Digital Identity And Enhanced Customer Due Diligence

The Problem: Financial Institutions Have Strict Customer Due Diligence Requirements That Increase Internal Compliance Costs

On May 11, 2018, the Federal Financial Institutions Examination Council (FFIEC) released new Customer Due Diligence (CDD) Examination procedures that reflect and codify the requirements of FinCEN’s final CDD rule.

These updates detail how financial institutions must establish appropriate risk-based CDD procedures to understand the nature and purpose of their customer relationships, in addition to, “conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information”.

The Solution: Use Blockchain To Track Due Diligence In Real-Time Without Lowering Consumer Data Value

I believe that real-time customer diligence is not only possible but will become the market standard in the near future as distributed ledger technology is applied to existing financial markets.

From the FFIEC,

“Improper identification and assessment of a customer’s risk can have a cascading effect, creating deficiencies in multiple areas of internal controls and resulting in an overall weakened BSA compliance program.”

Tracking customer identities and relating them to the transactions they complete in real time allows for banks to ensure that their own merchant partners are compliant from the start of the customer-merchant relationship, the revenue that the merchant deposits into a financial institution can also be tracked and related to future transactions as a way to continually maintain that due diligence for both the bank and the merchant.

The customer’s relation to their own transactions, and the value that third parties derive from this relationship needs to remain protected and valuable to the customer. It is on this foundation that I propose to build a blockchain based ledger that tracks the financial compliance relationship between these entities while protecting the data of the consumer.

The Problem: Associating Risk Profiles With Customer Relationships Requires Access to New Data From Merchants

Formerly, the procedure directed by the FFIEC to money service businesses (MSBs) was to, “enable the bank to predict with relative certainty the types of transactions in which a customer is likely to engage”. New guidance is suggesting a new direction to redefine customer due

diligence and put more pressure on MSBs and Financial Institutions (FIs) to perform Enhanced Due Diligence (EDD) where end-to-end tracking of MSB and customer relationships can be segmented based on risk and have the necessary resources be allocated to ensure compliance and limit the total risk on the financial institution.

The FFIEC is looking to pass the burden of compliance onto transactional tracking.

“The objective of CDD is to enable the bank to understand the nature and purpose of customer relationships, which may include understanding the types of transactions in which a customer is likely to engage.”

Robust transactional tracking means forcing MSB to allow FIs insight into the relationships between them and their customers in ways that may limit their ability to maintain those relationships.

If a bank adds a burden of information collecting on their clients, from the initiation of the relationship to the settlement of the transaction, and throughout the lifetime of that relationship then the merchant will be more inclined to work outside of the existing banking system.

The Solution: Use blockchain to share enhanced customer due diligence data generated at the point of sale without adding additional burden on the MSB and without increasing risk to the FI.

I propose using Distributed Ledger Technology(DLT) to decrease the friction between sharing customer and transaction data by encrypting that information and automating the transfer of that data directly into risk management systems operating within FI’s technology stacks.

When a secure bridge is built between the entities that are generating data (Customer > MSB > FI > FinCEN) the sharing of that data becomes inherently valuable while simultaneously lowering risk generated within the financial network.

If such traditionally trust-adverse entities can establish a data sharing network on a trustless system enabled by distributed ledger technology, then the security and scalability of high-risk revenue can be addressed without increasing burden on any one entity.

At LedgerSafe we are working on a solution that lowers friction between digital transactions and the financial entities that oversee the regulation of transactional networks. Learn more