In 2002, the Reserve Bank of India issued a mandate for all financial and non-banking financial institutions across the country to get their KYC procedures in place, and since then KYC has become a synonymous element of every customer’s onboarding journey in a financial institution, however, what is the meaning of KYC and why is it so important for banking and non-banking institutions to adhere to this mandate?

What is KYC?

In simple terms, KYC can be understood as an algorithmic and automated verification method, financial and non-banking financial institutions can leverage to accurately verify the identity of a customer. The industry acronym KYC alternatively stands for Know Your Client and Know Your Customer, and today more than 80 countries across the globe have standing instructions on how and why KYC procedures should be leveraged to verify the identity of a customer.

Source : Important checks when onboarding external relationships worldwide in 2019 [Link]

The idea behind KYC as a computer driven technology is quite simple.

The KYC algorithm gathers data on a customer from a multitude of sources ranging all the way from government issued identification documents to utility bills, to assess whether the claim of the customer in regards to their identity is accurate or not.

Before the epidemic growth of this verification process, institutions mostly relied on manual background checks and unchallenging good faith techniques to verify the legitimacy of a customer, thereby risking the institution to potential fraud or undue participation in terrorist activity.

However, since the popularity of this technology increased on a global scale, institutions across the globe leverage it to not only protect their business from fraudulent activities but also accurately estimate the risk model they should employ for specific customers.

Source : Success rate of relationship checks in financial crime prevention worldwide in 2019, by technology use [Link]

To understand this better, let us take the case of India.

As a banking institution, whenever a customer approaches you for a product or service, your first step of action is always to run a KYC check. Upon successful enquiry, you not only have access to the key credentials of the customer (such as their name, phone number, email address, permanent address etc.) but also to their financial history in the form of credit history delivered via credit rating agencies such as CIBIL, or Experian.

Essentially, a successful KYC enquiry on a customer equips you with a holistic view of their background information as well as their past financial history, such that you can position and better render your services and products.

However, the advantages of KYC do not end here.

Benefits of KYC

  1. Helps you efficiently access and assess the past financial history of the client in terms of assets and liabilities, such that you can accurately perform a risk assessment.
  2. Empowers you to effectively reduce your exposure to fraud by accurately verifying the identity claim of the client.
  3. Prevents your undue or unwarranted participation in terrorism and money laundering activities.
  4. Decreases the overall risk on your lending portfolio, thereby actively contributing to higher profit margins.

Documents Required for Facilitating the KYC Process

The exact documentation required to facilitate the KYC process tends to vary between jurisdictions; however, some of the main constituents remain consistent, and they are as shared below.

  1. Proof of residence via utility bills, government issued identification documents
  2. Proof of identity via social security number, Aadhar Card, Driver’s License
  3. Proof of income via credit reports, PAN Card, ITR filings
  4. Proof of employment via MGNREGA cards

Since in most developed economies, all or most of these credentials are interlinked to each other, the KYC framework cross checks references across them in an effort to verify the identity claim of the customer.

But How Exactly Does the KYC Process Work?

Source : Know Your Client (KYC) [Link]

The technology that empowers KYC remains the same across geographies; however, the exact steps of the process might slightly differ between nations. Shared below is a brief snapshot of the same.

Submission of Documents

As the first step of the process, the applicant needs to submit either or all of the documents listed earlier either via electronic or physical means.

Identity Verification

Once the documents have been successfully collected from the applicant, the first stage of the verification process is initiated. Depending on the document the applicant submits, the concerned agency is contacted, and a request for verification is submitted.

For example, if an applicant in India submits their Aadhar Card, then the institution to be contacted will be UIDAI (Unique Identification Authority of India).

Residency Verification

One of the key steps of the KYC verification process is ascertaining the residency status of the applicant. In most cases, the lender starts by verifying whether the applicant is residing domestic or foreign, followed by verifying their provided address with the concerned authority, such as municipality records.

Financial History

The next step of the verification process is validating the financial condition of the customer. In most cases, credit rating agencies (for example, CIBIL and Experian) are contacted to access the customer's financial records and get an accurate estimate of their assets and liabilities.

Transaction History

Last but not least, the institution checks the customer's transaction history, followed by flagging and assessing irregular and high-value transactions such that an accurate risk model can be crafted.

KYC Verification Agencies

As you might already have realised, verifying the KYC of a customer is a time and resource-intensive process, mainly due to the fact that there are so many individuals steps involved and multiple stakeholder inputs to be coordinated.

Keeping this in mind often, financial and non-banking financial institutions outsource their KYC procedures to an external agency.

The advantage of this method is twofold:

  1. The institution can benefit from the freed up resources they now have access to since KYC is being handled by a third party.
  2. The institution can bargain for lower prices due to the scale of economies principle followed by these external agencies.

Additionally, these days there are automated softwares available in the market, which can be directly integrated within the institution’s Loan Origination System, thereby enabling them to process customer requests faster and at a lower cost.

Conclusion

As the number of unbanked customers across the globe continues to decrease, the importance of a robust KYC process is the need of the hour, and due to this, the mechanics behind this technology are advancing every day.

So the next time you sign up on a banking platform or apply for a loan, reflect on the immaculate KYC process happening behind the scenes.

This is the power of modern fintech technology.

Thank you for reading, and I will see you in the next post.


Frequently Asked Questions (FAQs)

  1. What is the full form of KYC/What is KYC (Know Your Customer)?

The full form of KYC is Know Your Customer or Know Your Client.

2. What is the exact use of KYC?

Know Your Customer (KYC) is the process of accurately verifying the identity of a customer.

3. Explain the Know Your Customer (KYC) due diligence checklist.

The Know Your Customer (KYC) due diligence checklist consists of three steps

a. Accurately verify the identity of your customer.

b. Immaculately understanding the nature of the customer's financial activities

c. Crafting a customised risk profile for the customer for future monitoring.

4. Who introduced Know Your Customer (KYC) scheme in India?

The RBI (Reserve Bank of India) introduced the Know Your Customer (KYC) scheme in India in 2002.