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Improving "Know Your Customer" Processes for Trade Finance and Other Purposes

By Bill Camarda

Today, financial institutions play a critical role in ensuring that their customers aren't engaged in money laundering or other criminal or terrorist activities. However, "Know Your Customer" (KYC) and related processes can be time-consuming, costly, and frustrating. Worse, they can interfere with an international business getting the trade finance it needs. And beyond trade finance, it can delay or prevent financial institutions and customers from establishing a wide array of productive financial relationships. Some are looking to blockchain technology to help.

KYC rules require banks to verify a new customer's identity and the legitimacy of its funds, understand the context of its transactions, and evaluate its money laundering risks.1,2 However, KYC-related due diligence and investigation can take months, especially in international environments, and the delays may be worsening.3,4 According to one recent survey, 89 percent of corporate customers have had an unsatisfactory KYC experience, and 13 percent actually changed their financial relationships as a result.5

 

‘Jumping Through Hoops' for Trade Finance and Other Financial Services

 

Further, since each financial institution has its own KYC processes, customers may have to repeatedly jump through similar (but not identical) hoops for trade finance, other lending and banking relationships, securities broker-dealer accounts, currency exchange and money transfer services, insurance services, and more.6

 

KYC can be especially problematic for trade finance, contributing to a long-standing trade finance gap that especially impacts small- and medium-sized enterprises (SMEs). According to a new survey by the Asian Development Bank (ADB), 29 percent of trade finance rejections are linked to KYC. In some cases, ADB says, banks may have reasonable concerns about potential clients' ability to meet anti-financial-crime standards. According to ADB: "Anecdotal evidence suggests in most cases banks were not willing to expend the cost and effort to conduct KYC, particularly for potential SME [trade finance] clients that would not generate much profit. For SMEs, this second category is a particular problem because of the low profitability of requested transactions and the difficulty of evaluating firms which lack clear financial and other records."7

 

How Blockchain Might Help Ease KYC

 

Recalling how blockchain works may help make clear why it might be valuable in KYC and related processes. Blockchain establishes a digital ledger of transactions that can be shared across large, decentralized networks of computers. Cryptographic techniques enable each participant in a blockchain to add new transactions that are verified by other computers on the network using specialized algorithms. Once these transactions are verified and recorded, they become extremely difficult to change or remove.8 A blockchain network has no central point of control, and participant computers must reach consensus on verifying new entries. Therefore, advocates argue, blockchain might resist cyberattacks that can compromise centralized information systems.9

 

We've previously discussed potential blockchain financial applications in payment processing as well as trade finance, as well as addressing blockchain's role in enabling cryptocurrencies such as Bitcoin, the application it was created for. In contrast, KYC processes are primarily about verifying information, and only indirectly about transactions. But blockchain can verify information in much the same way it verifies transactions.

 

How Early Blockchain-Based KYC Services Work

 

Typically, blockchain-based KYC services establish a digital identity linked to a customer, and give that customer control of the document exchanges involved in KYC processes. For example, in start-up KYC-Chain's system, the customer owns a private wallet secured by private keys, and can give permission to financial institutions to immediately view the information they need to see, rather than forwarding it manually in paper or electronic format. KYC-Chain's software also enables a customer to confirm identity through a "zero-knowledge based proof" that shares only as much information as is necessary, rather than entire documents.10

 

Conventional KYC processes may involve a financial institution compliance employee phoning or emailing a new customer to access information such as location of incorporation, ownership structure, regulatory status, outstanding legal proceedings, and types of financial transactions anticipated.11 Deloitte's proof-of-concept KYCstart service envisions moving these tasks to regulated KYC added-value service providers. They would be authorized to perform a customer's KYC checking for all the financial institutions it wants to use, and veracity checks already performed by others in the network would be available to streamline future onboardings.12,13 Again, the customers themselves would control who sees their information. Moreover, they would be able to track authorizations via blockchain-based smart contracts.

 

Meanwhile, in Singapore, a consortium including OCBC Bank, HSBC, Mitsubishi UFJ Financial Group (MUFG), and the government's information and communications ministry has successfully tested a prototype KYC blockchain system that remained stable under high information flows, and effectively resisted tampering.14 (This KYC pilot is just one part of Singapore's multipronged efforts to leverage blockchain, highlighted by a new agreement with Hong Kong to collaborate on blockchain-based trade finance connections.15) The world's first blockchain-based trade finance letter of credit was recently issued, connecting Russia's largest bank, Sberbank, with the Eastern European steel and mining company Severstal.16

 

Linking KYC and Anti-Money Laundering in the Blockchain

 

As IBM blockchain expert Nitin Gaur notes, an integrated blockchain system that encompasses KYC at the customer onboarding stage and Anti Money Laundering (AML) analysis afterwards would have obvious advantages. It could offer a unified source of reliable data and chained transactions where all participants could access audit data and logs, including regulators. In order to share data in a trusted distributed ledger, financial institutions would be required to provide more useful data for analysis by participants throughout the network. With access to linked transaction information from many institutions, AML specialists – potentially including regulators – could gain powerful tools for identifying patterns of money laundering between banks in real- or near-real-time.17,18

 

Alternatives to Blockchain

 

Blockchain KYC solutions continue to emerge, and many companies are seeking to provide them. But non-blockchain approaches are also competing to improve KYC. For example, SWIFT's centralized KYC Registry aims to provide a single repository of high-quality, validated KYC information and documentation that correspondent banks, fund distributors, and custodians can share.19

 

As Finextra notes, it remains to be seen whether blockchain, non-blockchain, or hybrid solutions will dominate.20 One thing is clear: massive investments are underway to make KYC smoother and faster for everyone involved.

 

The

Takeaway:

Slow, inefficient Know Your Customer processes can make it harder for financial institutions and customers to collaborate in areas ranging from trade finance to currency exchange. Blockchain technology may make it quicker and easier to share verified KYC information, so these companies can work together faster -- and gain value from their relationships sooner.

Bill Camarda - The Author

The Author

Bill Camarda

Bill Camarda is a professional writer with more than 30 years’ experience focusing on business and technology. He is author or co-author of 19 books on information technology and has written for clients including American Express Private Bank, Ernst & Young, Financial Times Knowledge and IBM.

Sources

1. “Know Your Customer (“KYC”) Due Diligence Best Practices,” Volkov Law; https://blog.volkovlaw.com/2015/07/know-your-customer-kyc-due-diligence-best-practices-2/
2. “Blockchain for Enterprise – Focus on KYC, AML, and Regulatory Compliance – Are We Calling it RegTech?” Nitin Gaur, IBM Blockchain Labs, Infocast; http://infocastinc.com/insights/technology/blockchain-for-enterprise-focus-on-kyc-aml-and-regulatory-compliance-are-we-calling-it-regtech/
3. “KYC and Blockchain,” Finextra. https://www.finextra.com/blogposting/13903/kyc-and-blockchain
4. “Thomson Reuters 2016 Know Your Customer Surveys Reveal Escalating Costs and Complexity,” Thomson Reuters; https://www.thomsonreuters.com/en/press-releases/2016/may/thomson-reuters-2016-know-your-customer-surveys.html
5. Ibid.
6. “Anti-Money Laundering (AML) Source Tool for Broker-Dealers,” U.S. Securities and Exchange Commission; https://www.sec.gov/about/offices/ocie/amlsourcetool.htm
7. “ADB Briefs No. 83: 2017 Trade finance Gaps, Growth, and Jobs Survey,” Asian Development Bank; https://www.adb.org/sites/default/files/publication/359631/adb-briefs-83.pdf
8. Four Blockchain Use Cases for Banks, FinTech Network; http://blockchainapac.fintecnet.com/uploads/2/4/3/8/24384857/fintech_blockchain_report_v3.pdf
9. Ibid.
10. “21ˢᵗ century KYC,” Treasury Today; http://treasurytoday.com/2017/05/21st-century-kyc-ttff
11. “Deloitte's RegTech Offering: Blockchain-Powered KYC-as-a-Service Solution,” Bitcoin Magazine; https://bitcoinmagazine.com/articles/deloittes-regtech-offering-blockchain-powered-kyc-service-solution/
12. “Deloitte develops Blockchain proof-of-concept to mutualize KYC checks,” Deloitte; https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/technology/pressrelease/lu-pr-deloitte-digital-blockchain-poc-kyc-checks.pdf
13. “Deloitte Rolls Out KYC-As-A-Service Backed By Blockchain Technology,” ETHNews; https://www.ethnews.com/deloitte-rolls-out-kyc-as-a-service-backed-by-blockchain-technology
14. “Singapore regulator, OCBC, HSBC, MUFG create 'Know Your Customer' blockchain prototype,” The Business Times; http://www.businesstimes.com.sg/banking-finance/singapore-regulator-ocbc-hsbc-mufg-create-know-your-customer-blockchain-prototype
15. “Hong Kong and Singapore sign fintech deal, agree to work together on blockchain,” CNBC; https://www.cnbc.com/2017/10/25/hong-kong-singapore-sign-fintech-deal-will-collaborate-on-blockchain.html
16. “Sberbank Conducts the First Letter of Credit Transaction on the Blockchain,” Coinidol.com; https://coinidol.com/sberbank-conducts-letter-of-credit-on-the-blockchain/
17. “Blockchain for Enterprise – Focus on KYC, AML, and Regulatory Compliance – Are We Calling it RegTech?” Nitin Gaur, IBM Blockchain Labs, Infocast; http://infocastinc.com/insights/technology/blockchain-for-enterprise-focus-on-kyc-aml-and-regulatory-compliance-are-we-calling-it-regtech/
18. “Anti-money laundering and financial crime compliance,” Grant Thornton; https://www.grantthornton.com/~/media/content-page-files/financial-services/pdfs/2017/BK/AML-Continuum-Article-FINAL-7-31.ashx
19. “The KYC Registry: FAQ,” SWIFT. https://www.swift.com/our-solutions/compliance-and-shared-services/financial-crime-compliance/our-kyc-solutions/the-kyc-registry/faq
20. “KYC and Blockchain,” Finextra. https://www.finextra.com/blogposting/13903/kyc-and-blockchain

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