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ARTICLE
How to Perform Enhanced Due Diligence for High-Risk Customers
When a customer is deemed a high risk, banks and financial institutions must perform Enhanced Due Diligence in order to protect themselves from risk and stay compliant with Anti-Money Laundering, Combating the Financing of Terrorism, and similar regulations.
For example, imagine a financial institution accepts a transaction worth millions. However, it doesn’t check the background of the company. And then it turns out that the money was used for illegal purposes, such as financing terrorism or drug trafficking. This would be a legal disaster and an enormous loss of reputation for the financial institution. Enhanced Due Diligence helps prevent that from happening..
As the most robust form of Customer Due Diligence (CDD), Enhanced Due Diligence involves many different checks and processes designed for identifying, verifying, assessing, and monitoring high-risk customers.
In this article, we will define what Enhanced Due Diligence is, which customers can be considered high-risk, and how and why you should perform this process.
Defining Enhanced Due Diligence
Depending on how much risk is perceived to be associated with a given client, a bank or financial institution will implement Simplified, Standard, or Enhanced Due Diligence.
Enhanced Due Diligence is the most robust and thorough of the three and is often only used when a client is deemed high-risk.
Difference between Enhanced and Standard Due Diligence
The main differences between Standard and Enhanced Due Diligence are when they’re used and the number of steps they necessitate. Namely, most clients go through Standard Due Diligence, as it’s applicable to clients who are low-to-medium risk.
For example, if a person with no known criminal ties and a stable job wants to take out a small loan, typically just properly identifying them is sufficient. This is because the average person typically won’t be implicated in financial crimes and the damage they can do is somewhat limited. Therefore, Standard Due Diligence is performed.
On the other hand, if a political figure with a lot of influence suddenly wants to take out a huge loan, things get more complicated. In this situation, the bank would likely perform a Relatives and Close Associate (RCA) check to establish the person’s known network as well as a Source of Funds and Source of Wealth check to establish their funds and their origin.
This is because the second individual is at a higher risk of laundering money or performing similar financial crimes. Furthermore, they can cause more damage to the financial institution in question due to their larger funds and/or influence.
Furthermore, the checks themselves will be more thorough when performing Enhanced Due Diligence. For example, during the verification process, Enhanced Due Diligence will require additional sources of information when compared to Standard Due Diligence.
Lastly, high-risk customers must be monitored and reported on more closely. Therefore, ongoing Due Diligence is more robust and wider in scope as well.
When is a customer considered high-risk?
How risk is calculated is dependent on the bank or financial institution in question, as their internal risk appetite defines what is considered low, medium or high risk.
However, when it comes to high-risk customers, there are certain circumstances that are rather universal. This is because banks and financial institutions must comply with Anti-Money Laundering, Combating the Financing of Terrorism and similar regulations concerning how high-risk customers are monitored and reported.
Risk calculations for natural persons
Natural persons are considered high-risk customers if:
• They are from a high-risk country
• Can’t be properly identified
• Are performing the onboarding/transaction through a third party
• Have a suspicious transaction history
• Are a Politically Exposed Person (PEP)
• Are related to or have close ties to a PEP
• Are suspected of criminal activity
Since a natural person typically presents a lesser risk than a business, their risk profile isn’t as rigorously regulated.
Risk calculations for legal entities
Since legal entities carry more risk and can operate in multiple jurisdictions, there are many factors that can lead to them being placed under Enhanced Due Diligence. For example, if the legal entity:
• Operates in a high-risk country or a country that is under sanctions
• Is a cash-intensive business, such as a casino
• Operates in a high-risk industry, such as correspondent banking or investing
• Has complex and opaque ownership structures
• Has known criminal ties
• Has unusual/suspicious business relationships and/or transaction patterns
• Only facilitates transactions online or through a third party
Performing Enhanced Due Diligence for high-risk customers
Performing Enhanced Due Diligence for high-risk customers requires a lot of checks to be made along with ongoing monitoring. For this reason, most banks and financial institutions utilise Due Diligence software to partially or completely automate the process.
The Enhanced Due Diligence process consists of the following checks:
• Thorough identification and verification. Typically done through multiple sources and requiring government-issued forms of identification, such as a certificate of incorporation for legal entities or a passport for natural persons
• In depth analysis of the ownership structure, including identifying the Ultimate Beneficial Owner (UBO)
• Sanctions screening
• PEP and Relatives and Close Associate (RCA) checks
• Identifying the Source of Funds (SOF) and Source of Wealth (SOW)
• Adverse media screening
• Continuous transaction and risk profile monitoring
It’s because Enhanced Due Diligence requires such a large number of checks that it’s reserved only for high-risk customers. Furthermore, to better optimise their CDD software, banks and financial institutions utilise third party databases and registers to more easily and quickly screen customers.
Why banks must perform Enhanced Due Diligence for high-risk customers
While performing Enhanced Due Diligence for high-risk customers is complicated, it is also necessary. Banks must monitor high-risk customers to both keep themselves safe and to stay compliant with AML, CFT and similar regulations.
A failure to do so not only puts the bank at risk of hefty fines and reputational damage but also endangers their customers.
Therefore, their Due Diligence software must be able to distinguish between low and high-risk customers and act accordingly. Furthermore, the institution in question must submit a Suspicious Activity Report (SAR) if certain conditions are met.
Said conditions can be in relation to a suspicious transaction or more general red flags, such as odd business relationships or failing to disclose the beneficial owner.
Conclusion
In conclusion, to perform Enhanced Due Diligence for high-risk customers, banks and financial institutions must be able to perform a plethora of different background checks as well as monitor and report on said customer accordingly.
This is all done to prevent financial crimes such as money laundering and the financing of terrorism and as such, makes Enhanced Due Diligence an essential process in the finance world.
If you have any questions about Enhanced Due Diligence and want to streamline your KYC/KYB process to ensure 100% compliance, book a demo with Atfinity and reap the benefits of a fully automated, digital Customer Due Diligence process.
Book your demo today and see why leading financial institutions
worldwide trust Atfinity to drive their digital transformation.
Book your demo today and see why leading financial institutions worldwide trust Atfinity to drive their digital transformation.