Voice of the Industry

Navigating KYB challenges in modern banking and merchant onboarding

Monday 8 April 2024 08:25 CET | Editor: Mirela Ciobanu | Voice of the industry

As businesses undergo digital transformation, the need for robust KYB processes has never been more stringent. Understanding and verifying the identity of businesses is not just a regulatory requirement but a strategic imperative.


Advanced KYB solutions offer a streamlined approach to customer onboarding, minimising the risk of engaging with undesirable entities while maximising commercial objectives. The ROI of implementing effective KYB processes is significant, ensuring compliance without obstructing or frustrating legitimate businesses and consumers.

However, the onboarding process faces significant challenges, including heightened scrutiny, privacy concerns, and consumer expectations for instant gratification. In this competitive landscape, seamless onboarding has become a competitive edge, driving the need for innovative KYB solutions.

This article delves into the world of KYB, exploring its significance, challenges, and why advanced solutions are essential for modern business operations.


KYB in a nutshell

Businesses use Know Your Business (KYB) to verify the legitimacy of potential partners before engaging in transactions. It helps them understand whether the other entity is a genuine organisation or a potential front for illegal activities, like a shell company.

KYB goes beyond initial legitimacy checks, as it helps identify the company's ownership structure, including directors and the Ultimate Beneficial Owner (UBO). In addition, KYB evaluates potential risks by screening for sanctions, criminal convictions, and negative news associated with the entity or its individuals. KYB involves continuous monitoring and reporting to federal agencies. A significant aspect of the KYB process is defining the risk profile of the company a bank or a payment processor is considering onboarding. This helps in making informed decisions about whether to work with that entity and how to proceed with the collaboration.


What is the difference between KYB vs KYC?

KYC (Know Your Customer) and KYB are essential processes that check the identities of individuals and businesses, respectively. While both aim to mitigate risk and comply with regulations, they target different entities: KYC focuses on individual customers and gathering personal details for verification, while KYB investigates businesses, collecting and verifying information about their ownership, structure, type of business, and financial health.

It's noteworthy that when dealing with small and medium-sized businesses (SMBs), the company is often represented by an individual. When it comes to the type of business a PSP has to onboard, some companies bring higher risk than others. As a result, the credit card associations have established rules and regulations defining the use of Merchant Category Codes (MCC)* for risk monitoring purposes. In some instances, merchants are required to pre-register their business if it operates in specific high-risk MCC categories. These high-risk merchant category codes are assigned to industries that predominantly generate the highest levels of cardholder disputes, represent higher levels of financial risk to the banks, or create additional brand risk for regulatory reasons.

Although specific requirements may vary globally, some common elements of KYC and KYB procedures can be found in most jurisdictions.


The challenges with KYB

Heightened regulatory scrutiny is making the KYB landscape a challenging place

Regulators worldwide are tightening the screws on financial institutions, expecting robust KYB processes to combat money laundering, terrorist financing, and sanctions evasion. Financial institutions and fintechs use both internal assessments and outside service providers to comply with stringent global compliance requirements around KYB while aiming to offer the best onboarding experience. The lack of comprehensive global data sets causes prolonged onboarding periods in cross-border KYB. Plus, KYB often relies on customer KYC data (to verify the UBO). If KYC data is incomplete or inaccurate, identifying red flags within a business' network becomes even more complicated.

As this wasn't enough, the ruling by the Court of Justice of the European Union (CJEU) stirred concerns regarding access to beneficial ownership information, citing conflicts with privacy laws. As a result, public access to company beneficial ownership registers has been restricted, with the Netherlands Chamber of Commerce (KVK) among the first to implement this change. This development is worrying, especially considering a 2018 FATF study on the hiding of beneficial ownership, which highlighted the risks associated with such practices. Concealing beneficial ownership can hinder the ability of financial institutions and competent authorities to detect suspicious activities and combat crime effectively.

Maintaining a comprehensive view of fraudulent activities is decisive in combating fraud. Any gap in this process can allow fraudsters to exploit vulnerabilities and evade detection. Despite restricted access to public registers, advanced AML checks leveraging behavioural analysis and AI-driven analytics offer a promising solution to fill this void.

Data privacy concerns have been raised also by the EU's Artificial Intelligence Act (AI Act) which is set to have a significant impact on remote Know Your Customer (KYC) systems, particularly around remote biometric identification. Remote KYC providers will need to disclose how they use AI in their systems and provide detailed info about how biometric data is processed, stored, and protected. This could translate into more transparent communication with users about the role of AI in identity verification and the measures taken to safeguard their biometric information.

The AI Act could have a broader impact on the development and deployment of remote KYC systems worldwide. Also, non-EU providers serving EU customers will need to comply with the Act, potentially leading to the harmonisation of standards for remote biometric identification in KYC processes across different jurisdictions.


How consumer banking impacted business banking

When it comes to digital onboarding, both consumers and small businesses seek speed, efficiency, and ease of use. For instance, consumers expect online account creation to be quick and seamless, and so do SMEs. Managing these expectations in the business world, where there is more information to validate, presents a challenge. While entities share similarities with individuals in terms of the desire for a smooth KYC process, there are also regulatory complexities to consider, such as licensing requirements.

As a result, banks need to enhance their onboarding processes to meet these expectations. Incorporating elements of consumer banking into the KYB process can significantly improve the onboarding experience for merchants. Leveraging technology to drive automation and real-time approvals can expedite the process, leading to increased merchant acquisition and satisfaction while reducing attrition rates. In this process, it’s pivotal to consider the risk appetite and strike a balance between asking necessary questions for risk assessment and minimising customer frustration.


The fraud concerns

The rise of synthetic IDs and fake IDs, fuelled by advancements in generative AI, has raised significant concerns in the fraud prevention landscape. There is a pressing need to implement additional checks and layers of security to combat these evolving threats effectively. Striking the right balance between preventing fraud and ensuring a seamless experience for legitimate customers remains a challenge.

Another concern is posed by document fraud in the KYB process. It can enable criminals to establish illegitimate entities for illicit purposes, such as money laundering, terrorist financing, or other fraudulent activities.

Document fraud in KYB refers to the falsification or manipulation of documents presented during the verification process. This can include fake or stolen documents, altered documents (genuine documents may be altered or tampered with to change critical information, such as the business name, address, or ownership details, to deceive KYB checks), and forgery (documents may be forged to create entirely fictitious businesses, complete with fabricated credentials, in an effort to pass KYB verification processes undetected).

Educating customers about these emerging threats is essential, as it not only prompts proactive measures from banks and payment service providers (PSPs) but also fosters trust within the ecosystem.


KYB on the rise – data from Liminal survey

Despite these challenges, there is increased demand for digital and user-friendly KYB solutions from FIs, payment processors, and entities looking to create business accounts, domestically and across borders. In October 2023 Liminal surveyed 50 B2B technology buyers across financial services and fintechs in North America, Europe, the Middle East and Africa, Latin America, and Asia-Pacific and found that:

1. No matter the size of the company they are onboarding, FIs expect from their KYB solution provider capabilities such as taxpayer identification number (TIN) verification, ultimate beneficial ownership (UBO) identification, continuous know your business (KYB), politically exposed person (PEP)/sanctions, compliance rules library, and legal entity mapping.

2. Key KYB purchasing criteria among FIs include accuracy, regulatory compliance, and data freshness. Opposed, few FIs and fintechs consider cost a critical factor and even fewer, prioritise solutions offering more advanced UBO threshold capabilities.

3. FIs and fintechs prefer buying aggregated third-party solutions over direct government partnerships because third-party solutions streamline verification by bypassing slow government processes and siloed data systems.

4. There’s a growing trend toward automated solutions to enhance efficiency and reduce costs. At the moment, an overwhelming 98% of buyers depend on manual reviews. Artificial intelligence (AI) and machine learning (ML) enable solution providers to offer automated, precise solutions, mitigating compliance risks.

Liminal’s data suggest an optimistic view of the KYB market’s future, anticipating substantial growth, and an evolving landscape. As a result, solutions offering cross-country compliance and reducing manual work will have a competitive edge and vendors demonstrating KYB’s value beyond compliance will foster enduring relationships.


Technology revitalises KYB

Other solutions include reusable identities, document verification technologies, integrating KYC and fraud detection capabilities into KYB offerings, access to authoritative government data, the use of advanced analytics, and more.

Reusable digital identities for businesses can reduce onboarding times, without compromising data quality or increasing compliance risk. Platforms equipped with this capability perform a single high-assurance onboarding using standard verification methods for each legal entity. Subsequently, when the business seeks to open new accounts, this information can be easily shared with other trusted partners (relying parties) without repeating the entire process. This eliminates the need to re-verify details like legal name, incorporation status, and beneficial ownership.

KYB solution providers streamline entity verification, even when relying on traditional paper documents. They've integrated document verification technologies such as Optical Character Recognition (OCR) to eliminate the need for manual data entry by automatically extracting and populating information fields.

Platforms are integrating KYC and fraud detection capabilities into their KYB offerings.  This includes smartphone-based identity document capture and support for reusable consumer digital identities, streamlining the account-opening process for business owners.

Complex, cross-border corporate structures can hinder the identification of a legal entity's Ultimate Beneficial Owner (UBO). Determining which individuals meet regulatory UBO thresholds is a major factor in the time and cost of traditional KYB processes. Advanced KYB platforms directly access authoritative government data and use advanced analytics to map even intricate corporate relationships. This enables automatic calculation of beneficial ownership percentages, with adjustable UBO thresholds to ensure compliance across diverse regulatory requirements.


Key takeaways

Adopt technology - solutions like AI, machine learning, and data aggregation platforms can automate tasks, improve efficiency, and enhance data accuracy. Tech plays a pivotal role, but it must be tailored to each business/merchant’s unique needs and risk appetite. Ensuring that the applied technology is appropriate prevents unnecessary complications and inefficiencies. Based on the risk profile and risk appetite of the payments processor, some onboarding processes can be automated, while others will require manual review.

Furthermore, customer monitoring should be an ongoing process. It is recommended that FIs regularly monitor their business clients’ activities, including changes in ownership, negative news mentions, and sanctions lists, to identify and address potential risks. Also, constant training of employees involved in KYB processes on updated regulations, best practices, and red flags ensures consistent and effective implementation. Looking for advice/help is not an internal process - partnering with qualified third-party vendors specialising in KYB and AML compliance enables businesses to gain access to specialised expertise and advanced technology solutions. Using third-party data, such as D&B and Experian, is instrumental in optimising the KYB process. Implementing internal controls ensures that decision-making aligns with organisational objectives and gathers relevant data points. This approach aids in identifying and preventing synthetic fake IDs.

Balancing effective KYC procedures with privacy concerns is also important. Planning the onboarding process meticulously, understanding the target market and associated risk signals, and segmenting customers in real time help streamline the process while respecting privacy. Providers of remote KYC systems, based on biometric identification, will need to navigate new regulatory requirements (the EU Artificial Intelligence Act), focusing on risk management, transparency, and data protection.

And most importantly, FIs and fintechs are encouraged to build an organisational culture that prioritises compliance and emphasises the value of robust KYB practices within all business operations.


* A Merchant Category Code (MCC) is a four-digit number used to categorise merchants based on the merchant’s business activities and products or services being sold.


About Mirela Ciobanu

Mirela Ciobanu is Lead Editor at The Paypers, specialising in the Banking and Fintech domain. With a keen eye for industry trends, she is constantly on the lookout for the latest developments in digital assets, regtech, payment innovation, and fraud prevention. Mirela is particularly passionate about crypto, blockchain, DeFi, and fincrime investigations, and is a strong advocate for online data privacy and protection. As a skilled writer, Mirela strives to deliver accurate and informative insights to her readers, always in pursuit of the most compelling version of the truth. Connect with Mirela on LinkedIn or reach out via email at mirelac@thepaypers.com.

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Keywords: KYB, KYC, digital onboarding, fraud prevention, AML, merchants, UBOs, data privacy
Categories: Fraud & Financial Crime
Countries: World
This article is part of category

Fraud & Financial Crime

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