Last week the Finance Minister sat down at a meeting to discuss how KYC could be simplified for businesses. So in today’s Finshots, we tell you why it matters.
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The Story
Imagine that it’s the year 2000. You’ve gone with your parents to the bank. They want to open a new bank account. What do you think would have to be done?
They’d most likely filled an account opening form, pasted a latest photograph and signed a few papers. Their presence was probably enough to trust that they’re the ones opening an account. Identity proofs may not have really been a norm. And address proofs may not have been questioned.
But that meant dubious individuals could go and open a bank account on behalf of just anyone else. And that made nefarious activities such as terrorist financing and money laundering easy.
So in the early 2000s, the Reserve Bank of India (RBI) finally chalked out KYC regulations for the financial industry to clamp down on these practices. Maybe it was inspired in part by the 9/11 attacks in the US. While the US already had KYC rules in place, they realised that the rules needed to be stricter. So they clamped down. And maybe that had a ripple effect that reached India too — by 2005, the RBI strengthened its Anti Money Laundering Standards.
So now, anyone walking into a bank for a new account had to prove their identity and place of residence with valid documents.
Cut to today, KYC has come a long way. You can't really initiate any financial transaction without it.
But, while these stringent rules might reduce the chances of financial crime, it seems to have become a pain point for businesses.
Why, you ask?
When KYC was introduced, banks and other financial institutions were expected to abide by the rulebook. But not every customer had a proper document to prove their identity and address. There could have been mismatches. Or people’s photographs in their identity cards could have differed from how they looked then. Authentication was still hard. Financial institutions too wouldn’t want to lose out on customers because of cumbersome KYC procedures. So you can be sure that their level of due diligence wasn’t up to the mark.
Then came Aadhaar in 2010. It was a unique 12 digit number that gave Indians an identity record which was authenticated by individual biometrics. Now this made lives easy for the folks performing KYC checks at banks and financial services firms. To put things in perspective, the average cost of verifying documents came down from ₹500–700 per person to just ₹3. At least that’s what the Finance Minister Nirmala Sitharaman claims.
So yeah, acquiring customers was now cheaper and simpler.
But here’s the thing. Organisations tapping into Aadhaar data to onboard customers could become a privacy nightmare. If their systems weren’t secure enough, customer data could be tapped for easy misuse.
So that led the Supreme Court to turn the screws on this practice. In 2018 it struck down a law that allowed private entities to use Aadhaar authentication to establish customers’ identity before onboarding them to provide services.
Okay, but how does that change anything for banks?
Well, let's just say the big impact was felt on the fintechs who were riding high on India's digital revolution. For context, between 2016 and 2021, 14,000 startups kicked off, almost half of which were in the fintech sector. And if they wanted to innovate with digital services and get new customers to try them, they had to abide by the KYC norms.
But not having easy access to Aadhaar data increased their costs. At least ₹120 per customer. Besides, they had to shell out more money to secure their systems so that they could be trusted enough for the law to let them tap into the Aadhaar-based KYC method.
So they struck on an idea. They said “Hey, let’s just get digital copies of customers’ identity and address proofs and authenticate their existence by sending OTPs to their mobile numbers. That way we could get them to start using our services and nudge them to do a full KYC later if they want to keep using it.”
That folks, was the partial KYC trick to keep something called drop-offs at bay. Simply put, it made sure that customers weren’t hesitant to try a new service because completing a long KYC process would take time.
The government’s DigiLocker, a digital service that allows companies to access digital versions of customers’ documents like driving licences, academic mark sheets, PAN cards, etc. also helped them sail smoothly through the partial KYC process.
You also had something called the c-KYC (Central KYC) which helped various organisations obtain customers' KYC through a common online registry. Companies would just have to check if a customer had completed their KYC with another bank or financial institution. If yes, they’d upload that to a common pool on the internet, and other entities could simply look customers and their identities up.
But you can imagine that the RBI wasn’t happy with this. Simply because it has only aspired to make things as foolproof as possible in the financial sector with stringent KYC rules. When it rolled out a whole set of KYC guidelines in 2016 it wanted to ensure that entities who weren’t complying would be penalised. Albeit not directly, but at least in the form of putting a freeze on customers’ accounts if the KYC rulebook wasn’t being followed.
And now that it sniffed that digital entities were using a turnaround to push their services, it had to chip in again. It simply felt that the whole process was back to square one. Physical KYC verification just wasn’t happening to prevent fraudulent services or customers.
So it threw another spanner in the works. It simply said that it would tag customers’ accounts with such partial KYCs as “high risk”. And if that had to be undone, companies would have to either do a full KYC via video calls or in person.
Just think about it. Downloading data from the c-KYC registry hardly cost a Rupee per customer. But switching to a video KYC would cost 15x. And switching to an in-person KYC would cost a whopping 100x! The bottom line ― The RBI’s move was quite a death knell. It threw fintechs into a tizzy, derailing over 8 lakh corporate credit card users from startups and SMEs (Small and Medium Enterprises) in just a couple of months.
Fintechs couldn’t handle it anymore. They had to voice their opinion. So they kept some ideas on the table. The government could bring in a single repository to authenticate KYC documents. Or even expand DigiLocker in a way that KYC processes will become more reliable.
And maybe the government has finally heard them.
The Financial Stability and Development Council (FSDC), headed by the Finance Minister, met last week to discuss it. Think of it as an apex body that monitors large financial conglomerates.
The Council discussed ideas to simplify KYC in a way that would not just keep the norms strong but also simplify the process for fintechs. So soon we could have uniform KYC norms and a way to bring about inter usability of KYC records across the financial sector.
So yeah, that’s exactly why KYC is getting a much needed makeover. We’ll only have to hope that it shapes up quickly enough. Godspeed!
Until then…
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