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Risk Management: Exploring KYC and Credit Decisioning in Credit Card Payment Platforms
Modern technology enables companies to offer innovative, unique credit cards, but there are some important regulations and considerations that factor in when issuing those cards. Regulatory requirements ensure the soundness and safety of the financial system while credit decisioning ensures a business makes sound credit decisions.
Strict financial regulations lay out how companies that offer financial products must verify their customers, known as Know Your Customer (KYC) guidelines. But companies must also understand who their customers are – and their ability and willingness to pay.
This article explores KYC and underwriting as two important components of credit card issuing and essential elements of risk management.
Know Your Customer (KYC) is a way for credit card issuers to verify that their customers are who they say they are. KYC guidelines are substantial and play a critical role in ensuring compliance with regulations, preventing money laundering, mitigating fraud, and managing card program risk.
KYC requirements are issued by the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of Treasury. To abide by KYC, organizations must follow certain protocols:
Customer Identification Program (CIP) – Requires companies offering financial products to obtain a customer’s name, address, date of birth, identification number, and potentially other identifying information.
Customer Due Diligence (CDD) – Requires a financial firm to collect a customer’s credentials to verify their identity and evaluate their risk profile for suspicious account activity.
Enhanced Due Diligence (EDD) – Companies employ EDD procedures for customers that pose a higher risk for terrorism financing or money laundering, which includes collecting additional information.
Credit card issuers usually collect personal information from customers when they sign up for a credit card and may use a variety of methods to verify their identity, like checking government databases, comparing the customer's information to public records, and using biometric verification tools. Modern solutions for KYC mean entities can use APIs to automate the onboarding process for new customers and streamline operations.
Credit decisioning and underwriting look at a customer’s willingness and ability to pay. This means gathering and verifying customer information to determine creditworthiness. Since many credit card applications happen online, this usually involves some self-reporting when a customer fills out the application.
Credit decisioning and underwriting engines can use APIs to pull data from several sources, enabling more recent, accurate data on which to base credit decisions. Today’s high-performance underwriting engines enable credit card issuers to set more precise parameters and pull information from a broader range of data sources, including bank accounts. This is especially helpful for cash flow-based underwriting, which evaluates the inflows and outflows of the account over a period for more accurate underwriting.
This helps to ensure that credit is extended only to customers who are likely to be able to repay their debts and helps to manage the risk of defaults and delinquencies.
To better understand how the underwriting process works, we’ll define some key terms:
Knockout Rules – Decision rules that are typically applied before or in tandem with credit decision models to eliminate high-risk applications. These rules may include criteria about an applicant’s credit score, bankruptcies, number of open tradelines, and more. Knockout rules are generally set by the sponsor bank, third-party bank, or a third-party capital provider, though sometimes program owners will set their own.
Credit Box – The swath of credit available to borrowers based on the set underwriting standards. Like knockout rules, this is typically set by the sponsor bank, third-party bank, or a third-party capital provider.
Initial Credit Line (ICL) – This is the amount of credit initially extended during the underwriting process and is a reflection of the borrower’s ability to pay.
Tradeline – A tradeline is the word used to describe a credit account that appears on your credit report. Each account on your report is a separate tradeline and includes data about the debt and the creditor.
Once an individual applies, their credit report will be pulled from the credit bureaus. That data is run against any knockout rules and evaluated against the credit box. In some cases, knockout rules act as pricing indicators rather than gatekeepers for credit. For example, a person that has had a tradeline overdue in the past two years may conflict with a knockout rule, but rather than being denied, may simply be approved at a higher APR.
Known as “risk-based pricing”, lower-risk applicants receive lower APR offers while higher-risk applicants receive higher APR offers to make up for the potentially higher defaults. Credit card programs can set “tiers” of APRs and use decisioning criteria to qualify applicants within each.
Platforms like Tallied can also pull additional third-party data for both KYC and underwriting to offer more precise decisioning. For example, operations management software providers often have access to deep, real-time business data about their customers. This rich data can be pulled in to feed the underwriting engine, offering sharper credit decisions than other lagging indicators alone.
KYC and credit decisioning are fundamental to issuing credit cards, though they operate differently. KYC typically relies on a model to ingest data and provide a score based on the confidence level that the applicant is who they claim to be. Applicants with scores below the threshold are rejected, while applicants with scores that fall in unclear territory may be asked to provide additional information (called “manual doc-ing”).
Credit decisioning, on the other hand, tends to rely on a waterfall model. Underwriting is attempted based on credit bureau information first. If there is not enough information to underwrite on that data, alternative data may be included. If there is still not enough information, the applicant may be asked to link bank account information to enable cashflow underwriting. If still not enough information exists to underwrite after each of these data requests, the applicant is turned down.
Though they serve different functions, both KYC and credit decisioning help credit card issuers manage the risk associated with extending credit to customers. By verifying the identity of customers and evaluating their creditworthiness, credit card issuers can make informed decisions about whether to approve their applications for credit cards, and can reduce the risk of fraud, money laundering, and default. This helps to ensure the long-term viability of the credit card industry and helps to protect the interests of both the credit card issuers and their customers.
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Tallies is a financial technologies company and not a bank. Banking services are provided through Tallied’s partner bank, Evolve Bank & Trust, Member FDIC.
