Testimony of Richard A. Small
Assistant Director, Division of Banking Supervision and Regulation
Proposed "Know Your Customer" regulation
Before the Subcommittee on Commercial and Administrative Law, Committee on the Judiciary, U.S. House of Representatives
March 4, 1999
Mr. Chairman, I am pleased to appear before the Subcommittee on Commercial and Administrative Law to discuss the proposed "Know Your Customer" regulation. As you are aware, the Federal Reserve, along with the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision, issued a notice of proposed rulemaking with regard to "Know Your Customer" on December 7, 1998.
As a proposed regulation, there has been no final decision on the wording of any new regulation or, for that matter, whether it is necessary to have a new regulation. The rulemaking process provides for a period of time during which the public can comment on the specifics of the proposal. The comment period for this proposal concludes on March 8. As we are still in the midst of the comment period, I am not able to provide any information with regard to the Federal Reserve's determination as to how to proceed with the proposal. No determination will be made until the comment period has concluded and there has been an opportunity to complete the review of the comments that have been submitted.
As we move forward in our review of the comments and our determination as to whether, or how to proceed with the proposed rule, we will carefully weigh three important issues. First, it has become clear that the proposal raises privacy concerns that also pose a real danger of eroding customer confidence in the institutions at which they bank. The Federal Reserve recognizes the sensitivity of this issue. Second, the Federal Reserve will continue to recognize that participating in the government's programs designed to attack the laundering of proceeds of illegal activities through our nation's financial institutions could enhance public confidence in the integrity of our financial system. Third, we also will be mindful of industry concern about the potential burden that a "Know Your Customer" regulation might impose and that in doing so it would place banking organizations at a competitive disadvantage as the result of obligations that would come from the "Know Your Customer" regulation that do not apply to other types of financial service organizations subject to the provisions of the Bank Secrecy Act, such as brokerage firms and money transmitters.
It would be useful to provide some background information about "Know Your Customer" policies and the purpose of the proposed rule. The concept of "Know Your Customer" has been around for quite some time. Many banks today use such policies and procedures to protect the integrity of their institutions. In addition, bankers have expressed concern that there is no uniformity in the banking agencies' and Department of the Treasury's guidance on identifying transactions that would have to be reported under existing suspicious activity reporting regulations.
In the past, there have been expressions of Congressional interest in "Know Your Customer" regulations. The Annunzio-Wylie Money Laundering Act of 1992 authorized the Department of the Treasury to prescribe minimum standards for the anti-money laundering programs of all financial institutions covered by the Bank Secrecy Act. The legislative history of this law and other legislation addressing the government's anti-money laundering efforts indicates that the Congress expected that the minimum standards would include "Know Your Customer" policies. In the Money Laundering Deterrence Act of 1998, which was approved by the House of Representatives near the end of the 1998 session, Section 9 included a requirement that the Secretary of the Treasury comply with the provisions of the Annunzio-Wylie Money Laundering Act by promulgating "Know Your Customer" regulations for financial institutions within 120 days of enactment of the legislation.
These considerations led all of the federal bank supervisory agencies, including the Federal Reserve, to develop the proposal. In proposing the "Know Your Customer" regulation, it was our intent to provide banks with guidance as to what programs and procedures they should have in place to have sufficient knowledge of their customers to assist in the detection and prevention of illicit activities occurring at or through the banks. I should note that the proposal would not require banks routinely to turn over to the government information about their customers and would not require banks to monitor every customer transaction.
In an effort not to create a substantial burden for the majority of banking organizations, the proposal sets forth the concept of developing and applying "Know Your Customer" programs based on the perceived risks associated with the various customers and the types of transactions that the banks understood would be conducted by the customers. For the majority of customers, we assumed that banks would find that they posed no or minimal risk and their "Know Your Customer" programs would be nothing more than formalizing existing procedures for identifying customers and following existing suspicious activity reporting requirements.
The proposal also recognized that privacy was a critical issue. We specifically solicited comments on "whether the actual or perceived invasion of personal privacy interests is outweighed by the additional compliance benefits anticipated by [the] proposal."
To date, the response from the public on this issue has been unprecedented. The public comments indicate that bank customers believe that the "Know Your Customer" rule will result in material invasions of their personal privacy interests.
As I noted at the beginning, the comments have highlighted important issues, both with respect to privacy and other aspects of the proposal, that we will be considering in the days ahead.
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