Know Your Customer (KYC) is regarded as the backbone of a financial institution’s anti-money laundering efforts. Recently, industries have experienced a massive shift to digital transformation in the last ten years, and the change was more accelerated as companies started prioritising cost savings, efficiency and security. One particular industry that benefited most from the digital shift is the financial sector. According to a study published in 2020 by Ernst and Young, 60 percent of banks showed interest in using their funds to drive digital adoption technologies like AI, blockchain, analytics and robo-advisors. KYC is regarded as the backbone of a financial institution’s anti-money laundering efforts (AML). Hence it is commendable to see global spending on AML and KYC solutions reaching the $1.2 billion mark. This signifies how institutions are investing in rgtech, which is the management of regulatory processes within the financial industry with the help of technology. This is done so that regulations become more efficient and accurate. The adoption of the emerging technologies for KYC processes has been increasingly spearheaded by regulators and governments. For example, Dubai’s Department of Economic Development and International Finance Centre announced the expansion of a KYC tool for financial institutions that is powered by blockchain technology and it will help process more than half of all KYC checks in the city.
KYC is a regulatory requirement that underpins our current global economy, but many believe that its current processes are inefficient and outdated. It is imperative that financial institutions from all over the world must conduct time-consuming, cost-heavy checks in order to verify their customers’ identities. If not complied with existing regulations, not only will they face fines but they often have to navigate between many different regulatory borders, along with storing and protecting their huge amount of users’ data.
But, no matter how much entities strive to keep up with digitisation, evolving processes do not happen all at once and change is not linear. And this is exactly what we are seeing in the KYC space. While organisations have taken steps to innovate and improve, KYC processes still remain lengthy and inefficient, primarily because of a lopsided focus on information gathering and processing instead of conducting risk assessments. Banks have been doing their best by introducing technology into the elements of the KYC process. For example, live identity verification automates the processing of KYC documents in order to save some man-hours. But one of the biggest obstacles that are currently standing in the way of efficiency in KYC is the lack of efficient information processing between two parties.
The flaws of the existing KYC process
Financial institutions have been battling with inefficient and labour-intensive KYC processes for a long time now. Even with the help of technology, a study found that banks are still struggling with issues like lack of data accuracy and sufficiency, along with a rise in false-positive screening results. Additionally, 64 percent of banks believe that focusing on better customer due diligence (CDD) is the key to these problems. Traditionally, when financial institutions decide to onboard clients, they would require the company to share information as a part of the KYC process, which usually involves going back and forth between banks and customers, and multiple rounds of questioning. After that, banks are required to systematically update client information to ensure that data is stored in the most detailed manner possible. But there are two major problems with this. Firstly, only when suspicious activity takes place in their account, entities might be alerted. They are also required to conduct frequent media searches to keep the customer profile up-to-date.
Talking from a regulatory perspective, most regions believe that customers, be it individuals or businesses, have to take responsibility for their own data. This translates to the fact that client information is kept confidential and only the customer is allowed to share their information with chosen parties. However, this stretches the information gathering process since the information has to be separately received and validated by the banks and contributes to the overall inefficiency of existing KYC workflows. This could result in customers feeling frustrated with the lengthy approval process and prospects might miss opportunities during the delay or might back away due to the complex nature of KYC checks.
In 2020 alone, global institutions were fined $10.4 billion related to AML, KYC and data privacy violations and issues. While this may seem huge, if you start unpicking the complex and relentless requirements, it becomes quite clear that there are many regulatory loopholes for institutions to jump through. KYC checks are not done after institutions can verify a person’s identity and then continue to provide services. Instead, it’s a long-drawn process where banks and other financial institutions are required to conduct checks and monitor customer transactions on a regular basis that takes up substantial time and resources.
Banks and other financial institutions will also have to make sure they adhere to all applicable regulations, which can be cumbersome when facilitating transactions across borders and regulatory zones.
The Covid-19 pandemic has also accelerated criminal activities and they are slowly becoming sophisticated. Attackers are coming up with a lot of innovative methods which are often faster than the speed at which organizations are digitizing their KYC processes and are also exploiting the unstable economy to take advantage of the system. In order to fight this, it is important for institutions to support the existing KYC procedures. To fight against the fraudulent landscape, it is essential that banks leverage the diverse data points and come up with a comprehensive risk profile for their clients.
In essence, the risks are far-reaching and have severe consequences. To understand the magnitude of the problem, we only need to take one look at the Facebook data leak of 500 million users to see the serious economic and social implications of not adequately protecting user data. Business owners are usually very protective of their information or hide the source of assets in the likes of offshore bank accounts and shell companies. All these factors add to make the KYC process even more difficult.
Blockchain helping revolutionise the KYC process
More than anything, the data industry now requires a solution that will guarantee transparency, security, efficiency and scalability. Currently, KYC processes are extremely expensive and resource-intensive. Finding a solution to this will actually streamline the redundant and slow data gathering processes that are currently present, which will result in cost-saving for the industry while boosting the confidence of market participants and regulators. Blockchain technology is actually the perfect solution here. It is anti-fraud by design and makes sure that records are encrypted and immutable. By implementing blockchain technology, there will be no need for an intermediary providing assurance. Shared data can also come with the customer’s digital signature, and it can completely remove the need for third parties to be involved in the process and to validate data manually.
Blockchain can also be used to scale and process massive volumes of data. Given the enormous number of banks and clients present on a global scale, this is indeed a blessing. With the help of permissioned enterprise blockchain platforms, customers can be assured that their sensitive data and personal information is only shared on a need-to-know basis, which will happen under strict authentication requirements. All the parties involved will be present in a closed ecosystem and members involved decide to whom to grant access. Keeping this in mind, creating such a platform will also bring added benefits for regulators and customers alike. Working on the same concept, regulators would be able to review KYC processes, data, and accurately evaluate the risk profile of their clients, all while staying within the regulatory framework. Integration of blockchain technology will also be able to save time that goes behind consolidating and validating data. Customers will be able to liaise with their respective banks on KYC related queries.
Blockchain shaping future of regulated industries
KYC processes are essential to fight money laundering schemes, and banks will definitely benefit from the integration of blockchain technology into existing KYC methods. But the application of blockchain technology in highly regulated industries does not stop here. It has been witnessed previously that the public sector has continued to embrace new and evolving technologies. Seeing the advantages, they are now demanding more efficient and reliable systems to cut down on costs, realising that they can reap the benefits of blockchain technology in more than one way. From how to manage governments, allocating and granting funds in governments’ procurement processes, land registries, in providing citizens’ services, blockchain technology brings a plethora of benefits.
SWIFT, a global provider of secured financial messaging services has established a KYC registry with 1,125 member banks sharing KYC documentation. But this is only 16 percent of the 7,000 banks on their network. SWIFT’s KYC registry is an efficient and shared platform that helps manage and exchange standardized KYC data. Users can upload their documents for free to the registry and share them with other institutions. SWIFT validates the data rigorously, informs the client if it’s incomplete or needs updating, and sends out alerts to correspondents whenever the data changes.
There is no denying that there will be issues regarding the security of customers’ KYC information but, as long as all KYC is held on a private blockchain rather than a public one, these issues can be heavily minimised from a customer’s point of view. Experts say that data stored on the blockchain will merely be a reference point with a digital signature or cryptographic hash. This would give individuals access to the relevant client information in a repository separate from the blockchain, which will ensure a secure and private way of conducting and storing a customer’s KYC information.
Given all that we have discussed above, it is clear that blockchain could have a major role in streamlining these KYC and AML processes. But this may require cross-border consensus regarding what is acceptable and what needs to be done in terms of acceptable document verification. According to a report published by Goldman Sachs, the banking sector can achieve a 10 percent reduction in headcount with the introduction of blockchain in the KYC procedures. This amounts to around $160 million in cost-saving annually. Blockchain is also expected to reduce budgetary resources allocated for employee training by 30 percent, thereby saving $420 million. Overall operational cost savings are estimated to be around $2.5 billion dollars. The introduction of blockchain technology will also reduce AML penalties by $0.5 to $2 billion.