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As exciting as advancements in technology such as AI and cryptocurrency may be, these innovations have also contributed to a sharp rise in global financial fraud. In fact, according to INTERPOL’s Global Financial Fraud Assessment, such technologies make it possible for organized crime groups to operate even with minimal technical skill or knowledge—leaving both businesses and individuals vulnerable to their schemes.
For that reason, customer due diligence is more essential than ever to protect businesses and individuals. Keep reading to learn what exactly customer due diligence is and how it can ensure your business’s legal and financial health.
Customer due diligence, often abbreviated as CDD, is an important aspect of customer risk management and compliance. It involves verifying the identity of customers and monitoring their activities to safeguard against potential risks like money laundering, financing terrorism, fraud, and other criminal activities.
While CDD is most commonly associated with banks and financial institutions, it plays a critical role in industries such as real estate, legal services, gaming, and even non-profits. Real estate agents use CDD to verify client identities and assess money laundering risks, while law firms use it to verify clients and their sources of funds, particularly during financial transactions. In healthcare, providers and insurers also use CDD to validate new customer identities and assess their credentials.
For high-risk entities where high-net-worth customers or high-volume transactions are involved, enhanced due diligence (EDD) is often required. This involves conducting deeper investigations into business operations and sources of funds, and checking backgrounds against sanctions lists.
Implementing a comprehensive CDD process is critical for several reasons:
CDD helps businesses comply with anti-money laundering (AML) and counter-terrorist financing (CTF) regulations, which are mandatory in many industries. In the U.S., the two key AML and CTF regulations are the Bank Secrecy Act and the USA PATRIOT Act, established by the U.S. Department of the Treasury and the Financial Crimes Enforcement Network (FinCEN). Failure to meet the requirements set by these regulations can mean hefty fines and penalties, as was the case for Coinbase in 2023 when it was ordered to pay $50 million for lapses in CDD.
By verifying customer identities and assessing their risk, companies can avoid associating with individuals or entities involved in financial crimes. This proactive approach protects businesses from legal, financial, and reputational risks in the long run.
A thorough CDD process can reveal valuable insights into potential customers and partners, like whether an undisclosed beneficial owner or a history of unethical practices exists. This understanding helps organizations make informed decisions about moving forward and can build stronger relationships.
CDD is ultimately more than just a regulatory obligation; it’s a critical measure for safeguarding against illegal activities and ensuring the stability of business operations.
Customer due diligence requirements may differ by jurisdiction and the type of customer relationship involved, but their main goal is to prevent financial fraud and illegal activities.
In the U.S., the Bank Secrecy Act and USA PATRIOT Act establish requirements for financial CDD relevant to institutions like banks, lenders, and brokers. However, many other types of businesses, including social media, e-commerce stores, and online dating platforms, voluntarily adopt the same requirements to enhance their own security. These requirements include:
Banks are required to have a written CIP with various customer verification procedures, such as collecting a customer’s name, address, date of birth, and government-issued identification number.
KYB and KYC are due diligence processes used to verify the legitimacy of who you’re doing business with. Both procedures involve conducting deeper scrutiny to understand the other party’s activities and assess potential risks, including customer screenings.
While KYC focuses on individuals, KYB deals with business entities by validating registration documents and understanding the nature of their business.
Institutions must evaluate each customer’s risk level to create a customer risk profile or risk rating. Factors to consider include geography and business type, which should impact the business relationship accordingly.
CDD isn’t a one-time process. Institutions must continuously track customer activity, update their information, and review any suspicious changes in their behavior or circumstances.
Again, exact requirements vary between jurisdictions, as every country has its own regulations around customer due diligence. Regardless, the same underlying principles exist, helping guide businesses in managing risk and ensuring compliance with legal standards.
CDD involves a systematic approach to gathering and verifying customer information, assessing risk, and maintaining ongoing monitoring. The process consists of five key steps:
To prevent unexpected issues with a customer relationship, comprehensive customer due diligence is necessary before entering any agreements. A CDD checklist can help identify potential risks that may impact the partnership.
Use our checklist to help guide your CDD process:
At its core, customer due diligence is about protecting your business from financial crime while staying compliant with regulatory requirements. With a structured and thorough CDD process, companies can minimize risk, make more informed decisions, and build trusted, long-term relationships with their customers.
At Business Screen, we offer business screening and customer screening services to help organizations protect themselves from the growing threat of fraud in today’s digital world. By uncovering financial, civil, and reputation risks associated with prospective clients, we help you spot the difference between high- and low-risk customers. Contact us today to learn how we help reduce your exposure to fraud.
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