What Does Customer Due Diligence Mean for Banks

Cyberattacks targeting financial institutions like banks surged in 2023, with a record 3,348 incidents reported worldwide (Statista). This represents an 84% increase compared to 2022. With the increase in attacks targeting financial institutions, it is obvious that players in this sector need to implement strategies to strengthen their cybersecurity, as the cost of recovering from such attacks is higher than ever.

One strategy that banks and financial institutions often use to protect against cyberattacks is customer due diligence. The process of customer due diligence ensures that every new customer brought on board meets the minimum requirements set by the bank and regulatory authorities. If you want to learn more about how this works in the banking sector, keep reading.

What is Customer Due Diligence (CDD)?

Customer Due Diligence is a process that financial institutions implement to verify the identity of their clients and assess the potential risks associated with doing business with them. Some of the major processes involved include collecting, verifying, and analyzing information about clients to ensure they meet their requirements. One of the common requirements is compliance with anti-money laundering (AML) and counter-terrorism financing (CTF) regulations.

Why CDD is Important

CDD in the banking sector is very crucial for the following reasons: 

Regulatory ComplianceBanks implement CDD to ensure they meet legal requirements to know their customers, which is crucial for preventing illegal activity. Most regions have Know Your Customer (KYC) regulations that require these institutions to verify customer identities, a critical step to confirm that each new user is who they claim to be. 

Banks are also required to meet the requirements of Anti-Money Laundering (AML) regulations that are designed to detect and block money laundering and terrorist financing. CDD serves as a primary defense for complying with such regulations. At the end of the day, operating under these regulations allows financial institutions to avoid the risk of substantial penalties for non-compliance. 

Risk MitigationBy identifying and managing risk, CDD helps protect financial institutions from potential threats that could disrupt their operations. Through CDD, banks can identify high-risk customers who may be involved in illicit activities like fraud or terrorist financing, allowing them to take precautionary steps. 

CDD also enables institutions to assess and profile risk by analyzing customer information, so they can focus monitoring efforts on those who pose higher risks. The goal of these procedures is to prevent fraud by ensuring that only verified, legitimate customers are allowed to conduct business with the bank. 

Enhanced ReputationEffective CDD demonstrates the bank’s commitment to ethical practices and compliance, which strengthens public trust and confidence. Furthermore, by proactively managing risks, institutions can avoid the negative publicity associated with financial crimes that could otherwise damage their brand and customer relationships. In this way, CDD helps institutions protect their reputation and maintain strong, positive connections with clients and other stakeholders. 

Enhancing Decision-MakingConducting CDD gives banks valuable information about their customer base, which can inform strategic decision-making. For instance, understanding customer risk profiles allows banks to identify market segments or clients that align with their risk tolerance and compliance requirements. In the long run, this allows them to target the right customers, and manage resources effectively.

Reducing Insurance and Operational CostsBanks and financial institutions with strong CDD programs can often reduce their insurance and other operational costs. By minimizing the risk of financial crime, institutions can lower the risk of losses, which may, in turn, lead to lower insurance premiums. Also, minimizing exposure to fraud and compliance failures results in fewer resources spent on remediation efforts, investigations, and legal battles, which ultimately lowers operating costs in the long term.

Improving Customer RelationshipsConducting CDD allows banks to understand their customers better. The information gathered during this process enables financial institutions to provide personalized services, enhance customer satisfaction, and build loyalty. It is also important to note that when clients see that an institution values security and compliance, they may feel more secure and confident in continuing their relationship with that institution. 

What Does the Typical CDD Process Look Like?

The CDD process involves four key steps: customer identification, assessing customer due diligence requirements, risk assessment, and ongoing monitoring and screening. Let’s explain each of these steps in detail:

1.Customer Identification

This is the very start step of the CDD process and it mainly involves verifying the customer’s identity. Banks require valid identification documents, such as government-issued IDs, to confirm a customer's identity. Most banks have also adopted biometric verification methods and electronic identity verification to make the process more secure, reliable, and efficient. These technologies reduce the likelihood of fraud by ensuring that customers are who they claim to be. 

2.Customer Due Diligence Requirements

Once the identity is confirmed, specific information is gathered to understand the customer’s financial background. Such information includes personal details (like name, address, and date of birth), information about the source of the customer’s funds and overall wealth, and the intended purpose for creating the bank account. These details help financial institutions understand the nature of the customer’s financial activities to ensure they align with regulatory requirements.

3.Risk Assessment

Assessing each customer’s risk profile is a key step in the CDD process. Proper risk assessment allows institutions to determine the level of risk the customer may pose to the organization. Factors considered when assessing risk include the customer’s occupation, geographical location, and typical transaction patterns. 

When put together, these factors indicate how likely the customer is to engage in high-risk activities like money laundering. Customers in certain high-risk industries or from high-risk locations may warrant additional scrutiny before being onboarded. By accurately assessing risk profiles, institutions can tailor their monitoring efforts, allocating more resources to customers with higher risk ratings.

4.Ongoing Monitoring and Screening

CDD doesn’t end with onboarding; it requires continuous monitoring to catch any suspicious activity. This step involves using transaction monitoring systems such as Actimize by NICE to analyze customer transactions in real time. These systems automatically flag unusual patterns that may indicate potential fraud or illegal activities. 

Additionally, banks also do watchlist screening to check customer details against databases of known or suspected criminals. This step is critical for staying compliant with anti-money laundering and anti-terrorism regulations. By actively monitoring and screening customers, institutions can quickly respond to red flags. 

Types of CDD

There are three main types of CDD and these include: 

Simplified Due DiligenceSimplified Due Diligence is the least intensive level of customer due diligence, used for customers who pose a low risk to the bank. This type involves verifying basic identity information without detailed background checks. Using this type of CDD allows banks to onboard low-risk clients efficiently while still monitoring them to ensure they remain low-risk.

Basic or Standard Due DiligenceStandard Due Diligence applies to moderate-risk customers. This type involves collecting essential information such as personal ID and financial details to confirm identity and assess for any red flags. Using this approach helps banks meet regulatory requirements while understanding the customer’s general banking intentions and expected activities.

Enhanced Due DiligenceEnhanced Due Diligence is used for high-risk customers. It involves a deeper verification process that includes gathering additional information such as the source of funds and wealth history and examines business activities more closely. Some examples of the high customers that may require implementation of this type of CDD include politically exposed persons (PEPs) and customers from high-risk areas. 

When is Customer Due Diligence Required?

• High-Risk Jurisdictions: Customers from high-risk jurisdictions may trigger enhanced due diligence.

• Complex Transactions: Large or complex transactions may require additional scrutiny.

• Suspicious Activity: Unusual or suspicious activity, such as unexpected large cash deposits or wire transfers to high-risk countries, may trigger enhanced due diligence.

Customer Behavior Red Flags

Some of the red flags banks need to look out for when implementing CDD include: 

• Unusual Transaction Patterns: Large, unusual, or frequent transactions may indicate suspicious activity.

• Complex Transaction Structures: Complex transactions involving multiple jurisdictions or shell companies may be red flags.

• Cash-Intensive Businesses: Businesses that handle large amounts of cash may be subject to increased scrutiny.

Keyless Solution

Keyless offers a comprehensive solution to streamline the CDD process, including:

Identity Verification

Identity verification is a crucial step in CDD, and Keyless’s solution can verify customer identities in real time, reducing processing time and enhancing the customer experience. With technologies like Passwordless SSO and MFA, Keyless ensures that the sign-in process for verified users is both seamless and secure.

Biometric Authentication

Keyless’s secure biometric authentication capabilities strengthen security and reduce the risk of identity theft. Unlike most solutions, Keyless’s facial recognition technology includes advanced features such as liveness detection and robust encryption, minimizing facial spoofing attacks while protecting user privacy.

Final Thoughts

With the increasing number of cyberattacks targeting banks, Customer Due Diligence has become a critical component of risk management. By effectively implementing CDD practices, banks can mitigate the risks associated with financial crime, protect their reputation, and comply with regulatory obligations. Fortunately, advanced technologies, such as Keyless’ robust biometric verification and AI-powered solutions, have made it much easier to implement CDD processes. 

CDD FAQs

What is the difference between CDD and KYC?KYC (Know Your Customer) is a part of CDD that focuses specifically on identifying and verifying a customer's identity. CDD is a broader process that includes KYC, but also involves other process such as assessing the customer’s risk profile, monitoring their activities, and more. 

How often should CDD be performed?The frequency of CDD depends on the customer's risk level and regulatory requirements. Low-risk customers may only require periodic reviews, while high-risk customers, such as those in certain industries or regions, may need more frequent monitoring. 

What are the costs associated with CDD?The costs of CDD can vary based on factors like the complexity of the process, the size of the financial institution, and the technology used. These costs typically include personnel expenses for compliance staff, technology investments in CDD software, and fees for third-party services like identity verification and background checks.