While KYC has traditionally been viewed as burdensome “red tape,” lenders that collaborate with their business development officers to formulate a clear and succinct process can advertise their efficiencies as a market differentiator. To streamline the KYC process, business development officers will need a digestible snapshot of the KYC basics.

KYC. Three little letters that evoke a big response from nearly all asset-based lenders. But, why? Because we have mistakenly relegated KYC (Know Your Customer) compliance to the dark underbelly of the lending world – the “back office.” Traditionally, KYC has been viewed as an operational task (nay, an operational nightmare) and business development officers (BDOs) have stayed as far away from the process as possible. In doing so, however, we have unintentionally built a shroud of mystery around KYC that has made the compliance processes more onerous for borrowers. As borrowers become frustrated with the process, BDOs who can articulate a clear and simple onboarding process can gain a competitive advantage.

The Real Cost of KYC Compliance

In 2016, Thomson Reuters surveyed nearly 800 financial institutions about the effects of KYC regulation on their respective institutions and the results were astounding. Thomson Reuters found that financial institutions were spending, on aver age, $60 million per year on KYC compliance, with some spending as much as $500 million per year.

Even more astounding, however, was the data showing the indirect costs to the customer in the form of “poor client experience[s].” The survey indicates the aver age time for onboarding a customer increased 22% in 2015 and is anticipated to increase an additional 18% in 2016. The delay in the onboarding process is not the only factor frustrating borrowers, however. The survey also suggests that lenders are reaching out too many times to their customers to obtain KYC information. The repetitive contact, they point out, is a distraction to the customer.

Perhaps the most interesting finding, was the notable disconnect between the lenders’ perception of the ease of diligence process and the customers’ perception. While both sides agree that the onboarding process is onerous, customers are clearly feeling the impact more than the lenders. Whether it is true that the clients are being disproportionately burdened by KYC regulations is irrelevant; what is important is that the customers feel more burdened. The potentially negative impact on the lender-client relationship is the real cost of KYC compliance.

Reframing the “Problem”

The word “potentially” in the prior section is italicized to emphasize that the KYC process does not need to be a negative – instead, savvy lenders can use it to their advantage by formulating a clear and simple diligence process. Lenders should see their KYC diligence process and onboarding procedures as a marketing tool and equip their BDOs with the information needed to make the process smooth and seamless.

KISS It

How do you make KYC palatable to the clients? As the old saying goes, “Keep it Simple, Silly.” The following sections will demonstrate that for the purposes of creating a marketing advantage, the information required for KYC compliance is not that complicated. BDOs do not need to be experts in KYC regulations and the related nuances. They do, however, need to understand the basics and be comfortable with the jargon. The goal is to have the BDOs liaise with the customers in a streamlined and efficient manner to obtain the required KYC information – that means knowing what questions to ask the customer and understanding why they are asking for the information. To be clear, the determination of whether a customer satisfies KYC regulations should remain the purview of the lenders’ KYC experts.

The Basics

KYC (Know Your Customer) is a general term used to refer to the Office of Foreign Assets Control (OFAC), Anti-Money Laundering (AML) and Customer Identification Program (CIP) formal procedures a financial institution is required to perform anytime a new customer (defined as an individual, corporation, partnership, trust, estate or any other entity recognized as a legal person) opens an account (the term “account” includes the extension of credit).1 OFAC administers and enforces economic sanctions programs, prohibiting lenders from engaging in transactions with any sanctioned person, government or country.2 OFAC maintains a database, which lenders are required to reference to ensure they are not do ing business with any individuals or entities included on the prohibited list. AML laws are designed to prevent the introduction of funds obtained from illegal activity into the financial system. Section 326 of the USA Patriot Act requires each bank to maintain written CIP policies, procedures and processes.3

The purpose of these procedures is to provide the bank with a reasonable belief that they know the identity of its customers, and the source of the funds; and to ensure that they know the purpose of loans—both to help prevent identity theft and safeguard against terrorism or other illegal activities. KYC also allows banks to better understand customers’ needs, and thus, to provide better service.

KYC Cheat Sheet

Though each Bank’s CIP policies, procedures and processes will vary according to the types of accounts offered, methods of account opening, and its size, location, and customer base,4 below is a quick reference guide for BDOs and other relevant bank personnel as to the who, what, and when customer due diligence is required in connection with lending transactions5.

1. BY THIS TYPE OF TRANSACTION?

 

2. BECAUSE YOU ACT IN THE FOLLOWING CAPACITY(IES) UNDER THE NEW LOAN?

 

3. ON THE FOLLOWING COUNTERPARTIES?

 

4. ON THE FOLLOWING TYPES OF COUNTERPARTIES?

 

5. PRIOR TO CLOSING the loan transaction you need to obtain the following minimum information for each new customer:13

 

6. PRIOR TO CLOSING the loan transaction you need to follow your bank’s procedures for determining whether each customer appears on any federal government suspected terrorist list:14

 

7. You need to follow your bank’s procedures for providing adequate notice to each customer that you are verifying their identity: 15

 

8. Within a reasonable time after closing the loan, you need to verify the identity of each new customer. The primary source of verification is an unexpired government issued form of identification from each customer (i.e., documentary method):16

 

9. If you did not obtain the required documents before closing, or are not familiar with the documents provided, or there is otherwise an increased risk that the customer’s identity cannot be established, you need to verify the identity of each new customer through your bank’s non-documentary methods):17

 

10. If you cannot reasonably verify the customer’s identity using your bank’s established documentary and non-documentary methods, then you must perform additional verification for certain customers:18

 

11. If you cannot reasonably verify the customer’s identity using your bank’s established documentary and non-documentary methods, and additional verification for certain customers, you then follow your bank’s procedures for lack of verification:

 

12. You should consult your bank’s procedures for relying on an affiliate or another financial institution to perform some or all of the CIP:19

 

13. You must retain certain CIP information for at least 5 years:

The Take-Away

Undoubtedly, this new era of lending is marked by heavy regulatory oversight. While regulatory oversight has traditionally been viewed by asset-based lenders as burdensome “red tape,” lenders that learn to view KYC as a marketing tool can gain a competitive advantage. What was once solely the purview of the back office, should become the joint domain of the front-end BDOs and the back-office administrators. Institutions that collaborate with their BDOs to formulate clear and precise KYC and onboarding processes can market their efficiencies as a client relationship differentiator. One of the most important steps in developing a successful collaboration between the back office and the BDOs is ensuring the BDOs are armed with a digestible snapshot of KYC basics. To that end, this article can serve as a distilled reference guide for BDOs looking to add value to the client relationship by streamlining the KYC and onboarding process.

Shadi J. Enos is an attorney in the Bank and Finance practice group of Buchalter Nemer. She focuses her practice in the areas of commercial lending and corporate finance. Recently, The Commercial Finance Association (CFA) selected Enos to receive the CFA’s inaugural 40 Under 40 award.

Alexandra (Alexa) Ciganeris an associate in the Bank and Finance practice group of Buchalter Nemer. She focuses her practice in the areas of commercial lending and corporate finance.

1. Ffiec.gov article.
3 Ffiec.gov article
4 Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Examination Procedures, Customer Identification Program – Overview at www.ffiec.gov/bsa_aml_aml_infobase/pages_manual/OLM_012.htm.
5. The scope of this article focuses on the CIP requirements applicable to banks engaging in commercial lending activities. However, we note that CIP policies, procedures and processes are mandated for new “accounts”, which includes activities in addition to lending and applies to entities in addition to banks, a discussion of which, in each case, is outside the scope of this article.
6. Expert Q&A on LSTA’s New Know Your Customer Guidelines, p.2; LSTA Know Your Customer Considerations for Syndicated Lending and Loan Trading, Guidelines for the Application of Customer Identification Programs, Foreign Correspondent Account Due Diligence, and Other Considerations, pp. 7 &8. This question goes to whether an “account” (i.e., a formal banking relationship to engage in services, dealings, or other financial transactions) is established under Section 1020.100(a)(1). Transfer of a funded loan in the ordinary course does not constitute establish a formal banking relationship.
7. Expert Q&A on LSTA’s New Know Your Customer Guidelines, p.2; LSTA Know Your Customer Considerations for Syndicated Lending and Loan Trading, Guidelines for the Application of Customer Identification Programs, Foreign Correspondent Account Due Diligence, and Other Considerations, pp. 7 &8.
8. LSTA Know Your Customer Considerations for Syndicated Lending and Loan Trading, Guidelines for the Application of Customer Identification Programs, Foreign Correspondent Account Due Diligence, and Other Considerations, pp. 4-6. This question also goes to whether an account (i.e., a formal banking relationship) is established. Primary lenders at closing who are contractually obligated to provide credit extensions establish a formal banking relationship with the borrower.
9. LSTA Know Your Customer Considerations for Syndicated Lending and Loan Trading, Guidelines for the Application of Customer Identification Programs, Foreign Correspondent Account Due Diligence, and Other Considerations, pp. 4-6. Agent or arrangers, which are not also lenders, acting on behalf of the lenders, function in a manner that is ancillary to the formal banking relationship.
10. Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Examination Procedures, Customer Identification Program – Overview at www.ffiec.gov/bsa_aml_aml_infobase; Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Examination Procedures, Lending Activities – Overview at www.ffiec.gov/bsa_aml_aml_infobase & LSTA Know Your Customer Considerations for Syndicated Lending and Loan Trading, Guidelines for the Application of Customer Identification Programs, Foreign Correspondent Account Due Diligence, and Other Considerations, pp. 4-6.
11. USA Patriot Act and Know Your Customer Requirements for Lenders, Practical Law, p. 4 at http://us.practicallaw.com/6-504-7122; LSTA Know Your Customer Considerations for Syndicated Lending and Loan Trading, Guidelines for the Application of Customer Identification Programs, Foreign Correspondent Account Due Diligence, and Other Considerations, pp. 4-6. This question goes to between or among which parties is a formal banking relationship established, or, put another way, which counterparties constitute customers.
12. USA Patriot Act and Know Your Customer Requirements for Lenders, Practical Law, p. 4 at http://us.practicallaw.com/6-504-7122; LSTA Know Your Customer Considerations for Syndicated Lending and Loan Trading, Guidelines for the Application of Customer Identification Programs, Foreign Correspondent Account Due Diligence, and Other Considerations, pp. 4-6. Agents or arrangers which perform administrative or ministerial functions for the lenders and which do provide extensions of credit to the lenders, do not establish a formal banking relationship. In this regard, lenders are not considered customers of the agent or arranger.
13. 31 CFR 1020.220(a)(2).
14. Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Core Examination Overview and Procedures for Regulatory Requirements and Related Topics, Customer Identification Program – Overview at www.ffiec.gov/bsa_aml_aml_infobase
15. USA Patriot Act and Know Your Customer Requirements for Lenders, Practical Law, p. 4 at http://us.practicallaw.com/6-504-7122; Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Examination Procedures, Lending Activities – Overview at www.ffiec.gov/bsa_aml_infobase
16. Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Core Examination Overview and Procedures for Regulatory Requirements and Related Topics, Customer Identification Program – Overview at www.ffiec.gov/bsa_aml_aml_infobase
17. USA Patriot Act and Know Your Customer Requirements for Lenders, Practical Law, p. 4 at http://us.practicallaw.com/6-504-7122; Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Examination Procedures, Lending Activities – Overview at www.ffiec.gov/bsa_aml_infobase
18. USA Patriot Act and Know Your Customer Requirements for Lenders, Practical Law, p. 4 at http://us.practicallaw.com/6-504-7122; Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Examination Procedures, Lending Activities – Overview at www.ffiec.gov/bsa_aml_infobase
19. Federal Financial Institutions Examination Counsel Bank Secrecy Act/Anti-Money Laundering InfoBase, Core Examination Overview and Procedures for Regulatory Requirements and Related Topics, Customer Identification Program – Overview at www.ffiec.gov/bsa_aml_aml_infobase. Bank can also use a third party to perform such services and maintain its records, but is ultimately responsible for that third party’s CIP compliance.