heyYour experience suggests that KYC or Know-Your-Customer is cumbersome. Address proof is difficult to get, especially if one moves to a new city. One KYC never seems to be enough – every new transaction requires a new KYC process. Economic growth comes as much from innovation as it does from reducing friction in the process of doing business. Finance Minister Nirmala Sitharaman has acknowledged this reality in her budget speech, announcing her intention to simplify KYC procedures. As the finance ministry begins to put in place a risk-based framework, it would be useful to remind ourselves of the origins of KYC. Key areas such as address proof requirements and enforcement procedures should be the focus of our reform efforts.
Origin of KYC
There was, and remains, a general consensus that activities such as money laundering (ML), terrorism finance (TF), and weapons proliferation (WP) can be brought under scrutiny if the financial flows supporting these activities are can be identified and prevented. right on time.
A multilateral global body, the Financial Action Task Force (FATF) was established in 1989 to issue standards, including customer identification and verification, that member countries could adopt. Member states must translate these into laws and regulations for their jurisdictions. After the 9/11 attacks, money laundering, terrorism financing, and arms proliferation gained more prominence than ever before. In 2002, Indian regulators also imposed customer identification requirements under the Prevention of Money Laundering Act (PMLA) 2002. India became a member of the FATF in 2010, and since then our requirements under the PMLA have been continuously updated to ensure compliance. FATF Guidelines.
However, the FATF recommendations provide flexibility to countries in designing their KYC. For example, the FATF Task Force recommends that countries adopt a risk-based approach to identifying and assessing risks. That is, countries must identify money laundering or terrorism financing risks in all regions (or thresholds for transactions), and place different obligations on entities based on the identified risks. In fact, FATF allows member countries to completely exempt certain types of transactions or financial institutions if the risk of money laundering/terrorist financing/weapons proliferation is low.
While the FATF allows a risk-based approach, India chose not to follow it. there are three main Problem How we do KYC: a) excessive emphasis on proof of address, b) incomplete technical solutions, and c) poor design of enforcement actions. These could be important factors for change as we move towards simplification of our KYC procedures.
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Reduce the burden of address proof
Address proof is required for almost every transaction in India. While regulators have made efforts to expand the list of officially valid documents that can serve as proof of address, the question to ask is why do we need them? These are not coming from the FATF – other countries have adopted liberal definitions of addresses, especially for low-risk transactions, which include just a post box (PO) box number (US), date of birth (Australia), a Contact address included No emphasis on “Permanent Address” (Germany). Rationalization of address proof requirement should be the first step towards KYC simplification. This can be done by not requiring a permanent address, but only a correspondence address. This can also be done by mandating all financial regulators to rely on KYC which is already done while opening a bank account.
improve the design of the penalty
Non-compliance of KYC norms attracts penalty. But punishments must be proportionate – that is, how severe they are must vary according to the seriousness of the crime. Currently this does not seem to be the case with the Indian framework. Penalties often range from high fines to criminal sanctions and the possibility of revocation of a business license. There is also no appellate mechanism against regulatory orders. The lack of an appeal mechanism for RBI-regulated entities violates due processes. It’s no wonder that financial institutions choose to play it safe. A risk-averse strategy in a poor enforcement environment is to conduct due diligence even when it is not required.
Simplification of KYC is related to improving state capacity in regulation. The Finance Minister has already acknowledged the importance of decriminalization in his budget speech. The design of the penalty should be proportionate, and the reasoned order should be publicly available. The government should also create an appeal process against RBI decisions. Many of these recommendations were made by the Financial Sector Legislative Reforms Commission (FSLRC). In terms of KYC norms, the time has come to implement them.
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Moving Beyond Technology Solutions
Our response to KYC problems has been to bring in technology to streamline some of these processes. The problem is that they often don’t work as well as expected. For example, video and eKYC have not been implemented across circles. They rely on technology that can often be deprecated in itself. They can create new privacy risks. They may not even be as cheap as they are made. More importantly, they do not address the root cause – poorly designed policy and enforcement processes. Use of DigiLocker and account aggregators can solve some of the hurdles. However, the real solution lies in getting us to a place where technological solutionism is no longer needed. Recognizing the need for a ‘risk-based’ approach is a step in the right direction.
Renuka Sane is Director of Research at TrustBridge, which works on improving the rule of law for better economic outcomes for India. Thoughts are personal.
(Editing by Anurag Choubey)