Bank Response to Growing KYC Requirements

Since 2010, 28 major banks have been fined for breaching U.S. sanctions. Seven of these received fines exceeding US$500 million, of which the highest was US$8.9 billion. Moreover, a recent Know Your Customer Survey conducted by Thomson Reuters shows that some financial institutions are still spending up to US$500 million annually on KYC compliance and customer due diligence efforts.

In response, banks have moved to reduce their risk by terminating their relationships with particular institutions, countries, and regions. Many financial institutions have shed correspondent banking relationships in developing countries. The high and rising risk of fines and the costs of increased scrutiny have destroyed the tradition of banks extending services throughout the world. Not surprisingly, the poorest and most difficult-to-analyze regions have been hit the hardest.

This trend is exacting an enormous price on the growing number of corporates in developing economies. As these markets evolve, many are creating new opportunities for businesses to expand, which leads to increased demand for capital funding. However, the financial services trend toward de-risking means that these needs are not being met through the traditional banking system. Many corporates are being forced to turn to sources of funding outside of regulated markets, which are then harder to monitor.

Financial exclusion, driven by banks' de-risking, is a global problem. Still, regulatory requirements continue to get stricter, and regulators continue to remind financial institutions of the importance of understanding customers and their transactions.

Banks must know where money is coming from and where it is going. Throughout the world, they are required to validate customers' identity, monitor all transactions, and report suspicious activity to a designated government body. To effectively comply, financial institutions need a clear picture of each customer's profile, identity, and spending habits, as well as the kinds of transactions he or she is likely to engage in.

No matter the size of the bank, KYC is not easy. Collecting and managing all the requisite data requires a dedicated team of specialists and a transformation of processes, including verification of massive amounts of non-standard data and documentation. Inefficiencies in domestic processes can be extremely costly, and the problems multiply when transactions cross national borders. Issues with the current cross-border payment system include inaccurate client information, lack of complete visibility over customer activity, jurisdictional differences with common identity standards, and data and privacy concerns.

KYC Registry on the Blockchain

The good news is that it's a problem blockchain technology can help solve. That's because data on a blockchain platform's distributed ledger is verifiable and immutable, providing increased transparency to relevant participants.

Regulators impose fines and penalties on banks that do not conduct appropriate due diligence on the entities and individuals they deal with. The more readily a bank in a developed country can access information on end users and banks in developing parts of the world, the more comfortable it will be with facilitating the transaction. The shared nature of blockchain technology lends itself naturally to providing a single, unified registry of KYC information for affected banks around the world.

A recent trial of a new KYC application built on a blockchain platform recently facilitated more than 300 transactions during a collaborative four-day trial with 39 financial services firms, as well as various central banks and regulators. In this test, banks that were parties to the transactions were able to request access to KYC data on the individuals and entities that were involved. Meanwhile, the individuals and organizations participating in these transactions were able to update their test data, which automatically updated for all banks that had permission to access it.

By providing a single version of the truth, a blockchain-based tool can reduce duplication of effort across banks, eliminating the need for each institution to individually attest and update KYC records on individuals and organizations they work with. This technology presents the potential for banks to spend more time analyzing, rather than collecting and verifying, the data they receive. This may accelerate new-customer on-boarding. And because all data is fully standardized, the system significantly reduces the time, cost, and resources required to manage it.

Moreover, because such a system can provide a single, unified view of the on-boarding documentation from foreign correspondent banks, financial institutions in the developed world may gain the confidence to re-engage with customers in higher-risk jurisdictions.

With the support of regulators and the intelligence community, financial technology companies have the opportunity to leverage blockchain's unique approach to digital identity. More broadly, moving payment transfers onto a blockchain platform could generate a holistic view of the payment system, enabling banks to more easily identify money laundering and terrorist financing activities. The right blockchain technology design, coupled with KYC and AML standards that are consistent across regions, will significantly increase traceability to support financial inclusion for the countries and regions whose development hinges on access to the global banking network.

Abbas Ali is an associate director at R3, which built the Corda blockchain platform underlying the recent 39-firm KYC application trial. The company continues to develop the solution, which is scheduled to go live in 2019. To learn more, contact [email protected].