Know Your Customer (KYC) is a key practice that businesses undertake to verify the identity of their customers and comply with legal requirements related to AML. This helps AML regulators identify high-risk customers and protect their business from fraudulent activities. Implementing advanced KYC compliance software can further improve the efficiency of the risk assessment and classification process, providing AML regulators with powerful tools to identify and mitigate potential risks. A risk-based approach to KYC is essential for prioritizing resources and efforts to focus on higher-risk customers and transactions.

KYC risk assessment is a key tool used by AML regulators to assess the level of money laundering risk. In this way, AML regulators can ensure that they do not do business with individuals or entities involved in financial crimes, such as money laundering or terrorist financing, thereby protecting their reputation and ultimately their financial stability.

Risk Assessment Process

A customer risk assessment is a process used by AML enforcers to assess the level of money laundering risk associated with a particular customer. The assessment system involves several steps that involve collecting, analyzing, and verifying data. To begin, the customer collects information about the customer, including their name, date of birth, address, and identification documents. They also collect information about the customer’s transaction history, the type of accounts they have, and the nature of their business activities.

Once the data has been collected, the customer conducts a risk assessment to assess the customer’s potential money laundering risk. This involves analyzing the customer’s transaction history, business relationships, and other factors that may indicate suspicious activity. Based on the analysis, the customer is assigned a risk score that can range from low to high and unacceptable. Customers with a low risk score are considered to be less likely to engage in money laundering activities, while those with a high risk score are considered to be more likely to engage in suspicious activity.

A customer risk assessment system is essential to assist AML enforcers in complying with AML and cryptocurrency regulations and identifying potential risks. It enables the identification of high-risk customers and the implementation of appropriate measures to prevent money laundering, terrorist financing and other fraudulent activities.

Implementing KYC compliance software as part of the customer risk assessment system further improves its effectiveness, allowing AML enforcement agencies to automate and streamline the risk assessment process. A risk-based approach is an integral part of the customer risk assessment system, ensuring the efficient allocation of resources to address higher-risk customers and transactions.

Types of KYC risk assessment

Low risk

Simplified due diligence (SDD) - customers falling into this category pose a low potential risk to the organization and therefore organizations can apply SDD to them. SDD is the basic level of due diligence and organizations can expect a significant number of their customers to be categorized as low risk.

Medium Risk

Standard Due Diligence (CDD) - Customers in this category are considered to have a moderate level of risk and therefore organizations must apply CDD to them. CDD is a key part of AML compliance and must be done before establishing a business relationship, as well as after any suspicious transactions.

High Risk

Enhanced Due Diligence (EDD) - These customers have a high risk potential and therefore organizations must use EDD and a risk-based approach to build business relationships with them. EDD involves a more thorough analysis of customer activity. Organizations can only do business with high-risk customers if approved by a senior manager.

Risk Rating Factors

A rating system typically consists of several factors that are used to determine the potential level of risk of a customer. Some of the important factors considered when assessing customer risk are:

• based on customer profile: source of income - the nature and stability of the customer's source of income are assessed to determine the level of risk associated with it. Customers with a stable and verifiable source of income are generally considered to be lower risk;
• residential status: the residential status of the customer, whether resident or non-resident, affects the risk categorisation. Non-resident customers may have additional regulatory requirements due to potential jurisdictional complexities;
• geographical location: the geographical location of the customer, particularly if they live in high-risk jurisdictions, may affect their risk categorisation. Certain locations may be prone to money laundering or other financial crimes, requiring increased scrutiny;
• based on financial factors: net worth - the customer’s net worth, including assets, liabilities and overall financial stability, is an important consideration. Individuals or entities with higher net worth may be classified as lower risk;
• legal structure: for corporate borrowers, the legal structure of the entity is taken into account. Companies with sound legal structures and transparent ownership (identification of beneficial ownership) are usually considered lower risk;
• turnover: a corporate borrower’s turnover provides insight into its financial performance. Higher turnover may indicate that additional monitoring is required and is considered a higher risk profile;
• corporate borrower rating: if available, the credit rating of corporate borrowers is considered an additional factor for risk assessment. A higher credit rating indicates a lower level of risk;
• presence of credit marks: business operations - certain business operations are considered risky and uncertain, such as trading in crypto assets, arms manufacturers (dealers) brokers; business related to nuclear proliferation activities - explosives; dealers in high-value or precious goods (e.g. dealers in gems, gemstones, precious metals, art, antique dealers and auction houses, real estate agents, real estate brokers); multi-level marketing companies. Such customers are classified as high-risk;
• customers physically present at the time of establishing a business relationship: Customers who are not physically present during the onboarding process, such as those opening accounts remotely, may pose a higher risk due to limited ability to verify their identity;
• politically exposed persons (PEPs): PEPs are individuals who hold prominent public positions or are closely associated with political figures. They are subject to increased scrutiny due to potential risks related to money laundering and corruption. In the case of a client or beneficial owner being a PEP, the scrutiny is high, as is the risk profile.

Listed clients that fall into the low-risk category due to their legal status and regulatory oversight: primary dealers and financial institutions regulated by a central bank, companies regulated by similar regulatory agencies (FCA, SEC, etc.) such as investment funds, investment firms and portfolio management services, listed entities, state-owned enterprises, statutory bodies and regulators, insurance fund foundations, pension funds, etc.