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The Problem with KYC Requirements


The Problem with KYC Requirements


In this article, Tobias Baer identifies the three root causes behind excessive KYC (know your customer) requirements.

Unless you run a criminal operation, you would most probably agree with me that financial crimes should be prevented and that KYC is a critical element in preventing the illegal flow of money. Sadly, that doesn’t mean that KYC in today’s shape and form is working well.

I’ve written before about the deficiencies of a KYC regimen relying on third-party documents. A bank reviewing a notarized copy of my passport essentially relies on that notary’s ability to spot a fake document; at the same time in most jurisdictions banks actually lack the ability to query my passport in an official government database to confirm that I actually exist.

Unfortunately, there is a trend that institutions impose ever more burdensome and even absurd requirements on innocent customers. For the first time in my life, I just have closed an account solely because the KYC requirements had become too ridiculous and expensive – I literally had to spend over a hundred USD and several hours every year on pointless paperwork. The offending institution wasn’t satisfied with a public notary certifying my passport copy but then required a court to authenticate the notary’s signature, a licensed translator to translate my passport into the local language (admittedly, how should they have figured out what “name” and “surname” means?), and their embassy to legalise the court’s authentication – a lengthy process costing over USD 100 in fees. This year they decided to add a requirement of their foreign ministry to further authenticate the embassy’s signature – yet the whole process does nothing to solve the above-mentioned original issue that if my notary had failed to spot a fake passport, all these government officials would merely certify the authenticity of a copy of a fake document.

There are three root causes behind this mess. First of all, compliance officials face a very asymmetrical incentive structure. A bank’s share price will never rise by 50% because the Wall Street Journal publishes an article praising the bank’s compliance effort – but a single high profile compliance issue slipped through might cut the share price in half if the market fears billions of dollars in fines or even the loss of the banking license. As mistakes do happen, there is pressure to add requirements solely to be able to better argue to have “done everything we could” in case a problem does occur. Here the KPIs need a fundamental rethink – e.g., it might be more productive to have “white hackers” try to circumvent KYC safeguards and measure their success rate than adding ever more requirements with unproven effectiveness.

Key points include:

  • An asymmetrical incentive structure

  • Compliance processes

  • The role of regulators

Read the full article, At which point becomes KYC excessive and counterproductive?, on Linkedin.