Customer due diligence (CDD) is a critical component of compliance and a key line of defense against fraud. However, it also presents a challenge that fraudsters are constantly trying to exploit.
In this comprehensive guide, we’ll explore how fraudsters bypass KYC (Know Your Customer) checks, the common loopholes they exploit, and why incorporating alternative data sources is one of the most effective ways to detect and flag suspicious activity. But first, let’s start with a quick recap of the essential terms and concepts you need to know.
What Is Customer Due Diligence?
Customer due diligence (CDD) is a series of checks performed to verify a customer’s identity and assess their risk profile before establishing a business relationship. It is a fundamental part of compliance frameworks, including anti-money laundering (AML) and know your customer (KYC) regulations.
CDD involves collecting, verifying, and analyzing information from various sources, such as:
- Customer-provided details: Name, address, and official identity documents.
- Sanctions lists: To ensure compliance with regulatory requirements.
- Public and private data sources: To assess the customer’s activities and risk profile.
Types of CDD
The different types of customer due diligence (CDD) are simplified, standard, and enhanced, each tailored to a customer’s risk level. Standard due diligence involves identifying and verifying customer identities, which is sufficient for most cases. Simplified due diligence (SDD) is used for low-risk customers and requires only basic identification.
For high-risk customers, such as politically exposed persons (PEPs) or those in high-risk industries, enhanced due diligence (EDD) is necessary. In these cases, standard CDD is not sufficient to address the increased risk. EDD involves a more thorough investigation, including background checks, deeper scrutiny of the customer’s source of funds, detailed analysis of their business transactions, and more frequent transaction monitoring. These additional measures ensure compliance and help businesses manage risks effectively.
Dive deeper into enhanced due diligence (EDD) and see how it differs from standard CDD. Learn why EDD is crucial for managing high-risk customers and ensuring compliance.
CDD vs EDD
Why Is CDD Important?
Customer due diligence (CDD) is a legal requirement in many industries, especially for banks and fintech companies. It plays a key role in helping organizations:
- Prevent financial crimes like money laundering and fraud.
- Meet compliance standards outlined in AML regulations and FATF guidelines.
- Avoid fines and other penalties for failing to comply with laws.
By using identity verification, digital footprint analysis, and alternative data, businesses can manage risks effectively while maintaining a secure and compliant operation.
Customer Due Diligence Requirements
Customer due diligence (CDD) is essential for organizations like banks, fintech companies, and investment firms to manage risks and comply with regulations. Here are the four key requirements involved:
Customer Identification
When starting a business relationship or conducting significant transactions, organizations must verify a customer’s identity using official documents like passports or driver’s licenses. This ensures compliance with anti-money laundering (AML) regulations and helps flag high-risk individuals, such as those on PEP or sanctions lists.
Ongoing Monitoring
Regular checks are necessary to keep customer records up to date and identify any unusual activities. This process involves reviewing transactions and personal details to detect discrepancies or suspicious patterns over time.
Risk Profiling
Organizations assign customers a risk level (low, medium, or high) based on factors like transaction behavior and AML/CFT checks. Even low-risk customers undergo profiling to ensure compliance and proactive risk management.
Enhanced Due Diligence (EDD)
For high-risk customers or flagged activities, deeper checks are performed. This includes scrutinizing the source of funds, business relationships, and transaction history to mitigate potential risks and maintain compliance.
By following these steps, organizations can tailor their CDD efforts to customer risk levels while ensuring regulatory compliance and operational security.
Customer Due Diligence for Banks
CDD is a fundamental requirement for banks and other financial institutions, mandated by anti-money laundering (AML) regulations and Know Your Customer (KYC) standards. Here are the main reasons banks need to do CDD:
- Preventing financial crimes: Banks must ensure that the customer is who they claim to be to prevent fraudulent activities. This verification helps mitigate risks associated with identity theft and other forms of financial deception.
- Regulatory compliance: CDD ensures that banks comply with local and international AML regulations. This compliance is crucial for avoiding penalties, fines, or more severe regulatory actions like licensing issues.
- Risk management: Implementing a risk-based approach allows banks to adjust the intensity of the due diligence process based on the customer’s risk profile. This tailored approach is essential for efficiently managing potential risks that vary with each type of customer and their activities.
- Operational integrity: Through ongoing monitoring and updates to CDD procedures, banks maintain operational integrity and keep up with changes in customer status or risk profiles.
Under AML/KYC regulations, banks must verify the identity, address, and source of funds of new customers, with additional Enhanced Due Diligence required for high-risk individuals to investigate their background and financial activities. CDD is an ongoing process, involving continuous transaction monitoring to detect and report suspicious activities, forming a vital part of broader AML efforts to prevent money laundering and safeguard the financial system’s integrity.
Discover best practices with our free guide to reduce onboarding risks and stay AML/KYC compliant.
Download guide
How to Perform Customer Due Diligence
Customer due diligence (CDD) is a legal requirement that applies to new business relationships, high-value transactions, money laundering suspicions, or cases involving unreliable documentation. Here’s how to carry it out effectively:
- Verify Customer Identity
Start by identifying and verifying the customer’s identity using methods like online document verification during onboarding. This ensures compliance with KYC regulations and confirms their legitimacy. - Assess Financial Information
Analyze the customer’s financial data and business activities to identify potential risks. High-risk customers may require deeper scrutiny, such as understanding their source of funds. - Collaborate with Trusted Third Parties
Engage reliable third parties, such as lawyers or digital identity verification providers, to enhance the CDD process when necessary. - Maintain and Update Records
Securely store financial transactions and CDD data for at least five years. Regularly update customer information, especially after significant changes like ownership shifts or new business structures. - Leverage Technology
Use tools like open banking APIs and digital footprint analysis to validate customer details and uncover potential risks. Monitor email addresses, phone numbers, IP addresses, and devices for added security. - Continuous Monitoring
Keep an eye on customer transactions and activities over time. Regular monitoring ensures compliance and helps detect suspicious behavior early.
By combining traditional methods with modern technology, businesses can effectively manage risk, prevent financial crimes, and meet AML regulatory requirements.
Customer Due Diligence Solutions
Customer due diligence (CDD) solutions go beyond meeting basic compliance requirements—they help businesses proactively protect their operations from fraud and financial crime. By integrating advanced technologies, organizations can streamline processes and maintain compliance across products and regions.
Effective CDD starts with pre-screening, where suspicious users are identified early using tools like IP analysis and digital footprint checks. This layered approach ensures high-risk users, such as those from restricted jurisdictions or exhibiting unusual behavior, are blocked before completing onboarding.
Automation enhances efficiency by continuously screening individuals and entities against refreshed sanctions, PEPs, and financial crime lists. Monitoring for adverse media and high-risk transactions allows businesses to detect and address risks in real time without adding unnecessary friction to legitimate users.
With these solutions in place, businesses can confidently scale their operations while maintaining robust compliance and fraud prevention strategies, ensuring a safer and more efficient workflow.
Partner with SEON to reduce fraud rates in your business with real time data enrichment that only lets good users through to KYC and CDD.
Ask an Expert
Frequently Asked Questions
A due diligence checklist is a series of steps your organization must complete to ensure it remains legally compliant. The checklist steps may vary from one industry to the next, but they always include some form of identity and financial information verification.
Customer due diligence requirements vary from one industry to another, however, you will commonly find that a business must establish a user’s: 1) identity, 2) financial information, 3) residential address, 4) money-laundering risk.
Sources
- Thales Group: Annual Report Ebook
- Identity Force: What Are the Odds of Getting Your Identity Stolen?
- CNBC: 25% of households are either banked or unbanked
