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Verifying identity for money laundering compliance


Up to 5% of global gross domestic product (GDP) is lost annually to money laundering according to the UN Office on Drugs and Crimes. Considering that 2014 global GDP was $74 trillion, this means as much as $3.7 trillion could be laundered globally. In response, governments worldwide are giving financial institutions the role of being their eyes and ears, essentially policing by proxy. Financial Institutions have been tasked with identifying activities that may include the laundering of ill-gotten gains and the identification of shell businesses set up to transfer funds that support terrorism.

Against this backdrop, U.S. financial institutions are currently awaiting a final ruling from the Financial Crimes Enforcement Network (FinCEN) on customer due diligence. This proposed rule specifically addresses “beneficial ownership” and will require U.S. financial institutions to verify the identity of the natural persons who are the business owners. The ruling is important because it clarifies and amplifies the steps banks have to take to onboard as a customer, a business or other legal entity, such as a trust. Regulators are asking for at least one and as many as five owners to be identified.

Enhanced Procedures

Today, one challenge financial institutions face is the lack of consistent regulations to confirm who owns a business. And whatever FinCEN’s final ruling mandates, many banks will have to enhance their policies and procedures for verifying the identity of business customers.

For example, banks will face regulatory pressures to collect, check, and maintain records that verify beneficial ownership. Are they ready? What steps are they already taking to comply? Jurisdictions around the world are eagerly awaiting details on the methods the U.S. regulators will unveil to strengthen the visibility of a company’s ultimate beneficial owners.

In order to better understand how financial institutions are handling Know Your Customer (KYC) regulations and preparing for compliance around beneficial ownership, we recently released a study that analyzes and summarizes the views of more than 800 compliance professionals, 52% of whom have customers in the U.S. The study showed that over 85% of respondents have begun collecting beneficial ownership information. However, numerous challenges have arisen due to the absence of clearly defined regulatory guidelines and the need to verify the accuracy of this information.

In facing these challenges, large financial institutions are better equipped than smaller ones to adapt to the proposed new beneficial ownership requirements. The difference seems to be related to the willingness of large banks to use third-party data providers to verify and validate the identity of the beneficial owners.

The study also revealed that FinCEN’s upcoming beneficial ownership rules will alter the client onboarding processes at financial institutions of all sizes. Specifically, these changes focus on knowing who the ultimate beneficial owners are. The goal of gaining this understanding is to root out small businesses that have been set up solely to launder money. Our research results show that 79% of financial institutions currently verify the identity of beneficial owners, but only about half (53%) verify beneficial ownership status. And only 36% of the respondents in our study currently seek to identify non-disclosed beneficial owners.

Interestingly, our research identified a clear distinction between small financial institutions and large financial institutions in their approaches to KYC. For large financial institutions with millions of clients, there is an obvious need for a strategy which employs third-party data sources, especially since many times there are limited opportunities to know the customer on a personal basis. The massive number of clients coupled with a vast geographic footprint poses unique compliance and risk mitigation challenges for these larger banks.

These complexities are magnified when coupled with trying to verify that a corporate client is a shell company. The information financial institutions collect in-house and supplement with third-party data is a powerful approach to mitigating the risk these relationships pose. And our study results clearly showed that large financial institutions supplement their in-house data with third-party information such as adverse media, sources of wealth and new parties being added to the account far more effectively than smaller ones are able to.

Bad actors, knowing that large institutions may more easily identify them as such, may turn to smaller banks, where the same systematic strategy to identify them is not being used. We therefore believe that a singular opportunity exists for smaller institutions, especially those in metropolitan centers, to improve their customer due diligence through the use of third-party data.

Many small financial institutions, especially those in regional or rural markets, consider their primary differentiator to be a relationship focus. This enables them to compete effectively with larger banks. The rationale is that relationship managers at smaller financial institutions not only see their business customers’ banking activities, but they may also see the customer in person around town or in the community. These interactions can provide a level of accountability, or trust, based on the perceived relationship. This means small financial institutions may be relying more on customer behaviors they observe firsthand, rather than performing adequate due diligence on them.

In an environment where there is an increasing regulatory and civic need to identify criminals involved in money laundering, should smaller banks continue to rely heavily on their current trust-based approach? They could be putting themselves at additional and unnecessary risk by not taking a methodical approach centered on verifying and validating client data and performing all necessary due diligence. For an enhanced due diligence process to be effective, it has to adequately mitigate risk while not interrupting the normal flow of business activities.

Both large and small financial institutions need to prepare for FinCEN’s upcoming beneficial ownership rules. By fully knowing their clients, they can successfully help government protect the public. The use of third-party data can assist with this process both at onboarding, and throughout the lifecycle of a client’s banking relationship.

Mr. Polar is manager of Anti-Money Laundering Compliance Consulting at Alpharetta, Ga.-based LexisNexis Risk Solutions, a firm that helps companies and government entities predict, assess and manage risk. He can be reached at [email protected].