Do KYC Profiles Match Customers’ Business Behavior?


Instead, their two research papers point to flaws in the KYC process and new ways to assess risk.

In the first article, the authors adopted a recency, frequency, and monetary value (RFM) model commonly used by marketers to segment customers. They looked at the number of days since a customer’s last transaction (recency), the total number of transactions, the average number of days between transactions (frequency), and the buy and sell totals (dollar value).

After grouping customers into five groups based on their trading behavior, the authors compared the data to KYC profiles. They found that the vast majority of customers in each group were classified as medium risk despite very different trading behaviors. The authors concluded that the frequency and volume of transactions can tell advisers more about risk tolerance than standard questionnaires.

In a follow-up study published in May using data from the same company, the authors compared the risk allocations of the KYC profile to investment portfolios using a value-at-risk (VaR) divergence methodology. The authors used VaR to measure the risk raised (or reported) and revealed by individual clients. The risk obtained came from the KYC questionnaire and the client profile; the revealed risk has been shown in trading behavior and has taken into account the usefulness of wealth (or the idea that a customer’s total wealth affects how they perceive a loss).

By quantifying the risk raised and revealed by clients, the authors used the difference between the two to measure how appropriate their clients’ risk profiles were.

“We look at the impact of clients’ business behavior and cash flow on their portfolios and use VaR to quantify how much each client’s portfolio is actually ‘at risk’ and how far away clients are from it. their stated risk preferences, “the document says.

The authors found that advisers generally place clients in portfolios that are less risky than their stated profiles. The KYC is often used as a “safeguard” against which advisers build client portfolios, and advisers are generally conservative. It’s good for clients who are trying to preserve their capital, they wrote; less for those who want to maximize their growth but do not take enough risks to achieve their goals.

“Under-risked accounts are just as problematic as over-risked, but easier to defend for advisers to regulators and lawyers since there is no significant loss of funds,” the authors wrote. . “An example could be older clients who can preserve their capital but are unable to generate investment income to maintain their lifestyle. “

VaR is a useful communication tool to help clients understand dollar or percentage risk of the portfolio and conceptualize how different combinations of assets match their stated risk preferences, the authors said.

“By using the same measure for profile risk and revealed risk – especially the difference between the two – in real time, we believe VaR could become an important tool to help clients, advisers, brokers and investors. regulators to monitor a careful balance between all variables and stakeholders.

Knowing the behavior of your customers: a grouped analysis of financial transactionsBy John RJ Thompson, Longlong Feng and R. Mark Reesor of Wilfrid Laurier University and Chuck Grace of Ivey Business School, published in the Risk and Financial Management Journal, 14 (2), 2021

Measuring financial advice: aligning the risks raised and revealed by clients(Same authors and Adam Metzler from Wilfrid Laurier University), published on the SSRN network, May 21, 2021

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