What KYC is and why it matters in financial services

In 2024, reported fraud losses rose to $12.7 billion—a 25% jump in just one year. One way to fight rising financial crime is to reduce anonymity and monitor for suspicious financial activity. That starts with knowing who your customers are.

KYC, which means "Know Your Customer", is the process of verifying customer identity and assessing risk. While individual organizations design their own programs, banks, credit unions, and other financial institutions must meet strict regulatory standards to stay compliant.

This article breaks down U.S. KYC requirements and explores why KYC in banking matters. Failing to meet them can lead to steep fines, greater exposure to fraud, and loss of consumer trust, making strong KYC practices essential for financial and finance-adjacent companies. 

What is KYC?

Know Your Customer (KYC) is a due diligence process that financial institutions use to verify a customer’s identity and assess their risk. Some organizations refer to this as “Know Your Client” requirements, but the goal is the same: to ensure customers are who they claim to be.

At its core, KYC means finance companies have a process to verify that their customers are who they say they are. This helps prevent money laundering, terrorist financing, and other types of fraud. By verifying a customer’s identity at account opening and continuously monitoring transaction patterns, financial institutions can detect suspicious activity more quickly.

To meet KYC in banking requirements, customers must provide proof of identity and address. This can include ID card verification, facial or biometric recognition, and document verification. Common KYC documents include passports, driver’s licenses, and utility bills.

KYC checks are critical for evaluating customer risk and determining eligibility to use financial services. They’re also legally required under Anti-Money Laundering (AML) laws, which aim to ensure financial platforms aren’t used for criminal activity.

Why is KYC important in banking?

KYC verification is a legal requirement for banks and other financial institutions. It ensures they can accurately identify customers and assess potential risk factors. These requirements fall under broader anti-money laundering (AML) regulations, which were first introduced in the U.S. in 1970 to combat illicit financial activity.

Stricter KYC requirements emerged after the 9/11 attacks, when the U.S. passed the Patriot Act. Although discussions around enhanced due diligence had already begun, the attacks created the political momentum needed to implement them. Under Title III of the Patriot Act, financial institutions must comply with two key components of KYC: the Customer Identification Program (CIP) and Customer Due Diligence (CDD).

Today, KYC practices follow a risk-based approach to detect and prevent financial crime, including:

• Identity theft: KYC helps confirm a customer’s legal identity, reducing the risk of fake accounts or identity theft through forged or stolen documents.

• Money laundering: Criminal networks often use dummy or layered bank accounts to disguise the origin of illicit funds. KYC makes it harder to spread money across accounts undetected.

• Financial fraud: By verifying identity at onboarding, KYC helps prevent fraudulent activities such as using fake or stolen credentials to secure loans or access financial services.

KYC isn’t just a regulatory checkbox—it’s a frontline defense against financial crime and a key part of building customer trust.

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AML vs KYC: What’s the difference?

AML (Anti-Money Laundering) refers to the broader set of laws and regulations designed to prevent money laundering and other financial crimes. KYC (Know Your Customer) is a specific component within that framework. It focuses on verifying a customer’s identity and understanding who they are before providing financial services.

While AML outlines the overall compliance obligations, KYC is one of the key processes financial institutions use to meet those obligations. Each institution is responsible for designing its own KYC procedures, but those procedures must align with the AML requirements in each country or jurisdiction where they operate.

Who needs to have KYC processes?

KYC is required for any financial institution or bank that deals with customers while opening and maintaining financial accounts. Standard KYC procedures generally apply when a business onboards a new client or when a current client acquires a regulated product.

Financial institutions that need to comply with KYC authentication protocols include:

• Banks

• Credit unions

• Wealth management firms and broker-dealers

• Finance tech applications (fintech apps), depending on the activities in which they engage

• Private lenders and lending platforms

Know your customer requirements have become an increasingly critical issue for almost any institution interacting with money (so, just about every business). While banks are required to comply with KYC to limit fraud, they also pass down those requirements to organizations they do business with.

What triggers KYC reverification?

KYC reverification is the process of revalidating a customer’s identity and risk profile after their initial onboarding. It’s part of an ongoing compliance effort to ensure that customer information remains accurate and up to date, in line with regulatory expectations.

Reverification typically occurs when:

• Unusual transaction activity 

• New information or changes to the client

• Change in the client’s occupation

• Change in the nature of a client’s business

• Adding new parties to an account

For example, initial due diligence and ongoing monitoring may flag risk factors like frequent wire transfers, international activity, or ties to offshore financial centers. High-risk accounts are monitored more closely, and customers may be asked to explain certain transactions or update their KYC information regularly.

What are the components of KYC?

Understanding know your customer regulations means understanding not just the process itself but also how the different components work together to reduce fraud and illegal activity.  

The core components of KYC include:

• Customer Identification Program: Identify and verify the identity of customers. If you work with businesses, identify and verify the identities of the beneficial owners of companies opening accounts.

• Customer Due Diligence Program: Understand the nature and purpose of customer relationships to develop customer risk profiles.

• Continuous Monitoring: Conduct ongoing monitoring to identify and report suspicious transactions and, on a risk basis, maintain and update customer information.

Customer Identification Program (CIP)

Financial institutions must ask customers for identifying information to comply with the Customer Identification Program. Every financial institution conducts its own CIP verification process based on its risk profile, so a customer may be asked for different information depending on the institution. 

For an individual, KYC documents could include:

• A driver’s license

• A passport

For a company, the information may include: 

• Certified articles of incorporation

• Government-issued business license

• Partnership agreement

• Trust instrument

For either a business or an individual, further verifying information might include:

• Financial references

• Information from a consumer reporting agency or public database

• A financial statement

Financial institutions must verify that this information is accurate and credible by verifying the authenticity of documentation, using digital identity verification, or both.

Customer Due Diligence (CDD)

Customer due diligence requires financial institutions to conduct detailed risk assessments, including examining the potential types of transactions a customer makes to detect suspicious behavior. 

Using this information, the institution assigns the customer a risk rating that determines how often the account is monitored. Institutions must verify the identity of any individual who owns 25% or more of a legal entity, and any individual who controls the legal entity.

While there’s no standard procedure for due diligence, institutions can think of it in three tiers:

• Simplified Due Diligence (“SDD”): Used for low-value accounts, or when the risk of money laundering or financing terrorism is low. 

• Basic Customer Due Diligence (“CDD”): At this level of due diligence, financial institutions should verify a customer’s identity and level of risk.

• Enhanced Due Diligence (“EDD”): High-risk or high-net-worth customers that require a deeper understanding of the customer’s financial activities and risks. For example, if a customer is a Politically Exposed Person (PEP), they may be at greater risk for money laundering.

Continuous monitoring

Continuous monitoring means financial institutions must monitor their clients’ transactions on an ongoing basis for suspicious or unusual activity. This step embraces a dynamic, risk-driven approach to KYC. When suspicious or unusual activities are detected, the financial institution must submit a BSA (Bank Secrecy Act) form to FinCEN and other relevant law enforcement agencies.

What are KYC document requirements? 

The two mandatory KYC documents are proof of identity with a photograph and proof of address. Customers must provide an updated, unexpired government-issued identification proving nationality or residence and include a photograph or similar safeguard. These documents establish identity when users open a financial account, such as a savings, fixed deposit, mutual fund, or insurance account.

Documents commonly accepted as standard proof of identity and address include:

• State-issued ID card

• Driver’s license

• Passport

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How much does KYC cost businesses?

Financial institutions are expected to spend an estimated $51.7 billion on AML-KYC compliance technology and operations by 2028. Beyond the immediate cost of implementing processes, KYC has other costs, such as increased time investment and higher customer churn. 

However, non-compliance with KYC processes can result in steep fines. In 2024 alone, U.S. regulators issued over $4.3 billion in penalties related to anti-money laundering regulations. TD Bank alone was fined $3 billion in 2024. Penalties for transaction monitoring violations—part of broader AML enforcement—more than doubled year over year, climbing past $3.3 billion in 2024.

The impact of know your customer in banking 

KYC regulations affect nearly any business, platform, or organization that opens accounts or processes transactions through a financial institution. These rules were designed to prevent financial crimes like money laundering, terrorism financing, and fraud, many of which rely on anonymous or poorly verified accounts.

For financial institutions, KYC is more than a legal obligation—it’s foundational to building trust and protecting customers. Failing to meet KYC requirements can lead to steep fines, reputational damage, and, in some cases, legal consequences.

As the fintech landscape expands, more organizations must navigate these evolving requirements. Adopting a risk-based approach to KYC strengthens fraud prevention and improves the overall customer experience.

Simplify KYC compliance with Plaid: Plaid Identity Verification provides a low-friction, secure way to verify customer identities and meet regulatory requirements.