KYC Quagmire: The FinTech Conundrum

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The Reserve Bank of India ("RBI"), on 31st January 2024 directed Paytm Payments Bank Limited to halt all business transactions, latest by 15th March 2024.
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The Reserve Bank of India ("RBI"), on 31st January 2024 directed Paytm Payments Bank Limited to halt all business transactions, latest by 15th March 2024. The recent "debacle", as many may call it, has shed light on various issues that plague the FinTech industry. As the move by RBI was heavily triggered by the alleged lapse, on part of Paytm to comply with the RBI's Know Your Customer ("KYC") Guidelines, 2016 ("KYC Guidelines"), the KYC compliance is emerging as the primary concerns for FinTech industry.

At present, to put it briefly, the KYC compliance is governed by KYC Guidelines which were introduced as part of the directions received by the RBI under the Anti-Money Laundering Rules, Unlawful Activities (Prevention) Act, 1967 and The Weapons of Mass Destruction and their Delivery Systems (Prohibition of Unlawful Activities) Act, 2005 and tightened the security and privacy standards for FinTech's across the country. This cements the requirement of KYC compliance by every FinTech company.

Currently, the KYC guidelines requires companies to formulate a fool proof customer identification process in order to offer them any financial services. This process includes either Aadhaar based verification or in-person verification. Such verification methods give rise to several issues of which few are listed below:

  1. Increased Costs: If one is to look at the 2010's, the KYC procedures were simple and non-cumbersome as a person could simply walk into a bank and show their physical documents or alternatively provide their Aadhar card details to the bank officials. While the privacy implications of the same are not condoned, it was certainly easier on the pocket of banks or any entity which required KYC compliance. Fast forward to the year 2024, the KYC Guidelines envisages KYC through video or offline mode/ face-to-face verification which has led to an increase in costs of verification to the multiple of 15x, with the cost for each video KYC being around INR 15-30 and offline KYC going up to INR 100.
    Not only this, the FinTech's suffered an additional blow when RBI vide its circular dated on 28th April 2023 stated that customers shall be categorized as high-risk customers and accounts opened in non-face to face mode (including digital channels such as CKYCR, Digi Locker, equivalent e-document, etc.) shall be subjected to enhanced monitoring until the identity of the customer is verified in face-to-face manner or through Video based Customer Identification Process ("V-CIP"). This change has led to dual verification of customers which certainly has led to increase in costs.
  2. Access to Resources: Initially, FinTech's utilized repositories such as Central KYC Records Registry ("CKYCR") or Digi Locker for faster customer verification. However, RBI's insistence on V-CIP or face-to-face verification has drastically reduced the utility of these platforms. As a result, FinTech companies find themselves once again in a dilemma where they must choose between speedy and seamless KYC processes or strict adherence to regulatory compliance.
  3. Loosing consumers: As customer preferences shift towards seamless and frictionless experiences, FinTech firms are under pressure to streamline KYC processes to ensure faster KYC completion without compromising on security and regulatory requirements. Smaller companies end up losing various customers in the sales funnel as they lack the resources to ensure faster KYC completion.

The preceding discussion highlights two significant challenges facing the FinTech industry today – (a) rising costs, and (b) delayed KYC. To address these challenges, the industry is calling for modifications to the KYC Guidelines, allowing companies a degree of flexibility based on risk assessment and transaction size. Presently, the FinTech's would seriously benefit from the following developments:

  1. Revisiting e-KYC options for FinTech companies and ensuring that costlier options such as – face-to-face KYC or V-CIP is used only for high volume transactions meeting a pre-determined financial mark.
  2. Strengthening the infrastructure of depositories such as CKYCR and Digi Locker so as to ensure quick KYC along with safeguarding personal and confidential data of the customer from unwarranted disclosure and breach.

The FinTech industry is hopeful about upcoming regulatory improvements as following the Paytm crisis, as reported by news article, Finance Minister Nirmala Sitharaman has directed regulators to engage with FinTech firms on a monthly basis to address concerns and propose solutions. Not only this, the Financial Stability and Development Council ("FSDC"), which is a government expert committee headed by TV Somanathan, is in the process of re-formulating the KYC regulations and had its meeting regarding the same on 21st February 2024. FinTech companies expect a positive change as India is at the cusp of a start-up/AI/FinTech revolution and negative regulatory impact can adversely impact the same. The regulations must be modified to accommodate and balance the best interests of the regulators as well as the market. If FSDC is able to incorporate the solutions mentioned above and meet FinTech companies in the middle, overall positive growth of the industry as well as protection of customer data can be achieved.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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