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Ineffective Customer Due Diligence: Worst Risks That May Arise And Go Unidentified

Risks That A Company May Face And Fail To Be Identified Because Of Due Deligence - image from pixabay by WokandaPix

A company needs to understand the people it does business with. Therefore, many companies perform a percentage of customer due diligence. Customer Due Diligence is a very important and complex field used by financial institutions to evaluate and collect the relevant details of a customer or a potential customer. It helps you to identify and have knowledge of the risk profiles of the customers and verify their identities too.

Customer Due Diligence is a regulatory requirement for companies that want to enter business relationships with customers. Due diligence is an essential tool in the fight against money laundering and terrorism of finance. Due diligence helps investors and companies to understand the nature of a deal, the risks involved, and whether their deals fit with their portfolios. This check should be completed before entering a business relationship.

Companies may face risks since the extent to which they conduct due diligence on third parties during the engagement is unclear. Third parties include agents, distributors, introducers, service providers, suppliers, lawyers, auditors, or providers of CDD solutions such as online identity verification. Companies should ensure that all third parties they work with are trusted and reliable.

Infective customer due diligence - image from pixabay by WokandaPix
Infective customer due diligence - image from pixabay by WokandaPix

In the Middle East, Due Diligence is rarely done when onboarding suppliers, but even when it is done, it's not common since due diligence is periodically refreshed to detect any new risks that may show during the relationship. If the risks are not detected, this implies that the risks are not managed and may cause major effects.

Basic Requirements of Customer Due Diligence.

The rule has four elements, each of which should be in the anti-money laundering program. It involves collecting very basic information. The first is customer identification and verification, where the information collected includes name, address, and a photograph of an official identity document. Identification and verification of beneficial ownership here, you may ask for a government-issued document like a driver’s license, then understanding the nature and the purpose of customer relationships to advance a customer risk profile.

The other basic element is monitoring for the reporting of suspicious transactions. After this is done, the customer information is maintained and updated. Finally, the company should understand the customers' activities and their markets.

Major Risk Areas Where Due Diligence Aids.

  • Conflicts of interest, especially in the supply chain and acquisition areas, need to be managed. A company that does not do so risks being implicated in serious charges such as corruption, kickbacks, fraud, and bribery. Performing due diligence on the suppliers can assist in identifying any unstated connections and give any signs of potential conflicts of interest. Performing due diligence is very important as the trading relationships can stretch back to the parties and groups involved, and build strong bonds, thus creating tensions when transparent and open acquisition rules need to be met. In addition, conflict of interest is bad for companies since they may fail to detect this risk. Performing due diligence is the best solution for this.
  • They meet environmental, social, and government  [ESG] objectives. Each business has its objectives that need to be met. Objectives are goals set by a company that is in operation. Meeting these objectives demonstrates that a company works according to certain ethics and cannot destroy the environment, which is a major part of it. For example, suppose a company does not perform enough due diligence. In that case, it may fail to find out the sources of raw materials of the supplier when the protections are not submissive to the jurisdictions. When due diligence is done together with adverse media tracking, it can help to identify the issues facing the supply chain that may be hidden, hence giving the company an early warning of menace to their status [ESG].
  • Due diligence may also help in risks of Economic and Trade sanctions that the government may issue to certain individuals, companies, or a country at large. A sanction is a punishment, a penalty, or a coercive measure put forward to enhance non-violation. The bodies and regulators enforcing sanction compliance have strong powers of investigation. The penalties may cost huge amounts of money. It has now become standard for well-managed companies to want to get even the finer details of a supplier. Finer details include information about ownership or subject to sanction, among other things.

Suppose your customers reveal the risks of being enwrapped in a sanction investigation or even more severe. Understanding the risk of being involved in a violation is also crucial. These sanctions vary with time, often overnight, and the circumstances of suppliers may also change equally fast. Thus, companies must renew their due diligence and note any changes based on managing risk effectively.

Ways Used in Risk Management.

Most companies must reinforce their controls on the suppliers and third parties they engage with. Some of the actions that are to aid in managing these risks include:

  1. Review all third parties and suppliers by doing an exhaustive due diligence test and rectifying any issues.
  2. Refresh due diligence regularly and ensure ongoing monitoring, including adverse media monitoring.
  3. You apply an appropriate technological solution, where necessary, to make the process more efficient. For example, technology is efficient in counter-checking and alerts.
Infective customer due diligence - image from pixabay by geralt
Infective customer due diligence - image from pixabay by geralt

When Do You Need to Apply For Customer Due Diligence?

  • When establishing a business relationship before a new customer-business relationship, companies should perform due diligence to check the customers' risk profiles and verify their identities.
  • The company should check its accounts if the customers are suspected of illegal activities. Companies should implement due diligence to confirm that the customers they are doing business with are not suspected of any illegal activity, such as money laundering.
  • When the information provided by your customers and clients cannot be relied upon, it brings up suspicion, is incomplete, untrustworthy, and without meeting the requirements, a company needs to ensure fulfillment of more measures concerning due diligence.
  • Other customers or businesses must undergo further [CDD] measures when they have occasional transactions. Due diligence is much required for high amounts of money transacted frequently and those with people with bad reputations, not forgetting the high-risk regions.
  • If the customer is considered to be of high risk, the business is supposed to carry out enhanced due diligence checks. Enhanced due diligence works, especially if the business is engaging with a politically oriented person or if the person is from a high-risk country.

A business is supposed to keep a record of all financial transactions for at least five years. Financial transactions include all information collected via customer due diligence, business replies, and account files. This information is very sensitive, and if lost, it raises suspicions about the company.

A company should maintain up-to-date records of its customers so that in case the customers ever change. The business will correct its assessment of risk and do further due diligence if necessary. The business should also check and consider customers' financial records, both previously and at the moment, and their activities to create money.

Due diligence is essential as it gives a company access to important and confidential information on a business. Therefore, businesses and companies should be encouraged to perform due diligence before transactions.


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