Customer Due Diligence (CDD): What Banks Need to Know

Customer due diligence (CDD) in banking is a key risk management process. It verifies the identities of customers and quantifies their risk level for financial crimes such as money laundering and fraud. 

However, over 90% of applicants for financial services fall into the low-to-medium risk pool. This results in significant delays during manual identity verification, even for customers with minimal risk. These delays exasperate customers and drive them away. In Europe, 68% of retail banking customers abandon their attempts to sign up for new services due to the lengthy process.

Presently, identity verification in financial services is at a crossroads. Recent studies show that CDD is effective at preventing various financial crimes and that identity fraud in banking is on the rise, with 2023 totals showing a 14% increase over 2022. While the process helps prevent financial crimes, slow turnaround times cost banks customers. 

The best solution is automation. Automation can cut processing times for CDD and related identity verification tasks from days to hours, keeping customers from abandoning applications. 

This guide explains what CDD is, how it works, and the benefits it can provide when executed efficiently.

The Customer Due Diligence Process in Banking

As 73% of financial institutions have reported increased attempted financial fraud, CDD in banking has become a critical multistep process to assess and mitigate risks associated with financial crimes. 

This process includes four major checkpoints:

• Customer identity verification
• Understanding the customer relationship
• Ongoing monitoring
• Periodic reviews

Here’s what each involves:

1. Customer Identity Verification

The first step in the CDD focuses on confirming customers’ identities using reliable, independent source documents and data. This step attempts to determine whether applications for services contain anonymous or pseudonymous clients. Effective identity verification helps prevent identity theft, fraud, and terrorism financing.

2. Understanding the Customer Relationship

After confirming applicants’ identities, banks gather detailed information about customers’ activities, kinds of business, and purposes of their relationships with the bank. This knowledge enables banks to develop customer risk profiles, tracking unusual or suspicious behavior that may indicate financial crimes. Understanding the customer relationship also helps banks to tailor their services and compliance measures to each customer's risk level​​.

3. Ongoing Monitoring

Once banks have extended services to customers, they must keep track of customer transactions and behavior to detect unusual or suspicious activities. This step is critical for identifying patterns that may indicate illicit intentions. Effective monitoring systems can help banks prevent many financial crimes before they happen.

4. Periodic Reviews

Banks need to reassess customer information and risk profiles periodically. This is because previously legitimate clients may later engage in illegal activities. Periodic reviews ensure that the data banks hold about their customers is accurate and up to date. These reviews also provide important information for adapting customer risk profiles over time. By conducting these reviews, banks enhance their ability to detect and prevent financial crimes​​.

Differences between Standard vs Enhanced Due Diligence

Based on initial risk assessments, there are different kinds of applicable CDD:

Standard Due Diligence (SDD) 

SDD is for the lowest risk category and involves basic customer verification processes. It suffices for compliance with regulations like the Bank Secrecy Act (BSA) and the EU's Fourth Anti-Money Laundering Directive (AMLD4)​​​​.

Enhanced Due Diligence (EDD)

Customers with high initial risk assessments require EDD. This process probes for more detailed information such as:

• Source of funds
• Beneficial ownership
• Ongoing transactions

EDD complies with stricter regulations, such as the USA PATRIOT Act and the EU's Fifth Anti-Money Laundering Directive (AMLD5), which mandate deeper scrutiny to prevent financial crimes​​​​.

Ongoing Client Due Diligence and Risk Assessment

Both low and high-risk clients require ongoing CDD to monitor how they use financial services. This involves continuous monitoring of customer transactions and behavior to detect unusual or suspicious activities associated with financial crimes. 

The global amount of money laundered each year is estimated to range from $800 billion to $2 trillion. Banks must update customer information periodically to ensure accuracy and relevance. This practice is mandated by regulations such as the Bank Secrecy Act (BSA) and the EU's Fifth Anti-Money Laundering Directive (AMLD5)​​​​. Regular risk assessments help banks adapt to changes in customer behavior or other external factors.

The Key Benefits of Implementing CDD in Banking

When banks execute CDD processes quickly and effectively — typically with the aid of process automation tools — several important benefits arise for both the institution and its customers.

Reducing the Risk of Financial Crimes

CDD significantly reduces the risk of financial crimes such as money laundering, fraud, and terrorist financing. By verifying customer identities, understanding their financial behavior, and monitoring transactions, banks can detect and prevent illicit activities early. This proactive approach prevents serious financial crimes and protects banks from non-compliance penalties. 

Enhancing Reputation and Compliance

Effective CDD enhances a bank's reputation by demonstrating a commitment to transparency and regulatory compliance. Adhering to regulations such as the USA PATRIOT Act and AMLD5 builds trust with customers and stakeholders. Additionally, a strong compliance record reduces the risk of penalties and legal issues during investigations.

Improving Risk Management

CDD improves risk management by providing a comprehensive understanding of customer profiles and transaction patterns. This allows banks to identify high-risk clients and apply targeted monitoring and timely intervention before extending services and capital. Enhanced due diligence ensures banks remain vigilant against emerging threats from legitimate accounts and can adapt their strategies accordingly. 

Role Automation 

Process automation is crucial in reducing turnaround times by as much as 80%. Automated systems streamline identity verification and transaction monitoring, leading to significant efficiency gains.

Parts of CDD you can automate include:

• Collection and verification of customer documents using optical character recognition (OCR)
• Analysis of transaction patterns with machine learning algorithms to detect and flag suspicious activities for further review
• Ongoing monitoring by continuously scanning for changes in customer behavior or risk profiles
• Adverse media and sanctions screening

In the absence of automation, completing CDD thoroughly requires a high volume of skilled labor hours in spreadsheet analysis and email exchanges, causing banks to lose legitimate customers. With the right tools, lending staff can offload these tasks, creating more time for building customer relationships and reducing data entry errors.

Best Practices for Maximizing CDD Benefits

To maximize the benefits of CDD, banks should implement the following best practices:

A) Regular Risk Assessments

Periodically review and update customer risk profiles to reflect any changes in behavior or external factors.

B) Implementing Advanced Technologies 

Use process automation tools like OCR for document verification and machine learning algorithms for analyzing transaction patterns to detect suspicious activities.

C) Adverse Media and Sanctions Screening

Continuously scan for any adverse information or sanctions related to customers to mitigate risks.

D) CRM and Efficient Onboarding Processes

Develop a deep understanding of customer relationships and tailor services to meet their specific risk profiles while providing efficient onboarding for new clients. 

By adopting a proactive and technology-driven approach, financial institutions can significantly enhance their defenses against financial crimes, reducing the incidence and impact of fraudulent activities. This strategy bolsters security measures and enables institutions to deliver efficient personalized customer service. Implementing advanced technologies for financial crime compliance fosters a more secure and trustworthy banking environment and promotes long-term customer loyalty.

To learn more, request a demo today. 

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