When Should a Bank Apply Due Diligence?

Bank due diligence is a fundamental practice safeguarding the financial system’s integrity and preventing illicit activities. It involves financial institutions examining clients and transactions to mitigate risks. Its primary purpose is to deter and detect financial crimes, such as money laundering and the financing of terrorism. This approach helps protect institutions and the financial system from misuse.

Opening New Accounts

Banks apply due diligence before establishing any new customer account or service. This initial scrutiny ensures compliance and assesses potential risks. The process begins with Customer Identification Program (CIP) requirements, where banks collect and verify identifying information for all new customers. This includes a customer’s full legal name, physical address, date of birth, and an identification number, such as a Social Security Number or taxpayer identification number.

Beyond identity verification, initial Customer Due Diligence (CDD) is performed to understand the nature and purpose of the customer’s relationship with the bank. This involves gathering information about the customer’s occupation or business, their anticipated source of funds, and the expected types and volume of transactions. For legal entities, banks must also identify and verify the identity of beneficial owners—individuals who directly or indirectly own or control 25% or more of the entity. This data collection allows the bank to develop a customer risk profile, crucial for ongoing monitoring and compliance.

Monitoring Existing Relationships

Due diligence extends beyond initial account opening, becoming a continuous process of monitoring existing customer relationships. Banks regularly review accounts and transactions to ensure they remain consistent with the customer’s established profile and expected activity. This ongoing oversight helps financial institutions detect deviations that might indicate emerging risks or illicit financial activity.

Periodic reviews of customer information are a standard component of this ongoing due diligence. These reviews occur at set intervals, ranging from annually to every few years, depending on the customer’s assessed risk level. During these reviews, banks verify that the customer’s information is current and that their financial behavior aligns with previously provided details. Banks also utilize transaction monitoring systems that automatically flag activities falling outside a customer’s normal patterns or exceeding predefined thresholds. These systems identify potentially suspicious transactions that warrant further investigation.

Reacting to Unusual Activity

Due diligence is immediately intensified when banks detect unusual or suspicious activity within a customer’s account. This reactive application of due diligence is a key defense against financial crime. Examples include large cash deposits inconsistent with a customer’s stated business, rapid movement of funds between multiple accounts, or transactions involving entities in high-risk jurisdictions.

Triggers for enhanced due diligence also arise from changes in a customer’s profile or behavior. A significant, unexplained increase in transaction volume, a sudden shift in business activity, or the addition of new beneficial owners can prompt a deeper investigation. Banks also respond to red flags or alerts generated by their internal systems or from external sources, such as inquiries from law enforcement agencies. These indicators necessitate a thorough re-evaluation of the customer’s activity. Such triggers may lead to further internal investigation, and if warranted, the filing of a Suspicious Activity Report (SAR) with the Financial Crimes Enforcement Network (FinCEN) within 30 days of initial detection.

Adjusting Based on Risk Factors

The intensity of due diligence applied by banks varies based on a customer’s assessed risk profile. Banks categorize customers into different risk levels—low, medium, or high—which dictates when standard, simplified, or enhanced due diligence measures are employed. This risk-based approach ensures resources are allocated effectively to address potential threats.

Enhanced Due Diligence (EDD) is triggered when a customer presents a higher money laundering or terrorist financing risk. This includes situations involving Politically Exposed Persons (PEPs)—foreign individuals holding prominent public functions—customers operating in high-risk industries, or those from high-risk geographic areas. EDD involves more intensive verification procedures, more frequent and thorough ongoing monitoring, and often requires senior management approval for the relationship. Conversely, Simplified Due Diligence (SDD) may be applied to very low-risk customers, allowing for less intensive verification and monitoring, provided specific criteria are met and the risk remains minimal.