KYC and AML Requirements for Prepaid Cards

The coronavirus pandemic has represented a turning point in the use of cash. Because of lockdowns imposed across many nations and concerns around the risk of contracting COVID-19 from ATMs or banknotes,  many of us reduced our reliance on cash in day-to-day activities. In fact, a Bank of Engaland survey from July 2020 found that 71% of respondents were using less cash compared with before the pandemic, with the perceived length of time respondents can go without using cash increasing.

As these cashless habits become more ingrained in our societies, new financial instruments are introduced to address a range of more diverse financial needs. Among these, prepaid cards have become a very successful alternative not only to cash, but also to traditional credit and debit cards.

With prepaid cards, funds are connected directly to a card and can be used for payments, but they are not stored in a bank account. Although based on roughly the same principle, there are two different types of prepaid cards: multi-purpose/open loop and single-purpose/closed loop cards. If the former are re-chargeable cards that can be used almost anywhere, the latter can only be used at certain shops or chains.

Being a partial substitute for traditional bank accounts, prepaid cards were first introduced to cater to underbanked and underserved segments of the public. However, thanks to their flexibility and accessibility, they have quickly become very popular as an additional payment option among a growing number of consumers. The Global Prepaid Card Market size was valued at USD 2.01 trillion in 2019 and is predicted to reach USD 18.47 trillion by 2030. North America is currently the region with the highest market share, but Asia Pacific is expected to grow the most throughout the forecast period. According to a study by ResearchAndMarkets.com, this is mainly due to increasing government initiatives encouraging cashless payments and evolving retail, e-commerce, and corporate sectors in this region.

Introducing new regulations to prevent abuses

Convenience of use is one of the key reasons for the success of prepaid cards, but the anonymity connected to them has also attracted a growing number of criminals looking for new money laundering and terrorist financing avenues.

For example, the FBI highlighted the role that prepaid cards have in facilitating money laundering in a statement before the Senate Banking, Housing and Urban Affairs Committee in November 2018. In particular, “drug traffickers have been known to convert drug cash to prepaid debit cards, which they then use to purchase goods and services or send to drug suppliers, who use the cards to withdraw money from a local ATM”.

As a result, global regulators have started paying more attention to these financial instruments, introducing new and stricter requirements for their use.

In Europe, the key changes were set by the Fifth Anti-Money Laundering Directive (AMLD5). AMLD5 lowers the threshold for required know your customer (KYC) checks to €150 and to €50 in the case of remote payment transactions. Although EU countries originally had until January 2020 to implement AMLD5 at a national level, many of them still have some legislative work to do in order to transpose the directive. Once that happens, everywhere in the EU it won’t be possible to purchase cards of a value of €150+ paying in cash without identifying the end user first.

In Asia, the Hong Kong Monetary Authority (HKMA) published a revision of its Anti-Money Laundering & Counter-Financing of Terrorism Guidelines for Stored Value Facility (SVF) Licensees in October 2018. According to the guidelines, device-based SVFs (such as cards or physical devices including a chip) with a value of HK$3,000+ require normal customer due diligence checks, including ID verification and collection of personal details. In the case of network-based SVFs (where the value is stored on prepaid gift cards or mobile payment systems by using a communication network), the threshold for ID verification and customer due diligence is raised to HK$8,000+.

As another example, regulators in Singapore have embarked on a journey of legislation reform to streamline and modernise existing payments requirements. SVFs, which are currently used to the ‘light-touch’ regime of the Payment Systems (Oversight) Act (PSOA), should expect the introduction of stricter requirements over the next couple of years.

The role of technology in the fight against money laundering

New regulations are bound to put additional pressure onto issuers of prepaid and gift cards, whose margins have always been tight because of their intermediary function between multiple organisations. As lower thresholds for identity verification are introduced, prepaid card issuers will find themselves facing a dilemma: discontinue certain products that could leave them vulnerable from a regulatory compliance point of view, or introduce new measures to perform identity checks on the users of their cards before activation.

In those cases when the interruption of existing products would prove too commercially damaging, prepaid card issuers should consider implementing seamless digital solutions for remote KYC and customer due diligence checks.

This approach has the potential to solve a number of logistical problems while reducing frustrations for end customers. For example, most of us do not carry an ID card or passport with us at all times, so requiring a physical copy of an ID when purchasing a prepaid card in a shop could have a negative impact on prepaid card sales. At the same time, it would be extremely costly to train all staff at businesses that sell prepaid or gift cards – which often include Post Offices – in KYC compliance best practices.

By introducing technology that enables buyers to KYC themselves remotely through their mobile phone, issuers can ensure that cards are not activated until the required checks are performed and the new customer is approved by the card issuer’s compliance team. Among its many advantages, this technology-driven approach ensures full compliance at a very limited cost, without the need for extensive training in compliance best practices for staff or in-store manual procedures. From the customer’s point of view, the activation of a prepaid card is a necessary yet seamless step that can be performed on their mobile device, from the comfort of their home and when it suits them best.

A version of this article was originally featured in inCompliance, the magazine published by the International Compliance Association (ICA).