Speeding up the KYC process and boosting the underlying reliability of existing KYC processes are important goals for financial institutions that have been struggling under the weight of AML and other regulations.
Collaborative KYC projects that utilize blockchain technology are promising improved KYC processes: more transparency, higher accuracy, and faster customer vetting. Several proof of concept projects involving KYC have been completed, but as it stands, can blockchain really transform the KYC process?
Why KYC is a pain point for financial institutions
The focus on know your customer procedures (KYC) stems from increasing regulatory burdens and the associated exposure to fines – even if financial institutions ultimately also benefit from the increased knowledge. The pressure to implement KYC combined with the difficulty of consistently implementing KYC requirements is leading to plenty of pain points. Problems with KYC include:
- It’s an inefficient process. KYC processes are heavily reliant on the documents provided, and much of the KYC process is spent verifying paper documentation, rather than looking deeply into the customer, and the customer’s networks.
- Efforts are duplicated. It is common for multiple institutions to perform the same onerous KYC process, without sharing the outcomes. This is true even within financial institutions, where different departments might repeat an extensive KYC process on exactly the same customer.
- Difficulties enforcing compliance. Institutions struggle to monitor and enforce the rigour with which KYC procedures are applied and just one slip-up can lead to a large fine. Similarly, auditing KYC procedures is currently difficult.
- Communication with regulators. Performing KYC on the financial institution side is just one part of the equation. Communicating with regulators in order to establish compliance often involve rehashing and validating documents to meet the regulator’s requirements. It is a time-consuming, error-prone process.
It is clear that KYC is currently a cumbersome, inefficient procedure that does not necessarily guarantee that financial institutions will stay out of trouble with regulators.
- Blockchains are transparent. Any institution that has permission to access a blockchain underpinning KYC validation has access to all records. Access could include regulators too, removing the need to copy across reams of documents and allowing regulators much closer scrutiny.
- Paperless processing. The use of blockchain will remove the need to manually process and reconcile printed documents, reducing labour costs and speeding up the KYC process. Paper processes may be involved for initial screening, but once screened customers are assigned a unique digital ID on the blockchain so that future paper-based screening is not needed.
- Immutability of blockchain. By design, blockchains are tamper-proof, ensuring that the data stored in the blockchain cannot be changed without alerting other participants. It ensures that KYC utilising blockchain technology is fully auditable, producing trustworthy results.
So, blockchain can create a faster, clearer and more trustworthy KYC process. Needless to say, several efforts were launched to test whether distributed ledger technology in general or indeed blockchains, in particular, can be truly game-changing for KYC.
The KYC blockchain: proof of concept
Though institutions are not yet widely using blockchain technology for KYC or AML purposes, several attempts have been made to demonstrate that blockchain can deliver benefits for KYC processes.
In 2018, KPMG and Bluezelle developed a blockchain, KYC utility as proof of concept alongside HSBC, Mitsubishi UFJ Financial Group and OCBC. The effort passed the Singapore monetary authority’s tests, and by internal estimates, the platform could deliver 25% to 50% in cost savings thanks to reduced duplication.
Likewise, also in early 2018, IBM developed a shared KYC platform alongside Deutsche Bank, HSBC, Mitsubishi UFJ and the treasury departments of Cargill and IBM. It demonstrated how blockchain can offer an efficient, decentralized mechanism for collecting, validating and sharing KYC information.
Finally, in July 2018 digital services firm Synechron used R3’s Corda blockchain platform to enable a global trial with 39 companies which involved more than 300 KYC transactions across 19 countries. The company suggests that the trial proved how a blockchain model can transform a global KYC process.
Yet despite several successful attempts at proving the capabilities of blockchain in a KYC role no active, blockchain KYC application is running. What is keeping financial institutions from moving ahead with blockchain and KYC?
Hurdles to adopting blockchain for KYC
As much as knowledge sharing will greatly benefit KYC efforts, it is easy to see why financial institutions are reluctant to open up internal customer data to external parties. The mere suggestion of sharing customer data, even to a private and secure blockchain, could easily close the KYC and blockchain discussion.
There is also a question around governance: who will lead blockchain development and which parties will be involved in ongoing decision making once a blockchain KYC application is in active use? These questions also extend to decisions around data models, technology infrastructure and funding.
Finally, regulators are a stumbling point too. Data sharing is challenging in an environment where restrictions around the use of customer data are increasingly tightened. Likewise, regulators must support the concept of KYC in a blockchain environment, and be willing to become a part of a blockchain consortium so that KYC data is accessible to regulators via the blockchain.
Future steps for blockchain and KYC
With proof of concept in place, KYC blockchain applications may soon become a reality. It will require concerted steps by financial institutions, their major clients and by regulators. These could include:
- Solving data privacy concerns. Industry participants must find ways to alleviate concerns around data privacy. Blockchain is capable of extremely high levels of security thanks to encryption and it can be demonstrated that blockchain KYC applications can meet legal requirements such as GDPR.
- Standards and access. A common standard for KYC data is an important aspect of process efficiency. Common data standards allow relevant parties to easily tap into the blockchain, particularly in light of varying interpretations of KYC principles. Technical barriers to entry must also be low, few financial institutions have extensive blockchain experience.
- Sharing the cost burden. The more parties involved in setting up and maintaining a KYC blockchain solution, the lower the cost for each participant. Forming consortia will help. Facilitating payments to the financial institution that initially performs traditional verification before data is injected into the blockchain is also a good idea.
- Regulatory reform. Regulators must be supportive of efforts to improve the KYC process, including blockchain. It may involve rewriting regulations to enable blockchain KYC. This includes access to government data which can enable automated verification of the physical documents presented in the KYC process.
The rise of cryptocurrencies brought distributed ledger technology, and blockchain in particular, into the limelight. Blockchain is rapidly finding applications outside of cryptocurrencies, but in many fields, inertia and practical limitations are holding back blockchain adoption – including KYC applications.
With proof of concept now in place financial institutions, regulators and other affected parties could bind together to shape KYC blockchain solution. However, there are clearly hurdles to conquer and it may still be some time before blockchain-based KYC solutions start delivering everyday results.