In the past couple of years, you’ve probably heard the term due diligence or customer due diligence. Are you looking for a customer due diligence definition? How does this affect companies? And is every company affected? When should customer due diligence be performed? There are so many questions about this process, and there are companies that are required to perform it.
Here, we will cover everything you need to know about customer due diligence, as well as the entire process that is involved with it. Customer due diligence is one of the most important elements for financial institutions, and it is regularly performed either by the institution or a third party.
What Is Customer Due Diligence?
What is the purpose of customer due diligence? What is the definition of customer due diligence? In simple terms, due diligence is the process of investigation with a goal of discovering whether the customer will enter the agreement. This agreement can be a contract, a service, or anything else a business offers.
Due diligence can be a legal obligation, but this isn’t always the case. In the majority of cases, it refers to a voluntary action a customer will take before entering the agreement. Obviously, the goal of due diligence is to avoid any fraudulent activities or just regretting the decision.
A simple example of due diligence is conducting a thorough inspection of a house before buying it. Your goal is to ensure that everything is as it seems and that is a good investment. Since banks work with clients, they will perform customer due diligence or CDD.
And the basis of CDD is quite similar to what we covered before. Banks and financial institutions will take the necessary steps to learn as much as they can about their customers or people who will become their customers.
Customer due diligence is the process of verifying and confirming the identity of customers. CDD is an important part of AML or anti-money laundering, and the primary idea is to prevent any fraudulent activities.
Why Is It Important?
Why is customer due diligence important? The simplest explanation as to why customer due diligence is important is to avoid any problems with customers. And there are plenty of things that could go wrong. This is one of the main reasons why customers will go through a screening process if they are looking to get a loan.
Banks need to ensure that the customer will be able to pay it back. It is as simple as that. But there are also other important factors that make CDD an important factor for almost any financial institution.
CDD will play an important role in preventing money laundering, as well as identifying other types of financial crime (such as financing terrorism or tax evasion). Banks and other financial institutions will also be able to avoid any problematic clients that can harm their business.
Needless to say, any bank will try to avoid customers who are involved in illegal activities. But the only way to know whether something is happening is to “do their homework.” CDD is an excellent choice for companies that want to carefully choose customers, focusing on the quality of the service.
Different Types of CDD
Since the process can be quite complex, it is quite expected that there are different types of customer due diligence. It is so much more than simply verifying their identity. Each of these types will have its own use and purpose, and you can decide which one is appropriate to use in the specific situation. What are the 4 customer due diligence requirements for financial institutions?
- Standard – Standard customer due diligence is reserved for customers who don’t pose a large risk to the company. At least based on the initial assessment. This means that they will need to deliver documents and provide full names, dates of birth, the necessary addresses, and so on. If they are representing a client, it will be necessary to deliver authorization and details about the relationship with the client.
- Simplified – The simplified version of the CDD is for clients that have prior obligations to transparency. In the majority of cases, these are government entities, public agencies, or local authorities. It is also possible to find a list of qualifications for the simplified CDD.
- Enhanced – Clients that are assessed to pose a high risk for fraudulent activities and financial crimes will need to go through enhanced customer due diligence. There are numerous different triggers for the enhanced CDD. If a client has a trust, if they have control of a company (with nominee shareholders), if they are a PEP or a politically exposed person, and so on. The procedure will include all the details from the standard CDD but also include the source of funds and wealth. The enhanced customer due diligence meaning might depend on a variety of factors.
- Delayed – In the majority of cases, banks will not be able to start working with the client until they satisfy CDD requirements. However, there are cases when it is possible to make an exception. Naturally, this is only possible with low-risk clients, and the verification needs to be completed as soon as possible. If the requirements are not met, the bank will have to stop working with the client, as well as report any suspicious details they discovered.
- Ongoing – Based on the risk status, banks will have to perform regular checkups to ensure that everything is still according to law. For low-risk clients, the ongoing CDD confirmation will happen every year. However, medium-risk clients will need to go through the procedure every six months.
As you can see, the classification of CDD types is based on the risk. The lower the risk, the less complex the procedure is. You will also hear the term customer due diligence beneficial ownership, which refers to the person, the customer whose identity needs to be verified.
Who Can Do CDD?
It is important to notice that customer due diligence isn’t something that banks and financial institutions do whenever they feel like it. It is something they are required by law to implement on every single customer.
Furthermore, any financial institution and bank will need to go through the process and conduct a CDD for their customers. But they aren’t the only ones that need to do it. In fact, any business or organization that is at risk of being used for financial fraud and money laundering will need to do CDD as well.
As for the party that conducts the verification, the majority of banks and financial institutions opt for third parties to complete the process. It is also possible to use digital identity verification as a CDD solution.
So, be sure to check out all the options if you are in need of this service.
How To Do a CDD?
What is the customer due diligence process? The detailed process will mostly depend on the type of CDD required for the process. However, there are a few general rules banks and other financial institutions will need to follow.
What is the customer due diligence rule? There are a few general steps banks will need to follow. These steps include:
- Verifying the identity of the customer
- Assessing the risk of the potential customer
- Collecting and verifying additional information
- Monitoring future activities of the customer
- Reporting any suspicious activity
As you can probably expect, the low-risk customers won’t need to wait for additional documents and confirmations since it will be unnecessary. Everyone will have regular checkups, but the frequency will depend on the type of profile they have.
If you hire a third party to complete the process, you won’t need to worry about anything. The company will be able to do everything for you, and you can just follow their recommendations for checkups.
Due Diligence Is Not for New Customers Only
While it is quite obvious that new customers will need to submit all the details required, customer due diligence is not reserved for new customers only. It is something that affects everyone.
Over time, the activities of customers can change. And this means that their position might change as well. They might become a low-risk customer, but it doesn’t mean that their status can’t change. This is why it is crucial for financial institutions to monitor each transaction and change that happens with customers.
These analyses can be an essential part of the process, and they might affect customers’ statuses. As a result, the ongoing CDD is a type of CDD that will affect every single customer.
Naturally, if the customer continues to remain low-risk, the bank will still monitor and analyze the transactions, but the CDD will happen once per year. In case they become higher risk, these checkups will become more regular. As well as additional processes high-risk customer due diligence requires.
Furthermore, any sign of fraudulent activities will need to be reported to authorities as soon as possible.
If you are in need of different solutions, you should know that there are plenty of different options you can check out. The simplest way to approach the problem is to partner with a third party that will do the process for you.
As mentioned earlier, it is possible to go for customer due diligence software, which is something that will simplify the process even further. ReactivePay offers a bank account API that has numerous functionalities that might be useful to financial institutions.
This includes opening bank accounts (IBAN), customer acquisition process, account screening and validation, and of course, customer due diligence checks. Using the simplest approach can save you both time and money during the process, and everything will be finished in no time.
If you are curious to learn more about the Bank Account API, how it works, and ways it can help you, you can contact ReactivePay for all the info and potential questions you might have.