Know Your Customer, more affectionately known as ‘KYC’, refers to background checks that banks conduct on their customers to safeguard against inadvertently becoming channels of money laundering or aiding in other unlawful activities (read about a newsworthy case here). Most regulators impose a minimum level of KYC requirements with which banks must comply. KYC requirements typically focus on the Ultimate Beneficial Owner (‘UBO’) of a company, that is, the human that ultimately controls the company and on whose behalf the company’s transations are being conducted.
We will not be delving into KYC requirements in this article, but rather the next level of what it really means for a bank to know its customer – to Know Your Customer, and Know Your Cashflow (KYC2). This entails finding out and analysing the company’s sources of cash and what the company is spending its cash on. We term this the company’s Ultimate Economic Activities (‘UEA’). KYC2 is primarily a credit tool, but we believe principle-based application of KYC2 would also help bankers sniff out warning signals of money laundering.
Take Company X for example. Company X’s assets mainly comprise related party receivables, while its liabilities are mainly trade payables to third party suppliers and a long term loan. It appears that Company X procures goods from third parties and sells to its related parties. As part of KYC2, the banker would need to find out what is Company X’s value add, for example, does it process the goods, or is it merely a procurement company? What are the goods and from where are they purchased? For the group of Company X and its related parties as a whole, how do these goods ultimately generate cash?