Know Your Customer Soon - Somehow

We keep hearing that there will be Know Your Customer regulations "soon." We have been hearing this so long that the question seems to be will it really happen and, if so, when. However, the real question is what to do until there is a regulation. Because knowing your customer is more than a pending regulation. It is safe and sound banking. That's why examiners are already asking to see your "Know Your Customer" procedures and policy.

KYC Now?
So, what are they looking for? We actually have a lot to go on even before the regulation is proposed. Know your customer involves a lot of common sense. It also incorporates basic business and banking principles. There are also practical sources. One such source is John Atkinson, a guru with the Federal Reserve Bank of Atlanta. Atkinson, although not privy to the current KYC draft regulation, is familiar with the issues being considered, and shares his version of KYC with banks to help them develop KYC policies and procedures. Those of us who are Fed Watchers expect that the regulation the Federal Reserve Board proposes will not contain significant differences from Atkinson's advice.

Base KYC on your bank and market.
Atkinson stresses that each bank must develop its own KYC program. The bank, the nature of its community and the types of products the bank offers are important to consider or include in the program. So, much like CRA, a good KYC program involves knowing the bank's community.

Another point that Atkinson makes is that the KYC policy should cover loans - including commercial loans - as well as deposits. Loan proceeds and the activities supported by loans are an effective method of laundering the profits of illegal activity. So loan officers should be equally sensitive to the issues of KYC and requirements for identifying and reporting suspicious activities.

Three Key Elements.
A KYC program should accomplish several goals. First, it should establish the true identity of your customer. Before beginning a loan or account relationship with an individual or company, you should know who they are.

Second, verify the source of funds. This step is something that mortgage lenders have long taken. The borrower's downpayment must be verified before the application is underwritten and approved. It's necessary to know whether the applicant actually has the funds they claim to. The concept in KYC is similar. Verifying the source of funds is a step to ensure that the bank is dealing with legitimate money.

Third, the program should monitor ongoing activity. Many accounts that are used by criminals were legitimate when established. Others are established to appear innocent and maintained that way for a period of time before being put to illegal use such as money laundering. This can happen to commercial loan relationships as well as to deposit accounts.

These KYC program elements are designed to determine the true identity of the customer, determine and document the source of funds, and the normal and expected transactions or activity . In addition, on the practical side, KYC procedures help the bank to determine what documentation requirements apply and how to monitor transactions. Monitoring accounts enables the bank to determine whether routine activity is taking place or whether there has been a significant change. When changes are identified and determined to be suspicious, the bank should file a suspicious activity Report (SAR).

KYC Program Elements
If you have a KYC program, review it and compare it to these lists. If your policy is missing some elements, consider whether you should add them or they are not needed in your market.

If you don't have a KYC program, work on one starting now. Don't wait for regulations. It is easier to revise than to build from nothing.

Review KYC with your deposit taking staff. Find out how KYC works and what they do to know their customers.

Then take KYC to the lenders. Plan to spend extra time with your commercial lenders. Ask the lenders for examples of unusual downpayments for loans, unusual loan purposes such as a purchase that is inconsistent with the applicant's lifestyle. Ask the commercial lenders about the businesses in their portfolio. Use the information you get from them in the procedures you develop. Better yet, involve them in development of the procedures.

Advise management that regulations are expected before the end of this year.

KYC Elements For Personal Accounts
First (and very basic) get the customer's name and address.

Then determine the customer's previous address. This is particularly important if the customer has not been at the current address very long.

Get the customer's Social Security Number.

Obtain proof of the customer's identification. Get at least one picture identification such as a passport, driver's license, or college or work photo ID. You may also use a non-photo ID to support the identification. This could include a major credit card or a utility bill from the customer's place of residence.

Obtain the customer's home and work phone numbers. You may need these.

Determine the customer's current and previous employers. This information can help to establish their presence in the community. It should also relate to other information they give you, such as where they live and the amount of their deposit.

Determine the location of the customer's place of work and residence. Is one or both in your market area? If not, why did the customer choose your bank?

Verify the residence and/or employment with a phone call. A phone call, in which you thank the customer for bringing you their business, can help you determine whether they really live or work there.

Similarly, a letter sent to the customer could serve a similar purpose. If the customer is not there, the letter should come back.

Consider the source of funds used to open the account. Find out where the customer got the money. If it is cash, be suspicious. If by check, does the type and source of check match the customer's explanation?

For large accounts, ask the customer for a prior bank reference and write the institution about the customer. The bigger the account, the more the bank may be at risk. You need to know all you can about this customer. Besides, the amount of money at stake justifies the extra step. Consider establishing a cut-off point above which this type of verification is mandatory. Base the amount on what is normal for your market.

Check with service bureaus for information on how previous accounts were handled. If information from the service bureau causes the bank to refuse to open an account, the Fair Credit Reporting Act requires that you so notify the customer.

Check for other account relationships with your institution. If this is a long-established customer, you won't need to do as much work. You also want to be sure they get excellent customer service. But even with established customers, you should c heck to be sure that the new account is consistent with that customer's activity. No matter how long the customer has been with your bank, you should be sensitive to changes in their banking activity.

KYC Elements For Business Accounts
Determine the previous business name and address, if any. This will help to establish the bona fides of the customer and will also help you verify past activity for the business. For example, if the business moves its account just as it incorporates, you will need to know the company's previous name in order to verify information about it.

Obtain the company's taxpayer identification number. Sole proprietors may be using their own social security number. However, any company with employees, even a sole proprietorship, should have an IRS-issued EIN.

Obtain evidence of the customer's legal status. The customer should produce a business license and, if a corporation, a document issued by the state that validates the corporate status. This information should help to determine whether the business is real - and legal. You may also want to obtain the articles of incorporation, the corporation's by-laws, signature authority documents, partnership agreements, and similar documents. The appropriate documents will depend on the nature and complexity (or simplicity) of the company.

Consider the source of funds used to open the account. Is the amount reasonable, given the nature of the business and the age of the business. For example, you would expect an established business to have more funds than a new business.

Visit the place of business. This is not always essential, but it can be a good way of determining whether the business is as represented. If it's not, or not there at all, you have quickly identified a problem. All it takes is a little detour on your way home from work.

Obtain a description of the customer's primary line or nature of business. You need to know what this business is in order to evaluate information about the customer's account activity.

Obtain financial statements, including an estimation of cash sales and related deposits. Review them to determine whether they are sound and consistent with the customer's statements. Then use them as a basis for monitoring.

Copyright © 1997 Compliance Action. Originally appeared in Compliance Action, Vol. 2, No. 12 & 13, 10/97