Everyone in banking knows about KYC – Know Your Customer. Less well-known is its close cousin, Know Your Business.
Heidi Hunter, chief product officer at IDology, joins us to talk about the role of KYB for banking institutions and how they can do it more effectively.
A few takeaways from the conversation:
Know Your Business is a growing issue for banks and credit unions, as the rise in digital banking creates more exposure to fraud and other illicit activity.
A KYB challenge is its two-part verification process – first, determining a business’s identity/legitimacy, and then to try to identify the beneficial owner.
U.S. banks still relying on manual methods to onboard business customers may benefit from a digital system that uses a wider range of data sources.
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There’s plenty of alphabet soup on the risk and compliance side of banking – you have BSA and KYC, AML and CFT and PEP, and the list goes on. Our guest is Heidi Hunter, chief product officer at IDology, and she’ll be talking about Know Your Business and why its acronym – KYB – should be getting more attention from banking institutions. Heidi, it’s been a while – welcome back to the BAI Banking Strategies podcast …
Hey Terry, thank you so much for having me today.
Heidi, we’re all familiar with know your customer KYC in a banking context, KYB may be a little less familiar to listeners. And because businesses can also be customers, start us out if you could by explaining the basic differences between KYC and KYB.
KYC is something that we’re all very familiar with. We’re trying to get an identity understanding of who a customer is and make sure that, from a regulatory perspective, we verify that the person on the other side of the computer or the phone is really that person. KYB is a very similar premise, but it’s applicable to a business. When you’re trying to bring a business into your banking institution – whether you’re going to give them a business line of credit, a business banking account so that they can take payments and submit payroll processes like this – it’s the ability to verify that this is a legitimate business that has filed with the secretary of state, and that they’ve given you a beneficial owner who actually is authorized to transact financially and legally on behalf of that business. So, based in very similar needs, but one is looking at the individual for the services you’re going to give them, the other is actually looking at a business.
Why are we hearing more about KYB now? Why is it a more prominent issue, and what’s at stake for banks in addressing it or choosing not to address it?
With COVID, when we first went to shelter in place, that was the close of the face-to-face interaction, that temporary suspension. Prior to that, we spoke so much, I think, as an industry, collectively from the identity side and also from the banking side, about how we’ve all seen a rush to digital adaption for things like onboarding banking services, where you always had that holdout group of individuals that needed that face-to-face interaction. It was no longer available. So, these individual consumers went from maybe being resistant to those technologies to being forced to use them. And now absolutely, they’re loving the capabilities and how it makes their day-to-day lives easier. Well, during that window, what was interesting, those same applications were also applicable to small, medium and large business owners. If you think about it, those businesses, which before would have come into your branch to apply for these services, they also are in a need of a digital offering. I think what’s interesting is we have that rapid acceleration where consumer expectation has risen, and those consumers are also business owners and they’re looking for companies that offer that same type of experience. The benefit of adopting processes like this is that you can offer new products to a new subset of customers that maybe you weren’t thinking about before. And then, from a consequence perspective, obviously there is still that fraud hole that a fraudster is going to look to want to fill. If you do not have processes in place to verify businesses, it’s very easy for them. If there’s nothing in place to secure your business and your products, it’s a way that they’re going to try to get in and take advantage of you from that perspective as well, and we are seeing that today. There’s been a lot of different articles that have come out talking about there’s something like a 7% to 8% increase in small-business lending fraud since COVID started. We are seeing a great increase in channel fraud losses related to business, and fraudsters are leveraging the same type of things that they did or they do from a KYC perspective. They’re looking for opportunities from a business perspective as well, trying to pretend to be a small business owner and apply for services that they don’t legitimately have access to.
Adhering to KYC, of course, is a key regulatory requirement for banks. What are the regulatory standards or regulatory expectations at issue when it comes to KYB?
As a best practice, the pieces of that are a little bit fluid depending on the types of products that you want to offer. But the common line is that you want to ensure that this is an active business with an active secretary of state filing, and that if they are applying for a service in your state, they are licensed in that state. You want to make sure that, first and foremost, this is a real business. You want to make sure that their licensing is current, that there’s no red flags from a risk perspective, and that legally they’re able to transact. The other critical component is verifying that the person who is trying to open the account is a beneficial owner legally allowed to transact on behalf of the business. And then I think an added value to this is being able to enhance things like contactability, making sure all the data is current, looking at the business from a risk perspective for pieces of information that might indicate that while these things are good tangibly, this business might not be one that you would want to offer, say, a large loan product to. So those are those extra pieces that can also be helpful here.
Fraud targeting financial institutions is rising dramatically. Where does fraud risk fit into the KYB equation?
We know that approximately 70% of financial institutions still rely on doing a Google search to identify things like beneficial owners and businesses. The challenge with that is, while a Google search or a search such as that – it may be a Better Business Bureau search or a Dun’s check – it’s going to indicate some level. You might be able to pull out the location of the business. You could find out if they’re still active. You might get some star ratings or low star ratings or low ratings from something like this. But it’s not going to identify the fraud risk that business represents to your organization. It’s not going to indicate if that business has been transacting inappropriately with other FIs or through other products. It’s not going to indicate contactability. It’s not necessarily going to indicate a strong level of legitimacy. While you might be able to find things on the net, like their secretary of state filing, you’re not going to be able to get surety that business is still currently active and there isn’t some other issue within the SOS that is rendering them inactive.
You’ve touched on ultimate beneficial owners a little bit in the conversation already. One of the challenges for banking institutions that they face in KYC is identifying that UBO, given the common use of complex ownership structures, shell companies, things like that. How does the hunt for the UBO complicate the KYB equation and how banks seek to verify fundamental ownership information?
The interesting piece here is that typically those pieces of information have lived in separate environments. They might be able to find some linkage to a UBO but that still leaves KYC on the table. Because outside of being able to verify someone’s association to a business, you still need to meet KYC compliance on that individual, because if they’re transacting on behalf of the business, the same rules still apply. You want to make sure that they haven’t been reported as deceased by Social Security, you need to make sure that they gave a valid Social Security number that matches their identity, that their identity is legitimate, and that this isn’t falsified information. That challenge when you’re looking out at your policies and the things that you want to build in this space, those two pieces really go hand in hand. The ability to verify that the business is legitimate, and then you’re also looking for a legitimate individual and then establishing that linkage. That combination is really what’s important.
Can you share a specific example or two of KYB-related scams or failures in the U.S., and what their impacts were on banking institutions, including the financial or the regulatory impact?
This one really nettles me a good bit. With COVID and shelter in place, we established the CARE Act, and part of that was PPP loans to keep both individuals and businesses going. These small businesses were really struggling, and there was funding that was made available to them. I think very recently a man from New Jersey was convicted. He stole close to half a million dollars in those relief funds on behalf of a small business. Obviously, he needed bank accounts in order to collect that funding, so there were issues tied to banks that gave him the accounts that the deposits went to, and it ended up, obviously, this wasn’t a legitimate business. It frustrates me because there are good people that really needed that support, and also the banks that were tied up in this. The other one that comes to mind that recently we heard about was three individuals –I believe, two men and a female – who put together a very large multistate fraud scheme. In this fraud scheme, I think there were five or six states tied up in this. They created falsified business documentation, went to banks and were able to open accounts. And then they were applying for different small business loans, funneling that money into the banking system, using it to wash data. It was just terrible. I think they equated that loss out to around $10 million or $15 million that they were able to gain from various lenders and various financial institutions who also gave them that lending. These folks found loopholes and processes and they exploited them.
What can banks and credit unions do more effectively to address KYB issues? And would these actions be significantly different from what they’re already doing with KYC?
Research shows us that only approximately 5% of financial institutions have an automated B2B or corporate banking onboarding process. We know that outside of being very manual, which is very costly, it also is going to have an extended timeline for onboarding. On the customer side of banking, they’ve come to expect that rapid decision, but a small business might have to wait a month or two to get cleared by a financial institution as a result of a manual process. There’s only limited data availability when you’re leveraging something like a Google search or an online search to render out your information. While you’re going to find good information there, it’s going to be hard to pull that full correlation. It’s going to be hard to have that full confidence because those records aren’t being verified at a deeper level. By having more of a digital automated process where you’re working with someone to verify the bank, the beneficial owner, do KYC, pull all those pieces together, and give a digital outcome, you’re able to streamline your process, give added surety because more data factors are being checked, and also reduce the time that it takes so that you can give people a better onboarding experience. There’s many benefits to looking across and trying to establish a digital process here.
Tell us more about how this automated process can streamline a KYB process. It runs on data, and you’ve mentioned that data is limited. What sorts of data get fed in and where is that data sourced?
If you’re able to work with a digital KYB provider, you’re going to get access to a much broader data lake than you can find through a traditional Google search and it’s going to be chained together in a tighter factor. You’ll get information like secretary of state filings, Better Business Bureau, you’re going to get various government licensing, you’re going to get access to information on bankruptcies, on property changes, on liens and judgments, which is also important. If you’re onboarding a contractor and that person has 30 liens against them from various customers, they’re probably not someone that is going to have a solid relationship with you as a financial institution. That data is sourced at the state and the federal level. It’s also sourced in third-party and proprietary sources. And then since it is digital, updates are made at a really high frequency. As soon as that information is released, it gets put in. It’s a really, really good approach to doing that deep compliance check because all those different factors are feeding into it. By having that data diversity, the risk can also be brought in because while something may not populate at the state level as a problem, it’s going to show in other factors of the records that are being pulled in and pushed together.
Looking at small and medium-sized businesses, are there specific issues related to KYB for these kinds of smaller companies that banks and credit unions need to contend with that may be different from larger companies?
When we’re looking at small businesses, you’re going to take an inherent risk on somebody like that, just because you’re going to know less about them than something that’s more large and corporate and established. If you think about it, small and medium businesses, that’s a huge piece of the market. They’re the backbone of the U.S. economy, and they’re everywhere. That’s one of the great things about America is that you can start a business on just about anything. My daughter is selling, or she was back in June, I think she slowed down a little bit, but she loves to do origami and is folding paper cranes and has an Etsy shop online. I mean, it’s one of those great things is that if you have the initiative, you can do anything here. That’s the challenge to it, though, is that it can be anyone similar to identity. And how do we narrow in and make sure that this is a good business owner that has everything in place and somebody that you want to give access to your products.
Heidi, I’m out of questions, but I’m guessing you’re probably not out of answers. What am I forgetting to ask you about KYB that might be on point for listeners?
The last thing I would say, Terry, is we’ve talked so much about why you need this to protect yourself, to make sure that you’re covered from a risk and a regulatory perspective. But there’s so much opportunity here. This is a completely new opportunity for a lot of folks. Not only to automate, but to offer a small or medium business an excellent experience that makes them a lifelong customer. It’s a new part of the market that you can work with. In the case of an FI, it’s an opportunity to reinvest in your community and watch it grow. I think that’s the part of this that I really love is thinking about a business as a customer and thinking about how we secure, protect and serve them the way we’ve all grown so well to take care of our banking customers, like our regular end users. So, the opportunity piece, to me, is the part that I really love, and I think what’s on the table for our financial institution today.
Banks and credit unions have been focusing more attention on the small and midsize business segment, so it stands to reason that any new product or service that can help them connect is worth looking into. Heidi Hunter, chief product officer at IDology, we appreciate you making time to join us on the BAI Banking Strategies podcast.
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