What documents are needed to know your customer

Risks dealing with borrowers

It is common practice among lenders to run some sort of background check on those who apply for a loan or some other kind of financial scheme. Banks and other financial institutions do the same all the time. The basics of this practice seem quite self-evident, but as a matter of fact there is a lot more risk in such a deal than people often stop to consider. 

All investments are risky by nature, and from the point of view of a financing entity, or even individual, all loans and customer portfolios are investments as well. In many cases these settlements require the lender or granting entity to desimburse varying amounts of money, expecting even higher returns so they can make a profit. It is always a bet to the future, and not in all cases it pays off. For that reason, financing institutions must assess the risk in every operation and every customer, in order to decide whether or not they will engage in it, and if they do, what will be the terms under which such deal will be settled.

Higher risk operations and customers will undergo tighter restrictions and more strict controls, and are likely to access less services or smaller amounts, at least until they prove they are worthy of the entity's trust. An entity that takes too many risks is likely to lose money, while not enough risk taken means less opportunities for growth and profit. It is a delicate balance, and managers must be very careful and very proficient so they make the right decisions that ultimately benefit their businesses as much as possible.

Knowing your customers

It is of critical importance for a financial entity to be aware of the identity of its customers, including their backgrounds and associations. The risk about making a bad decision and financing a project that is going to sink or a company that is likely to go bankrupt, or even personal loans borrowers won't be in conditions to repay, isn't the only potential danger associated with providing financial services. 

Customer due diligence (CDD) is a series of steps expected from all clients of financial entities to take in order to apply for a scheme or deal. CDD includes the disclosure of enough information so the customer is properly identified and evaluated, and the purpose for which the money is intended or how the transactions are expected to be run, in case of commercial or corporate clients. This information will also be used to evaluate compliance and risks associated with the customer's activities.

There are KYC (Know Your Customer) standards for different levels of customer risk, and each applicant will have to comply with different levels of due diligence according to the activity they pursue and other factors such as credit risk or credit score. High level institutions in different countries have their own set of KYC rules that might be also submitted to a higher level of approval by institutions of international reach such as the IRS.

Enhanced due diligence

When a financial entity identifies an applicant with suspicious or risky activities, more documents and information might be requested for further assessment of the situation. There are different due diligence standards for these cases, known as Enhanced Due Diligence (EDD). The purpose of EDD isn't just to protect the granting entity from financial loss in case the customer runs businesses poorly or its capital sinks, but also from the real risk of money laundry, fraud and even financing terrorists or other illegal activities.

It isn't uncommon that people with illicit businesses or activities create companies in different sectors that acts as screens behind which they get financed and make deals with other companies. It is fundamental for granting entities to run a comprehensive background check on these risky applicants. Professionals are trained so they can identifiy suspicious applications, and set an alert on any possible indication of money laundering. 

Applicant under an EDD regime must submit some or all of the following information and documents: source of funds and resources for the activity, name and basic personal information of all account holders as well as partners and other people who would directly benefit from the activities performed, purpose of the account, expected money flow and transactions, details on the business itself, banking references, financial statements and business projections. In case a customer's activity differs greatly from projections, such case must be explained thorougly.

Financial entities might run routine checks on high risk customers, in order to monitor their activities. Financing illegal activities might not only affect the entity's profit but also its reputation.

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