FinTechOverview of Know Your Customer (KYC) Verification

INTRODUCTION

Know Your Customer (‘KYC’) is a process of verification through which institutions confirm and authenticate the identity and address of a customer. KYC is precautionary measure to curb illegal activities such as money laundering, bribery, or corruption. Identity verification of customers involved in financial transactions of huge figures had become an imperative objective to restrict money laundering and terrorist financing.

By imposing the requirement of KYC on each financial customer, the Government through the Reserve Bank of India (‘RBI’) is able to keep a track on such activities and take measures to curtail them. Banks, digital payment companies, and financial institutions are now required to ensure that customers complete the KYC process before allowing them access to financial services.

In pursuance of the same, certain Customer Identification Processes (‘CIP’) were introduced as a condition precedent to institutions undertaking transactions through account-based relationships or otherwise.

The concept of Customer Due Diligence (‘CDD’), introduced under the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005 (‘PMLA Rules’) provides methods for verification of the client’s identity considering the type of client, business relationships, nature of transaction and so on. KYC is a part of such CDD. The regulatory framework for KYCs in India is prescribed in the RBI Master Directions – Know Your Customer (KYC) Directions, 2016 (‘KYC Master Directions’).

Through this article, we attempt to analyse the basics of KYC in India.

WHAT DOES KYC MEAN?

KYC is a systematised process for verifying the identity and address of a financial entity’s customers. Under the KYC Master Directions, all Regulated Entities (‘RE’) are compulsorily required to conduct KYC verification before undertaking any transactions with its customers. In this context, RE has been defined under Paragraph 3 of the KYC Master Directions to include Banks licensed under Section 22 of the Banking Regulations Act, 1948, All India Financial Institutions, Non-Banking Financial Institutions, Prepaid Payment Instruments Issuers and so on.

Paragraph 4 of the KYC Master Directions necessitates a duly approved KYC Policy for all REs. Additionally, four key elements to be included in the KYC policy have been enumerated by the KYC Master Directions, namely:

• Customer Acceptance Policy;
• Risk Management;
• Customer Identification Procedures (CIP); and
• Monitoring of Transactions

Thus, introduced with the two-fold objective of preventing fraud, money laundering, or similar criminal activities; and getting a better understanding of the needs of the customers, KYC is watershed step directed towards prudent risk management.

TYPES OF KYC

1. Paper based KYC

Paper based KYC is a type of ‘in-person’ KYC that verifies the identity of the customer through submission of self-attested copies of proofs of identity and address of such customer. Being a tradition mode of CIP, this process of verification requires the physical presence of the customer before verifying authority/agency.

Despite the ease of such KYC owing to its familiar model, the manual nature of this type of KYC makes it cost-intensive and susceptible to operational delays and consequent inefficiency. Further, paper based KYC generates a substantial record of documents that need to be stored, thereby imposing an additional burden of safekeeping and storage of such documents.

2. Aadhaar based e-KYC

The significant factor of such KYC is that it relies heavily on the Unique Identification Authority of India (‘UIDAI’) database. Undertaken over a remote access, this KYC does not require the physical presence of the customer, and is therefore compliant with the digital model.

Aadhaar based e-KYC can be conducted in two ways, i.e., OTP based and Biometric based. The OTP based Aadhaar e-KYC requires the customer to have his mobile number linked with his Aadhaar. Thereafter, the process of e-KYC involves entering such mobile number with the verification authority and receiving a One Time Password [OTP]. Once the link between the customer and his Aadhaar is verified, the KYC is completed. Following a similar structure, the Biometric based Aadhaar e-KYC uses UIDAI approved biometric scanners to verify the link between the customer and his Aadhaar to complete the KYC verification.

Aadhaar based e-KYC can be conducted by commercial banks and telecommunication companies that hold the specified licenses from the UIDAI.

3. Offline KYC

Clause (pa) of Section 2 of the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 defines offline verification of KYC as:

“Offline verification means the process of verifying the identity of the Aadhaar number holder without authentication, through such offline modes as may be specified by regulations.”

Therefore, when KYC based on Aadhaar is conducted without relying on the UIDAI database, but through submitting an offline form of Aadhaar, such KYC is known as Offline KYC. This could be undertaken through an xml or pdf based authentication and does not require biometrics. Offline KYC is accessible by all private banks, financial services and insurance companies provided that the customer’s consent is sought. The only pre-condition in such KYC is that the person’s phone number must be linked with their Aadhaar to facilitate the download of offline Aadhaar.

4. Digital KYC

The concept of a digital KYC was introduced in the KYC Master Directions through Amendment dated 09.01.2020. Digital KYC can be conducted by all banks, NBFCs and FinTech companies in situations where offline verification cannot be carried out.

Paragraph 3 of the KYC Master Directions defines Digital KYC as:

“capturing of the live photo of the customer and officially valid document or the proof of possession of Aadhaar, along with the latitude and longitude of the location where such live photo is being taken by an authorised officer of the RE.”

In this context, an Officially Valid Document (‘OVD’) as defined in Paragraph 3 of the KYC Master Directions includes:

• passport,
• driving licence, 
• proof of possession of Aadhaar number,
• Voter’s Identity Card issued by the Election Commission of India,
• job card issued by NREGA duly signed by an officer of the State Government,
• a letter issued by the National Population Register containing details of name and address.

The process for obtaining Digital KYC is further elaborated under Annex-I of the KYC Master Directions.

5. Central KYC

Central KYC is the process of verification of customers based on a central repository of the customer KYC records to facilitate inter-usability of the KYC records by the Banking, Financial Services and Insurance (‘BFSI’) sector. Rule 2(1) (aa) of the PMLA Rules states that the Central KYC Records Registry acts as the repository that “receives, stores, safeguards and retrieves the KYC records in digital form.”

The KYC documents for Central KYC are submitted to the Registry through the Central Registry of Securitisation Asset Reconstruction and Security Interest (‘CERSAI’) portal. Once the signed form of the Central KYC along with proofs of identity and address are submitted to the Registry and the process of Central KYC is completed, a 14 digit KYC Identification Number (‘KIN’) is issued to the customer. The procedure for CDD and sharing of KYC information with the Central KYC Records Registry is provided under Paragraph 56 of the KYC Master Directions.

Despite Central KYC being a cost effective and time efficient mode of verification as it provides a single portal to upload documents for KYC, it is only available for use by the Government or Government regulators such as RBI, IRDAI, SEBI and so on.

6. Video KYC

Video KYC is an assisted or non-assisted KYC where the proofs of identity and address along with a video recorded through an app or a web portal provided by the service provider is submitted to be viewed and verified manually by an Agent. Apart from being paperless, such KYC provides for a fraud-free authentication where technology is used to verify the genuineness of documents and authenticity of the link between the individual and the documents.

It available as Video-based Customer Identification Process (‘VCIP’), Video-based In-Person Verification (‘VIPV’), and Video-based identification Process (‘VBIP’).

Among these, Paragraph 18 of the KYC Master Directions lays down the conditions, infrastructure and procedure for V-CIP. It is defined as a method of:

“customer identification with facial recognition and customer due diligence by an authorised official of the RE by undertaking seamless, secure, live, informed-consent based audio-visual interaction with the customer to obtain identification information required for CDD purpose, and to ascertain the veracity of the information furnished by the customer through independent verification and maintaining audit trail of the process.”

The technology intensive procedure for Video KYC makes it accessible only to banks along with OTP-based Aadhaar e-KYC or Offline Aadhaar verification, and to NBFCs and FinTech Companies that use Offline KYC.

BENEFITS OF KYC

KYC norms were introduced with a view to prevent money laundering and terrorist financing. Additionally, it helped in understanding the customers and prudently managing any risks that may arise. The KYC verification, therefore, promotes financial inclusion and risk management.

KYC allows monitoring of the customer’s activities. Such data collection and processing helps in ensuring that the financial institutions and other REs are not exploited to engage in money laundering, tax evasion or terrorist financing.

Quite a few non-individual customers (such as companies, partnership firms and so on) are engaged in financial services like trading through a demat account, mutual fund investments, etc. KYC requires verification of the legal status of such customers, hence, clearing any ambiguity relating to such engagement.

KYC also finds relevance under the revised RBI Master Directions on Prepaid Payment Instruments (PPI), 2017 where the categorisation of payment instruments involve a Full KYC PPI.

 Summarising the benefits of KYC, it is an essential process of verification as it:

• Acts as a safeguard against money laundering, tax evasion and other illegal transactions.
• Is instrumental in risk management of customers.
• Ensures secure issue of PPIs, thus safeguarding the financial system from breaches.

AMLEGALS REMARKS

KYC verification while transacting with a bank is a significant step for opening of bank accounts, or investing in fixed deposits. Its requirement is based on an understanding that after recording the individual’s identity, the banks are in a better position to predict and consequently prevent frauds. In cases of investments and life insurance, conducting KYC ensures that the purchases are made by a real, legal person and that no black money is in circulation. It ensures that the monetary transactions taking place are transparent and legitimate.

The financial institutions may choose the type of KYC based on its infrastructure and requirements. The procedure to be followed for different types of KYC is prescribed in the RBI Master Directions, thus clearing any ambiguity with regards to the same.

With the recent introduction of Digital KYC and Video KYC methods, the process of KYC verification is made up-to-date with the current trends and technological advancements.

The various methods for obtaining KYC, including paperless, Aadhaar based, video based or physical verification, has made the verification process easily accessible to people across the country and not restricted to a specific class of people. Applicability of automation to the KYC process has made the CDD process efficient, faster and easier.

Hence, introduction of KYC has been a reformative step forward which has improved the economic and financial conditions of the country and benefited the population and banks/financial institutions at a large scale.

– TEAM AMLEGALS, assisted by Ms. Anumeha Smiti (Intern)