By Omri Raiter, Co-Founder and the Chief Technology Officer of Hexatone Finance.
Banks and regulated financial institutes are responsible for ensuring their services are used exclusively by law-abiding citizens — not by money launderers, terrorism financers, or other illicit entities or individuals. They’ve long used special processes to vet their customers to provide that assurance, with Know Your Customer (KYC) being the gold standard. But as technology has advanced and considerations have changed in the finance world, a slightly less familiar process has gained transaction: electronic Know Your Customer (eKYC).
Whether you’ve recently come across the term for the first time or you’d just like a little more background, let’s take a deep dive into what eKYC is, its greatest advantages, and why it could help to increase trust and reduce risk in the finance sector.
KYC: a Brief History
Instead of skipping straight to eKYC, let’s quickly recap what KYC is and where it came from. As the name suggests, KYC is about banks literally knowing their customers — they ask for the information needed to verify their clients are who they say they are, usually by asking for identity documents.
The process dates all the way back to 2001, when governments recognized the role, that financial institutions can play in identifying terrorist organizations and preventing them from operating. The US passed the Title III of the Patriot Act, which required certain levels of record-keeping and customer identification (among other measures).
As part of KYC, banks must comply with the regulations of the country they operate in, particularly rules related to anti-money laundering (AML). Failure to comply means significant penalties.
Traditionally, the KYC process involved customers providing their physical documentation to institutions so they could be verified through in-person face and ID verification. However, the world has moved on since then. The prevalence of online banks and digital everything has led to something a little different: eKYC.
The Dawn of eKYC
eKYC is the same as KYC in principle, but everything takes place digitally. In addition to what we’ve already seen, it must also comply with electronic identification standards and trust services (eIDAS) regulations.
Customers provide electronic versions of their documents, and they may prove who they are through artificial intelligence and machine learning solutions, recording themselves, or speaking to someone over video. Perhaps a mixture of the three.
For instance, customers might upload their documents through their phone and record a video of themselves saying a certain phrase. Their identities would then be verified by staff or using technological solutions such as liveness detection.
In some cases, it may involve biometric information like checking fingerprints or automatic facial recognition.
Creating these solutions was no easy task considering the need for 100% reliable processes with no margins for error, but technological processes are on the rise and changing the game. I will try to explain why, or at least cover the main aspects of it.
Benefits of eKYC
The first advantage of eKYC that will surely enter most people’s minds is that it allowed banks to continue functioning normally (or as close to normal as possible) during the pandemic. Customers could open their accounts virtually instead of heading into branches or refraining from opening accounts at all. In 2020, more customers opened their accounts online than in person in the US.
Yet the benefits of eKYC go far beyond mere convenience.
For one, eKYC is a more affordable alternative for financial institutions — it’s paperless, so it reduces the costs involved with doing everything physically, which results in more overheads.
These costs could decrease even further in the future if digital IDs are introduced, which would provide a more universal type of identity and therefore cut out the workloads of banks by forgoing the need for complex registration processes or helping customers to recover their passwords.
Because of the lower levels of bureaucracy involved in eKYC and other digital solutions, they’ve become an appealing solution. In fact, authorities like the Federal Reserve and the European Supervisory Authorities have made public appeals encouraging more sophisticated technological solutions to compliance.
Plus, the paperless aspect is also great for sustainability.
How eKYC is Accelerating Trust
The most significant benefit of all that eKYC brings is the provision of compliance that takes place on a much larger scale and which identifies risks much more comprehensively.
For instance, in Hexatone Finance we developed a unique solution, based on a proprietary AI framework with machine learning algorithms that can analyze new and existing customers financial data and their transactions continuously, making it more likely that they’ll pick up on suspicious behavior that they might have missed otherwise.
It’s no secret that the risks that lie in this sphere are becoming greater. For instance, synthetic identity fraud (which involves the use of fictitious IDs) is the fastest-growing kind of financial crime in the US. As criminals become more sophisticated, regulators need to keep up.
Plus, the requirements for complying with AML and eIDAS regulations are becoming increasingly complex over time as countries across the world struggle to fight terrorism and related issues. This means that it will be more difficult for banks to keep up, and they will require more sophisticated solutions.
For instance, the US Financial Crimes Enforcement Network (FinCEN) added additional requirements in 2018 that required banks to verify not just direct customers but everyone who controls or profits from the company (such as shareholders and board members).
Similarly, in 2020, the European Union launched the Anti-Money Laundering Directive 5 (AMLD5), which required financial institutions to carry out stricter customer due diligence, gain a better understanding of the beneficial owners of legal entities, and improve their control of customer identity.
And as the world of eKYC continues to develop, more regulatory technology (“RegTech”) firms are springing up to offer solutions and streamline processes further.
The Future of Finance?
KYC had its time, and it certainly played an essential role in changing how we view the roles and responsibilities of banks and financial institutions. However, it’s time to hand the baton over.
We’re only at the very early stages of seeing what eKYC can do, but it seems increasingly likely that it will play an essential role in the future of finance. As we in Hexatone Finance see every day institutions are becoming aware that preventing fraud and risks doesn’t start and end simply with verifying customers at the beginning of the registration or onboarding process. A more comprehensive approach is needed, and a smart Platform that combines both machine learning capabilities and fully support the eKYC process requirements are one of the most significant ways to overcome this problem.
