Digitizing AML/KYC Compliance with Blockchain

The applications of blockchain technology are moving beyond cryptocurrencies to improve processes in multiple industries. Distributed ledger technology, in particular, is laying the foundation for innovative solutions that improve transparency, enable automation, and save costs. A significant use case of blockchain technology is to fulfill anti-money laundering (AML) and know your customer (KYC) compliance requirements. 

Financial service providers like banks and insurance companies heavily invest in resources to enhance compliance programs. Surveys indicate that financial institutions spend between US$60-$500 million annually on AML and KYC compliance processes. These user identity verification measures are generally paper-based, require manual human input, and often result in the duplication of tasks across organizations. Moreover, regulatory requirements in many countries are complex. They impose punitive penalties on businesses for non-compliance. Also, slow transactions speed is another challenge for existing financial services. 

Which blockchain platform is appropriate?

Not all blockchain platforms are suitable for all purposes, some are applicable for specific enterprise use cases. In the case of efficient management and exchange of AML and KYC compliance data, private, permissioned blockchain solutions fit best. Key financial industry players have already invested substantial amounts of time, money, and effort in developing private DLT based applications. They have successfully conducted “proof-of-concept” tests using blockchain.

For instance, in June 2018, Synechron and R3 Corda piloted a KYC compliance solution built on DLT. In the test, Corda based solution completed 300 transactions within 39 participants across 19 countries. Institutions, involved as part of the network were able to request access to customers’ KYC data. Further, customers could approve requests and revoke access to personal data as per their discretion. Customers could also update their test data, which was further updated automatically on the DLT platform that all permissioned institutions can access.

Solving inefficiencies in existing KYC/AML processes

Existing KYC/AML processes are inefficient due to the following reasons.

Information asymmetries between financial service providers and regulators

Service providers prepare and submit compliance reports to regulators, which require their employees to review and manually reconcile paper documents. It leads to significant labor costs and the risk of human error. Blockchain-based AML and KYC compliance solution can eliminate such challenges by -

• Reducing the use of paper documentation
• Reducing the time spent on manually reconciling documents
• Enabling fast and efficient KYC data verification processes

Duplication of AML and KYC compliance work 

Financial services do not efficiently collaborate with other institutions to share KYC/AML information. They also don’t share information among internal divisions within the same organization. It is a common occurrence in transactions involving multiple banks which require each institution to independently validate customers' KYC/AML data.  In addition, some FIs fail to provide a central internal database to maintain a client’s KYC/AML data. As a consequence, some clients re-submit their KYC data (proof of address, identification documents, etc.) on multiple occasions to apply for another service from a different division of the same FI. This recurring replication of KYC/AML diligence makes the process extremely costly, inefficient and slow.

In addition, the duplication of compliance efforts also increases costs related to false transaction investigations, such as the ones flagged for non-compliance with KYC/AML.

Also Read: Blockchain and KYC: The Next Disruptive Step in Decentralization

Inadequate completion and reconciliation of KYC/AML documentation

According to a KPMG report, FIs currently expend 80 percent KYC/AML resources on reconciling documentation. They spend only 20 percent on examining the KYC data and assessing client risk.

By adopting DLT, they can spend human resources on analyzing the risk of the underlying KYC and transaction data. DLT can also automate and streamline collaboration and validation required to maintain KYC data.

How DLT reduces AML and KYC compliance overheads

According to BIS Research, a US-based market intelligence firm, financial organizations reduce administrative costs by 90 percent using DLT in KYC/AML compliance programs.

DLT can eradicate inefficiencies inherent within KYC/AML compliance programs. With a private, permissioned platform built on DLT, financial institutions can share users’ KYC/AML data (with customer consent) among their divisions and with other organizations. Such a platform will be accessible to a group of permissioned parties. Instead of relying on individual and repeated verification processes, DLT enables financial services to use a unified platform of digital distribution, secure and auditable source of user information. DLT can also streamline information asymmetries between institutions and regulators. Permissioned regulators can directly access an institution's compliance system to extract reports. This way, financial systems can demonstrate their regulatory compliance in real-time. It will thus improve transparency with regulators and dramatically reduce compliance costs.

Prior to implementing blockchain-based KYC/AML systems, financial entities must identify and address the following challenges:

Ensuring the Validity of Verified KYC/AML Data Stored on the DLT Platform

As discussed above, blockchain eliminates the duplication of multiple same sets of documents. Although efficient and cost-effective, this system creates the possibility that fraud or mistakes in validating documents will not be detected by other FIs on the DLT platform. This requires that (i) all of the FIs agree to the necessary steps needed before KYC Data is validated, and (ii) substantial trust is established in each of the network’s participants to properly verify client documents. 

DLT mitigates this issue by creating a permanent record and audit trail of when and who validated each document and therefore promotes accountability in the system.

Incentivizing the sharing of information between FIs

FIs must be incentivized to share KYC Data on a DLT platform. The more FIs that contribute to the platform, the greater the cost savings for participating FIs.

One emerging solution for incentivizing FI participation on the DLT platform is by paying an FI to validate the KYC Data. FIs that perform the original validation of client KYC/AML Data could be compensated by each FI that accesses and relies upon the validated KYC Data. This motivates participating FIs to both protect client information and to properly verify the KYC Data. If this is not done, an FI could lose out on earning

Concluding thoughts

Organizations need to obtain, process and verify users’ personal information in a quick and efficient manner. At the same time, it is essential to safeguard such information from being hacked and comply with KYC/AML legislation. DLT is a tool that financial institutions can use to fulfill their compliance requirements.

We, at Oodles, provide DLT based custom blockchain application solutions to develop custom decentralized solutions for different efficient financial use cases like KYC, digital identity management, and lending processes.