Streamlining KYC: Decoding Issues & Solutions

Streamlining KYC: Decoding Issues & Solutions??

In her recent article, Monika Halan aptly highlighted the pressing issues within the KYC (Know Your Customer) sector. Despite its critical role in financial services, many operators (and even customers) would say the current KYC processes are broken. Take for example the recent incidents involving mutual fund investors. This has spurred a renewed debate within the financial ecosystem, prompting SEBI to reconsider certain requirements like linking PAN with Aadhaar for mutual fund transactions.?

In this edition of "Future Finance" we delve into the world of KYC, exploring its current norms, the issues it faces, especially with the rise in fraud, and potential infrastructure solutions that could revitalise it.

Why is KYC Needed?

Stating the obvious; KYC is an essential process in the financial sector for verifying the identity of customers. This is critical to prevent financial crimes like money laundering, terrorism financing, and fraud. The process involves collecting and validating personal details like identity and address proof at the time of opening a new bank, loan, fund or other account.?

By conducting KYC, financial institutions can save the identity trail of customers, enhancing the ability to safeguard operations and ensure the legitimacy of their customers.?

Where We Stand in India and the World

While the fundamental objectives of KYC are largely consistent worldwide, the implementation and regulatory frameworks do vary across nations. In the US for example financial institutions collect and verify information like social security identification number, date of birth and address for all, whilst high-risk customers are required to provide more detailed information.

In the European Union, electronic IDs and trust services are used to verify customer identities. Companies are also required to disclose beneficial owners to central registries. In the Middle East, even passports and residency permits are verified.?

In India, the Aadhaar-based eKYC system has emerged as a popular tool to electronically verify identities through the national biometric database.?

Despite this, the KYC process is cumbersome and often inconsistent across different financial products and institutions.?

Source: Appian

Current Infra Challenges Despite the evolving framework, KYC processes in India and worldwide face several infrastructural challenges:

• Complexity and Lack of Unity: Different financial entities have their own KYC protocols, leading to confusion and higher operational costs.
• High Costs: According to KMPG, the average bank spends about $48 Mn per year on improving and managing their KYC along with the Anti- anti-money laundering (AML) process.??
• Frequent Updates and Revalidations: Customers are required to update their KYC information regularly and submit fresh KYC details every time they engage with a new financial entity.
• Fraud and Identity Theft: KYC systems are increasingly targeted by sophisticated fraud techniques, including synthetic identity fraud and deepfake technology.

Sophisticated fraud tactics pose significant risks to customers. Incidents of synthetic identity fraud, where fraudsters create fake identities using real and fabricated information, are increasing. AI-generated videos are being used to impersonate legitimate customers during KYC calls, and biometric data theft is becoming more common. Simplifying and securing the KYC process can drive greater financial inclusion and protect consumers.

What’s the Solution?

Recognising these issues, the Indian government announced measures for a uniform KYC policy in Budget 2024. A committee of industry experts has been set up to propose changes, aiming to streamline the KYC process across all financial sectors and reduce the need for repeated verifications.

A significant development is the plan to revive the Central KYC Records Registry (CKYCR) with an upgraded version, CKYC 2.0. This initiative, led by the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI), aims to address previous shortcomings, such as poor-quality document compression and lack of database validation.

With CKYC 2.0, validations will be integrated, and customers will have portal access to check their records. They will also receive updates when their records are retrieved, reducing the chances of fraud. If successful, CKYC 2.0 could revolutionize the industry by ensuring consistent data quality and transparency.

With CKYC 2.0 fraud issues will also get mitigated as the customer is empowered with transparency. They will be notified when their KYC records are accessed for them to know how many regulated entities have access to their records in real-time!?

Driving Change with Digital Public Infrastructure (DPI)

The CKYC 2.0 project is a strong use case for DPI, enabling both regulated entities and customers to benefit from a low-cost, transparent model. Tools like Digilocker, which provides secure access to documents, have already been game-changers in this regard.

Innovation in Fintech Infrastructure

The lack of standardised KYC processes has led to a surge of fintech startups offering innovative solutions.

Some have developed aggregated KYC models with fallback mechanisms to ensure maximum conversion. There is a need for these models to be further enhanced with risk-based or fraud control systems.

In conclusion, While KYC is crucial for maintaining the integrity of the financial sector, it currently faces numerous challenges that need addressing. The plan to revive CKYC is a positive step towards simplifying and securing the KYC process. Apart from a push from the Govt, regulated entities will play a crucial role in ensuring the quality of data is maintained. Fintech innovations can further support these efforts, creating a more efficient and secure financial ecosystem.

What are your thoughts on the current KYC landscape? Will the uniform KYC with CKYC 2.0 be a game-changer, or is there more that can be done? Tell us in the comments section.?