KYC norms hindering financial penetration

A doctor got a call from India’s largest nationalised bank. He was told his account would be blocked unless he came and completed a few pending KYC (know your customer) formalities. He rushed to the branch where he was subjected to a pitch for a premium credit card. Annoyed at being pulled out of his schedule on a false pretext, he demanded to know what KYC formalities were pending. He was informed that KYC formality was only an excuse for marketing the bank’s latest product to him.

A story about mafia king pin Al Capone (1930s in the US) illustrates the importance of KYC. Al Capone could not be convicted on violence charges because no witness dared to testify against him. He was ultimately put away on tax evasion charges. The story underlines the importance of following the money and making sure illegal money does not use legal channels and become legitimate. Money laundering can be spotted and prevented only when all users have been identified before being allowed to use the financial system, that is, when their KYC requirements have been completed.

The need for KYC leads to paperwork at the time of opening an account, but that is unavoidable. To prevent a repeat of KYC procedures every time a financial account is opened or details have to be updated, India launched the Centralised Know your Client (CKYC) where information and documents about an individual could be kept in a central repository and be made available to eligible entities. The individual would have to provide information only at one place—the CKYC repository. All financial system players would access the information and documents from there after obtaining the individual’s approval. This is in theory. In practice, each intermediary is forced to duplicate many of the steps.

Why is CKYC failing to have the desired impact? The biggest reasons are lack of clear directions from the various regulators (RBI, Sebi, IRDAI, PFRDA, etc), lack of online connectivity between the various players and the central repository, lack of process standardisation across regulators, lack of clarity on who and how the cost of the central repository will be borne, etc.

KYC poses even more onerous challenges for companies, firms, trusts, etc. They may have multiple changes in authorised signatories or ultimate beneficiaries. They also have to update their KYC periodically. Every time this happens, they have to complete the process with each player with whom they have an account.

Consider the case of Moneylife Foundation, a non-government organisation engaged in spreading financial literacy and consumer awareness. Its bank account was frozen due to alleged non-fulfilment of some KYC condition, which was ultimately found to be not required.

Solving the KYC problem will have a huge positive impact. The lack of standardisation and ease in fulfilling KYC norms is slowing down the financialisation of the economy and the shift from a cash to an electronic economy. It is not a difficult issue to solve as the infrastructure already exists. All it requires is a multi-regulatory body like the Financial Stability and Development Council to create a consensus on cross-regulatory standardisation and implementation.

Till that happens, there will be more instances like that of the opportunist salesman who tried to market a credit card to a customer who agreed to listen to him only because he uttered the magic words: “You are not KYC compliant”.

CKYC is failing to have the desired impact due to lack of clear directions from the regulators, and lack of connectivity between the stakeholders and the repository