KYC using blockchain

Sukant Khurana
Apr 29, 2018 · 6 min read

by Anupama Jinde

Guided by

Sukant Khurana

THE ERA OF KYC

Origins:

“One match is enough to make an explosion”

The 9/11 events changed the world in more ways than one. The ripples of the terrorist attack touched many lives, industries and business spheres. It sealed the compliance regulations mandate in the USA, through legislations like the Patriot Act, Bank Secrecy Act etc.

The Reserve Bank of India, like the rest of the world, followed the lead and rolled out the speculated “Know Your Customer” in a full-fledged manner in 2004[1]. This was followed by the Securities and Exchange Board of India (SEBI) in 2012[2].

Simply put, the KYC norms mandate every customer of the bank to prove the veracity of their existence by submitting the Proof of Identity and Proof of Address. Consequently, the KYC process involves collecting, tracking and storing huge amounts of data, so that it may be reported to regulatory agencies in a timely fashion.

With the world virtually becoming boundary-free, cross-border banking transactions have grown by leaps and bounds. So has the need to ensure adequate security measure are in place.

Enter KYC.

The Need for KYC

Customer Admittance:

Anonymous accounts are restricted entry into the banking system. Preliminary pieces of information such as names, birth dates, addresses, contact numbers are collected.

Customer Identification:

In the case of suspicious banking transactions, the customer accounts can be flagged under Enhanced Due Diligence (EDD) process to the bank head office for review.

Monitoring of banking activity:

Spurious and doubtful activity in any account can be zeroed in by the bank after understanding its customer base using KYC.

Risk management:

Now that bank has all the preliminary information and activity patter, it can assess the risk and the likelihood of the customer being involved in illegal transactions

FINANCIAL ACTION TASK FORCE (FATF) was to enforce the following acts for KYC [3]:

· Combating Finance of Terrorism (CFT)

· Anti-Money Laundering act (AML)

CHALLENGES IN KYC

Disparity in specifications

• Every bank has their own specifications they adhere to

• Due to this lack of standardization, complying to each request in a customized way is time consuming.

Stringent regulations

• Regulation rules are changed often; adding more compliance burden on the banks.

• For example, in Cyprus, it is mandated that each relationship manager have an in-person meeting with the customer as part of the KYC process [4].

Adverse impact on customer relationships

• It becomes understandably irksome for a customer to provide the same information to different banking entities, sometimes in the same jurisdiction.

• Banks may even have more follow ups periodically for KYC.

Escalating cost

• Thomson Reuters estimated via a survey, that due to hassle of KYC, onboarding costs increased by 18% and they foretell a further rise of 14%.

  • Onboarding time for a new client is now a minimum of 26 days[4].

BLOCKCHAIN IN KYC:

HOW DOES IT WORK?

The blockchain is an immutable distributed ledger shared in the public domain. Every participant interacts with the blockchain using a public-private cryptographic key combination.

In its essence, since it is devoid of any single central authority, banks are taking keen interest in its applications to solve the hassles created by the present use of the KYC process.

For KYC operations, banks can use a either a private or a public blockchain. In a private one, the bank uses it for its internal audit and regulatory compliance. In a public one, where it shares data and control with other institutions.

THE PROCESS:

1. Whenever a new customer enters into the ecosystem, the ‘Trusted Party’ i.e. the bank verifies the documents.

2. Once checked for veracity, the bank uploads this data onto the blockchain

3. Whenever any new data is needed to be appended, the ledger could enable encrypted updates to the ledger.

4. These updates can be accessed by other entities in real time as and when required.

5. A Digital Identity — analogous to a digital passport — of the on-boarded customer can then be used as a trust sign for future transactions.

BENEFITS:

DATA QUALITY:

· Data alterations can be tracked and monitored — chances of misuse and fraud are reduced.

· Since all data is stored in a homogeneous blockchain, resulting better governance and use of data would help banks detect fraud at an earlier stage.

LOWER TURNAROUND TIME:

· Direct access to the KYC data could save huge amount of time for institutions.

· The hassle of disparity in specifications can thus be eliminated.

CIRCUMVENTING MANUAL EFFORT:

· Required compliance reports can be automatically generated from the data of the blockchain. This would help reduce non-compliance penalties.

· Manual error while performing the KYC initiation can be avoided.

CAVEATS:

TRUSTED PARTIES:

· The trust factor in the veracity of blockchain is built on the fact that the verifying parties are doing their job with due diligence.

· To this end, the authenticity of data depends on the integrity of the ‘Trusted Parties’ to ensure the data is valid.

NATURE OF BLOCKCHAIN:

· It needs to be decided whether the blockchain would be a private or a public one or even a hybrid one.

· Even so, it is a question whether the child private blockchains would be used integrated into the central global one.

TRACKING CHANGING VARIABLES:

· Variables which change often are difficult to track for banks, e.g. minority investors with <25% stake in a client company.

· Thus, off market transactions involving such ever changing data can be a dilemma.

TRADITIONAL VS BLOCKCHAIN KYC

CURRENT SCENARIO

SBI to roll out Blockchain in KYC [5]

“By next month, we should have two beta production solutions ready for use by the 27 banks. We will also invite further participation. The beta production that will be ready are smart contracts and second is KYC,”

-Mr. Baraokar, Head of Innovation, SBI

IBM completes Proof-of-Concept [6]

IBM has partnered with HSBC, Mitsubishi UFG, Deutsche Bank. It is a part of the Shared Corporate Know Your Customer platform. To this end, IBM was working on its Proof-of-Concept. Its phase I has been completed.

Cognizant and Indian Insurers join hands for blockchain customer data sharing[7]

Cognizant is helping Indian Insurance companies to build a robust platform using the blockchain technology. This is to assist the Insurers to collect customer and policy information for various KYC related due diligence activities.

REFERENCES

1. RBI — KYC Guidelines — https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=2039&Mode=0

2. SEBI — KRA Guidelines –

https://www.sebi.gov.in/sebi_data/attachdocs/1329473921391.pdf

3. KYC legislations -

http://www.fatf-gafi.org/about/

4. Thomson Reuters 2016 KYC Survey –

https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0ahUKEwjD75fdpNvaAhVLRo8KHdG-BqkQFggoMAA&url=https%3A%2F%2Fwww.thomsonreuters.com%2Fen%2Fpress-releases%2F2016%2Fmay%2Fthomson-reuters-2016-know-your-customer-surveys.html&usg=AOvVaw1ejrLdSZvFp4jyVOIpSb0Z

5. SBI to use blockchain in KYC — https://economictimes.indiatimes.com/industry/banking/finance/banking/sbi-to-use-blockchain-for-smart-contracts-and-kyc-by-next-month/articleshow/61715860.cms

6. IBM completes PoC for blockchain KYC –

https://inc42.com/buzz/cognizant-insurers-blockchain-solution-data-sharing/

7. Cognizant joins hands with Indian Insurers for blockchain KYC — https://inc42.com/buzz/cognizant-insurers-blockchain-solution-data-sharing/


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