Consumer Issues
From KYC to know your customers’ business and its risk

Banks need to go beyond the traditional approach of check box approach in KYC. The first step in risk mitigation in the banking system needs to start with know your customers’ business and the business risk

Know Your Customer (KYC) has traditionally been a check box approach. It starts with collection of proof of identity and residence by banks and financial institutions and verification of the same. This process of verification gets completed when the bank staff ticks the appropriate column in the account opening document for verification process. Of course, nature of document submitted varies, depending upon the type of client that a bank or financial institution is interacting with, but the overall approach remains same. However, KYC conceptually has never been restricted to these two critical document sets. And banks and financial institutions have kept their approach towards KYC restricted to collection of documents only.
 

In the current regulatory set up in India, concept of KYC goes much beyond that. The Reserve Bank of India (RBI) defines KYC as: “KYC is an acronym for ‘Know your Customer’, a term used for customer identification process. It involves making reasonable efforts to determine true identity and beneficial ownership of accounts, source of funds, the nature of customer’s business, reasonableness of operations in the account in relation to the customer’s business, etc which in turn helps the banks to manage their risks prudently”.
 

The recent increase in the non-performing assets (NPAs) of banks, especially public sector  banks (PSBs), have caused the need to have a re-look at the KYC process and enhance the scope of KYC process, not in the regulatory context, but purely from implementation of KYC process . Basic regulatory framework is in place, but the implementation of the framework, has been found wanting in many cases. Banks have been found lacking in analysing the risks associated with client’s business and as a result, many clients have turned delinquent. While it may sound strange to find somebody linking business risks to KYC process, the fact remains that there has never been a Chinese wall segregating these two concepts. The recent experience of huge NPAs getting built in the banking system in India, highlights the need to have robust checks built within KYC process that can protect banks from increasing incidents of delinquency.
 

Recently while speaking at a banking conference, RBI deputy governor Dr KC Chakrabarty said, “KYC is a critical component of a bank’s risk management framework. A customer-centric business needs to know its customer, the nature of his business and the inflows/ outflows into the accounts, if it is to provide customised business products and solutions. This, I call as KYC-B. The banks further need to understand the risks associated with customer’s business to manage risks arising from potential delinquency, fraud and consequent losses as also legal and reputational risks arising from exposure to customers having links to multi-level marketing (MLM) business, terrorist activities and hawala transactions, which is another manifestation of KYC and may be termed as KYC BR”.
 

KYC-business (KYC-B) basically makes a bank more accountable towards ongoing process of customer due diligence. KYC-B will give banks an insight into any changing patterns in the account behavior of a customer and help them manage customer’s account in a better way, while KYC- business risk (KYC-BR) is purely risk focused as the name suggests. KYC-BR will not just supplement the anti-money laundering (AML) measures; it will also provide banks and financial institutions an insight into building of credit risk in the customers’ account. With management of these dual risks, a bank will be able to mitigate reputational as well as legal risks.
 

Significance of KYC-B and KYC-BR are going to gain importance in the days to come if the banking system has to be made robust. Banks need to go beyond the traditional approach of check box approach in KYC. The first step in risk mitigation in the banking system needs to start with KYC-B and KYC-BR.
 

(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)

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COMMENTS

Ramesh Jaradhara

3 years ago

Banks create their own NPAs-as said by Pro Anil Agashe is true. Banks so far looked in to their clients from traditional perspective. As an officer in a PSB I realise that credit appraisal process is far from satisfactory in PSBs.It needs to be given emphasis on KYC-B and KYC-BR concepts from risk mitigation perspective in each and every credit proposal. Then only we can check over-growth of NPAs in the banking system.

RAVINDRANATH

3 years ago

At the outset let me give a thumbs-up to the article.

I would like to comment on the last-but-one para of the article, as to why something is not happening which ought to happen.

In the good old days of non-computerised era, entries were made in the customer's ledger account and the officer would check every entry in the ledger with the cheque on hand. In the process he/she would get a quick glance on the usage of funds as to where the funds are going and whether the payments made are consistent with the business of the customer and whether the transaction volumes are commensurate with the balance in the account/limits availed, etc. Today, everything is centralised, where the branch maintaining the account has very little chance of knowing where his/her customer's funds are being channelled. Secondly the pressure of work at the branches do not allow the staff to go through the accounts till one day the account starts turning sticky. Of course, there are still ways to prevent the account going out-of-hand by taking certain precautions like not granting frequent overdraft/overlimit, unless understanding the need therefor or observing frequent return of cheques [both inward as well as outward] etc. Vigilance at an early stage in such accounts will save the bank from disaster.

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