for a future article.
As you can see, AML and KYC are interlinked: while some procedures might be somewhat different in both these cases depending on the country you’re in, most of the regulations will often address them jointly, and now you’ll be able to understand why.
So there you have it—the next time these acronyms come up, you’ll be the smart one in the room, fully aware of their meaning, importance, and usage -And to think you were doubting the sexiness of compliance!