Customer due diligence (CDD) refers to collecting and verifying customers’ information and supporting organizations in complying with regulatory requirements and protecting them against financial crimes. FATF makes it compulsory for businesses to establish customer due diligence and urges financial institutions to verify the identity of their customers and beneficial owners as well. In this article, you will learn why CDD is required by laws and regulations like the Anti-Money Laundering (AML) Act and the Bank Secrecy Act.
What is Customer Due Diligence?
Customer due diligence is the process used by organizations, businesses, financial institutions, and other sectors to collect and verify customer’s identity. It serves as an essential component of the KYC (Know Your Customer) AML (Anti-Money Laundering) compliance checklist. CDD also involves ongoing monitoring of customer information to detect any suspicious or illicit activity. This approach facilitates the mitigation of risks associated with financial activities like money laundering and terrorist financing.
There are three types of Customer due diligence;
- Simplified Due diligence involves a basic level of information required by organizations to verify their customers.
- Customer due diligence includes the verification of customer identity and and ongoing risk assessment to protect organizations from financial crimes.
- Enhanced due diligence refers to a higher level of monitoring and verification of customers, particularly assessing the profiles of high-risk customers and their transactional activities.
FinCEN, The Financial Crimes Enforcement Network, issued the CDD rule, which reforms the Bank Secrecy Regulation, to enhance financial transparency and anticipate illicit actors from exploiting companies for unlawful activities. According to FinCEN, there are four requirements of CDD including Verification of customer’s information, verification of beneficial owners, assessment of customer’s risk profile, and ongoing monitoring to detect suspicious activity.
Difference between CDD and EDD?
Customer due diligence and enhanced due diligence are two essential components of KYC compliance, however, the difference lies in their roles in identity verification. These components are crucial for all businesses but lay particular importance on financial institutions. Here are a few differences between CCD and EDD for better understanding;
| Key Factors | CDD | EDD |
| Protocol | It involves the verification of basic information about the customer and is carried out during initial customer onboarding | It involves the in-depth investigation of high-risk customers and monitoring their activities. |
| Level of risks | It is applicable to all customers regardless of risk assessment. | It is applicable for high customers and includes a risk-based approach |
| Analysis | It refers to the collection of basic information such as name, date of birth, address, or source of income. | It refers to customer background checks, business associations, and sources of funds. |
| Regulatory Compliance | It is an essential component of regulatory compliance. | It is required when CDD fails to meet the requirements. |
In order to ensure regulatory compliance and evaluation of increased risks, it is essential for businesses to establish an Enhanced due diligence checklist and ensure its implementation.
Due Diligence Checklist
A due diligence checklist refers to a set of standards and specific information required for the verification of a customer’s identity and assessment of potential risks associated with high-risk customers. Here are the crucial components of the due diligence checklist;
- Customer information
- Identity verification
- Nature of business or activity
- Source of funds
- Ultimate Beneficial ownership
- Customer’s transaction history
- Politically exposed persons (PEPs)
- Sanctions and watchlists
- Regulatory compliance
- Risk assessment
- Enhanced monitoring and reporting
These steps help to make sure that no essential aspect is left unnoticed in the whole process of due diligence.
Why is CDD essential for Businesses?
Customer due diligence is crucial for businesses to comply with updated laws and regulations and to make the best possible decisions for their operations. It helps to protect businesses against potential risks and to detect suspicious activities. CDD is essential for all businesses but plays a significant part in financial institutions.
The most crucial aspect of CDD in business is protection against reputational risks. Money laundering and terrorist financing can harm the relationship with customers and clients and disrupt the reputation of businesses. CDD plays its role in preventing financial crimes and preserving ethical standards.
Prevention of Fines & Penalties
Customer due diligence assists businesses to avoid financial fines and penalties. If the businesses are not following CDD requirements, they fall prey to financial penalties and even criminal prosecution. The process ensures the privacy and integrity of customer information and promotes transparency. It refers to safeguarding personal information from fraud and identity theft.
Ongoing Monitoring
The implementation of CDD is not a one-time process rather it involves ongoing monitoring and risk assessment approach to manage the process effectively. With the passage of time, customers’ behavior and activities change which leads to an evolving risk profile compelling organizations to continually monitor and update their CCD processes.
Singapore’s Example
Various countries around the globe are taking steps to introduce CDD in their laws and regulations. To accomplish this purpose, Singapore has mandated CDD in various regulations including the Corruption, Drug Trafficking and Other Serious Crimes (Confiscation of Benefits) Act, the Terrorism (Suppression of Financing) Act, and the Monetary Authority of Singapore (MAS) guidelines. These laws require financial institutions like banks, fintech firms, and insurance companies to carry out customer due diligence to verify the client’s identity and assess potential risks.
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