Redefining the new normal for KYC compliance

The colossal changes that the world witnessed since the beginning of the COVID-19 pandemic are also redefining the new normal for KYC compliance.

The current status of KYC compliance is one characterised by crucial transitions in all its aspects. This transition – part of the overall digital transformation in financial services trend that has been dominating the industry for quite some time – was drastically accelerated by the 2020 pandemic.

Historical delays in the digitisation of KYC compliance

Historically, the compliance department has been one of the last functions within financial services firms to embrace digital transformation. A general reluctance to steer away from established processes caused the compliance function to remain an extremely manual and paper-based process for longer than other comparable functions within the business. Even when it involved a digital element, this was usually through a traditional system within an on-premise IT infrastructure that could only be accessed from the machines at the office.

In fact, a 2019 study by Know Your Customer (see graphic below) revealed that 37% of surveyed compliance professionals still relied on a “fully manual” or “mostly manual” customer onboarding and KYC process, while 29% of respondents described their KYC procedures as “50% automated and 50% manual”.

The role of regulations in accelerating change

Perhaps surprisingly, the biggest catalyst of digital transformation in KYC compliance since the beginning of the COVID-19 pandemic has been financial regulators around the world. In fact, regulators have started to replace diffidence with encouragement regarding technology adoption and digital transformation for AML/KYC processes. This shift, which had already started, was massively accelerated by the coronavirus pandemic.

For instance, during the inaugural AML/CFT RegTech Forum in November 2019, the Hong Kong Monetary Authority encouraged Hong Kong’s banks to “consider, test and implement” RegTech solutions to drive innovation and stronger compliance across the sector.

In April 2020, the Financial Action Task Force (FATF) issued official recommendations to promote digital onboarding solutions during the pandemic.

In January 2021, the HKMA and Deloitte released a report on the state of RegTech adoption in the area of AML/CFT compliance. According to the research findings, about 90% of all retail banks in Hong Kong have either already implemented or plan to implement RegTech solutions to facilitate remote on-boarding for individuals, while there has been strong growth in testing remote onboarding solutions for corporate customers as well.

On 17 June 2021, the HKMA launched a new Regtech Adoption Practice Guide series to provide financial institutions with detailed practical guidance on how to successfully implement RegTech solutions. Each issue of the series focuses on a different technology or application area with the objective of driving RegTech adoption in the Hong Kong banking sector.

Similarly, a paper on “COVID-19-related Money Laundering and Terrorist Financing Risks and Policy Responses” published by the Financial Action Task Force (FATF) in May 2020 highlighted that a number of national regulators have begun to encourage “the use of responsible digital identity and other responsible innovative solutions for identifying customers at onboarding and while conducting transactions”.

This follows the FATF’s own Digital ID Guidance – released in March 2020 – which states that “non-face-to-face onboarding and transactions conducted using trustworthy digital ID are not necessarily high-risk and can be standard or even lower-risk”.

Challenges to faster digitisation

Despite the encouraging signals, a number of challenges to fully digitising the KYC compliance function remain, including:

• A general reticence from compliance teams to replace established manual processes with new and fully digital solutions;
• Reluctance from certain IT departments to embrace technology trends that would accelerate the change, such as cloud computing solutions and “BYOD” (Bring Your Own Device) practices to facilitate remote and flexible working;
• Limited opportunities to think strategically about the role of compliance in shaping business processes, finding solutions that are efficient, fully compliant, and easily scalable to grow across international markets despite growing operational costs and regulatory requirements;
• A lack of clarity from a minority of regulators on what constitutes a compliant process in the digital vs paper-based environment.

What today’s customers expect

As daunting as these challenges may seem, the risk of doing nothing is even greater. During the pandemic, financial institutions that fail to implement digital KYC and remote onboarding procedures risk having to interrupt acquiring new customers altogether. At the same time, customers’ expectations of smooth and digital experiences are becoming more and more engrained every day, fostered by the convenience and ease of use that new FinTech players are able to provide.

We don’t know yet what the long-term impact of the coronavirus pandemic will be on FinTech ‘unicorns’. However, customers who have experienced the type of digital KYC journey that digital banks are able to provide will not go back to certified paper copies of documents or unnecessary and repeated touchpoints of communication when they need to open a bank account or access other financial products.

So, if established financial institutions want to prepare their back-end as well as client-facing operations for the challenges of the next decade, the KYC compliance function is a great place to start.