Banks cannot take on a customer without knowing who they are. Know Your Customer, or KYC, is the set of rules and procedures that require financial institutions to verify identities, understand the nature of a customer's business, and assess the risk of money laundering or terrorist financing. It is a legal obligation, not a courtesy.

The process has several steps. Customer identification collects a government-issued ID, proof of address, and a tax identification number. Customer due diligence assesses the customer's risk profile based on occupation, source of funds, and expected transaction patterns. Enhanced due diligence applies to high-risk customers, such as politically exposed persons or businesses in cash-intensive industries. Ongoing monitoring tracks transactions against the expected pattern and flags anything unusual.

KYC is expensive. Banks spend billions on identity verification systems, analysts, and compliance staff. It also frustrates customers, who must provide documents and answer questions. But the alternative is worse. Banks that fail KYC face fines, loss of licenses, and reputational damage. In 2012, HSBC paid $1.9 billion for KYC failures that allowed drug cartels to launder money through its accounts.

The rules vary by country but follow standards set by the Financial Action Task Force. The United States implements them through the USA PATRIOT Act and FinCEN regulations. The European Union has its own anti-money laundering directives. Cross-border banks must comply with all of them.