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Every day, your inbox fills with new applications, and you're tasked with verifying identities, cross-checking documents, and ensuring compliance with ever-evolving regulations. While it may feel like a repetitive task, this process is crucial in safeguarding your institution from financial crime.
Think of the Customer Due Diligence (CDD) process as your institution's security system. Just like you wouldn’t allow an unknown person into your office without verifying their identity, CDD ensures only legitimate customers gain access to your services.
In this article, we’ll guide you through the essentials of the CDD process, helping you gain a deeper understanding to protect your institution against fraud and financial crime.
What is Customer Due Diligence?
Customer due diligence is a critical process used by financial institutions and other regulated entities to verify the identities of customers and business partners, ensuring compliance with anti-money laundering (AML) and counter-terrorist financing (CTF) regulations.
The primary objective of CDD is to confirm that the individual or entity you are engaging with is who they claim to be and that they are not involved in illicit activities or financial crimes. CDD includes several key components that helps you identify, assess and continuously monitor for potential risks posed by these individuals or entities.
Why is Customer Due Diligence Important?
The Customer Due Diligence process is important because it primarily serves as a countermeasure to combat money laundering and a wide range of financial and non-financial crimes.
For banks and financial institutions, CDD is also important in managing compliance risks. This is because without proper CDD measures in place, institutions expose themselves to significant risks, including hefty fines, legal consequences, and reputational damage.
Moreover, with the rapid advancement of technology over the past two decades, criminals now have access to more sophisticated methods to carry out illegal activities. Here, CDD plays an important role as a proactive prevention control to keep criminals out of your ecosystem, at the onset and throughout the business relationship.
Who Must Adhere to CDD Practices?
Customer Due Diligence applies to individuals and entities across various industries. While it is mandatory for organisations in regulated sectors, businesses in unregulated sectors are also strongly encouraged to adopt CDD measures.
Anti-money laundering regulations can change over time, and sectors previously unregulated may come under scrutiny as new risks or data emerge. A proactive approach to CDD helps future-proof your organisation against evolving regulations.
Entities required to follow CDD practices include, but are not limited to:
Financial Institutions (FIs)
Designated Non-Financial Business and Professionals (DNFBP)
Casino and Gaming
Real Estate Developers and Agents
Precious Metal and Precious Stone Dealers
Lawyers, Notaries and Other Independent Legal Professionals
Accountants
Trusts
Corporate Service Providers
Non-Profit Organisations (NPOs)
Businesses onboarding High-Risk Individuals
When Should You Perform Customer Due Diligence Checks?
Customer Due Diligence (CDD) checks are crucial at various stages of the customer relationship to prevent financial crime and ensure compliance. While CDD is typically performed when establishing a business relationship and throughout the customer lifecycle, it should also be applied to one-off projects or transactions.
Conducting CDD for ad-hoc transactions helps institutions understand the nature of the business and the source of funds. This allows for preemptive safeguards against potential money laundering risks and financial crime exploitation.
Below is an overview of critical points where CDD checks need to be performed:
Onset of Business Relationship
When a customer first engages with a financial institution to open an account or initiate a transaction, CDD must be conducted. This ensures that the customer’s identity is verified and that the institution is not knowingly facilitating illegal activities.
Significant Changes to Customer Profile
If there are substantial changes to a customer’s information or risk profile, such as alterations in the nature of their business, source of funds, ownership, jurisdiction, or transaction behaviour, CDD checks should be conducted again. This ensures that the customer’s details remain current and accurate.
Continuous Transaction Monitoring
Banks and financial institutions must continuously monitor customer transactions to identify any deviation from the customer’s known profile. Suspicious activities must be flagged and investigated to prevent potential involvement in financial crimes.
Identification of High-Risk Customers
High-Risk Individuals (HRIs), such as Politically Exposed Persons (PEPs) and sanctioned parties, pose significant risks for money laundering and corruption. As global regulations evolve, customer due diligence requirements are expanding in scope to include individuals with adverse media profiles, reflecting regulators’ increasing demand for a more comprehensive approach to identifying HRIs.
With tightening regulations, tools like internet-based adverse media searches have shifted from optional to essential for identifying HRIs and ensuring compliance. Once these high-risk individuals or entities are identified, Enhanced Due Diligence (EDD) is required, involving thorough background checks, source of funds verification, and ongoing monitoring to mitigate potential risks.
New Regulatory Requirements
When regulatory requirements change or new laws are enacted, banks and financial institutions must update their CDD procedures to ensure compliance with the latest mandates and maintain regulatory compliance.
Effective Approach to Performing Customer Due Diligence
To effectively conduct customer due diligence, institutions must design their CDD programs to meet, at a minimum, regulatory requirements. While national regulations like FinCEN in the United States play a role, this article focuses on the Financial Action Task Force (FATF) Recommendation 10 due to its broad international scope and relevance in guiding us in this process.
FATF Customer Due Diligence Requirements
FATF Recommendation 10 mandates that financial institutions perform CDD when establishing business relationships, conducting transactions or wire transfers above USD/EUR 15,000, suspecting money laundering or terrorist financing, or when there are doubts about the accuracy of customer information. Appropriate CDD measures to be undertaken include:
Collecting and Verifying Customer Identity Information
Banks and financial institutions must collect identity information from customers and verify it against reliable, independent sources. This also includes business details such as the nature of the business, its address, and the source of funds.
Verifying Beneficial Ownership
Banks and financial institutions must take reasonable steps to identify and verify the beneficial owner. For legal entities, this includes understanding the ownership and control structure of the business.
Understanding the Purpose and Nature of the Business Relationship
Banks and financial institutions must understand the specific services the customer seeks, the types of transactions expected, and the customer’s regular business activities.
Ongoing Monitoring and Risk Assessment
Throughout the course of the business relationship, banks and financial institutions should also monitor and scrutinise transactions undertaken to ensure consistency with the institution’s knowledge of the customer, their intended nature and purpose of the relationship, their risk profile and source of funds.
Example of an Effective Customer Due Diligence Workflow
The above customer due diligence workflow is one of the many ways in which banks and financial institutions can effectively perform CDD checks on their customers. At its core, a strong CDD program should help address four critical Know-Your-Customer (KYC) questions:
Who is the customer?
A robust CDD process ensures that banks and financial institutions can accurately verify a customer’s identity and ensure that they are factually who they claim to be.
Who is the customer not?
Beyond identity verification, an effective CDD process helps institutions identify potential risks by confirming that the customer is not a high-risk individual or bad actors associated with illicit activities.
Is the customer still who they say they are?
CDD does not stop after initial checks. Continuous monitoring is essential in ensuring that the customer risk profile remains consistent over time and that any changes are promptly flagged.
What does the customer do?
Transactions play a key role in facilitating money laundering and financial crime. An effective CDD programme should include real-time monitoring mechanisms to detect unusual transactional activity associated with the customer and alert compliance teams for timely intervention.
By collecting comprehensive customer information and conducting thorough risk assessments, banks and financial institutions can gain a clear understanding of each customer’s risk profile. This information allows for more efficient resource allocation, for instance, low-risk clients can be processed quickly, while more resources and attention can be dedicated to managing higher-risk clients.
What are the Key Trends in Customer Due Diligence?
Customer Due Diligence processes have significantly evolved in recent years, driven mainly by technological advancements, regulatory changes and increasing sophistication of financial crimes. Some of the key trends in CDD processes are as follows:
Increased Use of Technology and Automation
Thanks to the global pandemic which changed the way consumers interact with financial services, banks and financial institutions are also increasingly relying on digital onboarding technologies and automated KYC checks to streamline CDD processes, ensuring quicker, accurate customer verification.
Enhanced Scrutiny on Corporate Structure and Beneficial Ownership
Regulators are pushing for greater transparency around the ownership of legal entities and trusts. Banks and financial institutions are now required to conduct more thorough checks to identify beneficial owners, especially in complex corporate structures. This is crucial for preventing money laundering and terrorist financing.
Ongoing and Real-Time Monitoring
The scope of CDD has evolved in scope from a one-off check in the past to a continuous process today. Banks and financial institutions are increasingly focusing on continuous monitoring of customer risk profiles, relationships, and transactions, ensuring they detect suspicious activities in real-time and adapt to any changes in the customer's behaviour or circumstances.
Strengthened Risk-Based Approach
CDD processes are increasingly adopting a risk-based approach, focusing more resources on high-risk clients, sectors, or jurisdictions. This shift enables institutions to tailor their CDD efforts based on the customer’s risk level, rather than applying a one-size-fits-all approach, aligning with evolving global regulatory expectations.
Harmonisation of Global Regulatory Standards
Over the past few decades, significant progress has been made in aligning international CDD standards. Intergovernmental organisations like the FATF have led efforts to update guidelines regularly, reflecting the growing sophistication in methodologies of financial crime and ensuring that regulations stay ahead of new and emerging threats.
Balancing Customer Due Diligence and Customer Experience
Customer due diligence processes are essential for safeguarding both the financial system and institutions against financial crime. However, these processes often present a challenge. One key challenge is finding the right balance between thorough due diligence and maintaining a smooth customer experience.
Banks and financial institutions must determine the fine line between conducting sufficient CDD checks and not overwhelming customers with excessive steps. If the onboarding process is excessively cumbersome or filled with hurdles, it can frustrate customers and result in customer exit.
The goal is to implement comprehensive checks while still ensuring that the customer experience remains as seamless and efficient as possible. To aid us in this process, we turn to technology to help streamline the CDD process from start to end.
An Integrated Approach to Addressing CDD Requirements
As regulations evolve and financial crime tactics become more sophisticated, CDD requirements will only become more demanding. If your institution still relies largely on manual workflows, it is at significant risk of non-compliance.
Banks and financial institutions that are working with us have experienced faster onboarding, reduced customer friction, and improved retention. Additionally, with enhanced visibility into customer risk profiles, their network of counterparties, and transaction patterns, our clients have been able to take quicker, more proactive steps to mitigate exposure to financial crime risks.
Our comprehensive end-to-end compliance risk solutions have also helped our clients improve reporting and audits by streamlining processes through automation, providing a comprehensive audit trail, and delivering accurate, transparent data that meets growing regulatory demands.
The time to modernise your CDD processes is now, before compliance requirements become even more complex. Learn how our solutions can help your institution achieve total compliance in one integrated workflow. Speak to our friendly solutions experts today to find out more!
Concluding Thoughts
In this article, we’ve thoroughly explored the customer due diligence process and its critical role in the broader KYC regulatory framework. The key takeaway from this article is that a strong understanding and implementation of CDD helps protect your institution from potential financial crime risks posed by bad actors.
We’ve also highlighted how technology empowers compliance officers to balance rigorous checks with a smooth customer experience. Regulatory tech solutions are essential for streamlining, automating, and enhancing due diligence processes, ensuring better compliance while easing the administrative burden on compliance teams.
If you found this article helpful, feel free to share it with other professionals who may benefit. Before we finish, we've included an additional section of frequently asked questions (FAQs) to further clarify the topic. Thank you for your support!
Customer Due Diligence FAQs
What Are the 3 Types of Customer Due Diligence?
The three main types of customer due diligence are:
Simplified Due Diligence (SDD): Applied to low-risk customers or minimal-risk situations with fewer verification steps.
Customer Due Diligence (CDD): Also known as Standard Due Diligence, involves basic identity verification for low-risk customers and typical situations.
Enhanced Due Diligence (EDD): Applied to high-risk customers, involving thorough checks on identity, source of funds, and nature of business relationship.
What Information Is Collected During CDD?
Information collected may vary depending on types of due diligence. Information to collect during CDD may include:
Customer Identity Information: name, proof of address, nationality, contact information etc.
Identification Documents: government-issued passport, driver license, registration documents, certificate of incorporation etc.
Source of Funds and Wealth: income from employment, business operation, investments etc.
Nature and Purpose of the Relationship: intended use of account, expected transaction behaviour, intended business activity etc.
Beneficial Ownership Information: ultimate beneficial owners, key management personnel, shareholders with significant ownership, corporate structure including parent, subsidiaries and affiliates.
Risk Assessment: Risk profile, PEP status, sanctions and negative media risks etc.
Transaction information: transaction history, counterparty, method, location, size and frequency etc.
How Often Should CDD Be Updated?
Frequency may vary depending on the degree of risk posed by the customer or entity. As discussed in the prior sections, CDD should generally be updated when:
There are significant changes in customer risk profile
Customer becomes associated with high risk individuals
Transactions deviate from usual behaviour
After a regulatory change
High-risk customers to be updated every 1 year or sooner.
Medium-risk customers to be updated every 2 years or sooner.
Low-risk customers to be updated every 3 years or sooner.
What Are the Red Flags of CDD?
Banks, financial institutions and their compliance teams need to stay vigilant and look out for key indicators and promptly address potential risks before they escalate. CDD red flags to look out for include:
Inconsistent or incomplete information
Unusual or complex ownership structures
Conducting transactions with high-risk jurisdictions
Unexplained or unusual transaction behaviours
Customer is a PEP or they are associated with PEPs
Reluctance or delays in providing information
Unclear or high-risk source of funds or wealth
High volume transactions but rarely involves legitimate business activity
Discrepancies in KYC documentation
Frequent changes in beneficial ownership
High-value transactions involving offshore accounts