What is KYC? Importance, Process, and Types Explained

What is KYC?

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Know Your Customer (KYC) is a process of verifying a customer’s identity, used by financial institutions like banks and other non-banking financial companies (NBFCs). 

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This process helps financial institutions and NBFCs protect themselves from criminal activities like financial fraud, money laundering, and scams.

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In 2004, the RBI ordered every financial institution and NBFC to verify the identity and address of their customers through the process of KYC.

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Importance of KYC

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KYC is an important part of the customer verification process for several reasons. Check out the importance of the Know Your Customer process: 

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1. Anti Money Laundering (AML)

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Banks' anti-money laundering initiatives rely heavily on KYC. Banks can detect potential dangers of money laundering by performing comprehensive customer due diligence and checking the identities of their clients. 

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Therefore, they can prevent money laundering, which is the process of disguising the true sources of illicitly acquired funds.

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2. Preventing Financial Crimes

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The fight against fraud, corruption, tax evasion, and terrorist funding is only one of many financial crimes that banking institutions can combat using Know Your Customer (KYC). 

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Knowing their customers and their financial practices helps banks identify suspicious activity and prevent financial crimes.

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3. Boost Security

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In the digital era, identity theft is a major worry. Banks can reduce the likelihood of fraudulent account access and transactions on behalf of unwary clients using Know Your Customer (KYC) procedures, which verify the identity of account applicants.

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4. Builds Trust

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Customers are more likely to have faith in their banks if they have a strong Know Your Customer system that exceeds regulatory standards.

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They are more likely to feel comfortable entrusting their financial transactions to a bank that takes identity verification and the prevention of fraudulent activities seriously.

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5. Regulatory Compliance

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In order to ensure the safety of the financial system, regulatory bodies have made it clear that banks must adhere to KYC standards. 

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If banks comply with the law, they will not face fines, legal ramifications, or harm to their reputation.

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6. Risk Management

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Know your customer (KYC) helps evaluate risks related to customers. To classify customers according to their risk level, banks might compile a customer risk profile for everyone. 

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This lets financial institutions prioritise their resources and take extra precautions when dealing with customers who pose higher risks.

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Process of KYC

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The process of KYC is conducted with utmost care by the financial institutions to ensure security. Mentioned below is the detailed KYC process: 

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1. Customer Identification

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To ensure the safety of their clients, banks require official documents and personal details. Some examples of such documents are passports, driver's licences, utility bills, and government-issued IDs. 

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In order to verify the accuracy of the customer's information, it is verified with reputable sources.

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2. Due Diligence

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To better understand their customers and the kind of banking services they want to provide, banks do customer due diligence (CDD). 

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This is a good first step in figuring out the account's goal and spotting any strange or questionable activity.

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3. Risk Analysis

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Some of the criteria used by financial institutions to determine the level of risk associated with each customer. This includes their geography, occupation, income source, and past transactions. 

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Additional due diligence processes may be implemented for consumers deemed to pose a higher risk.

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4. Consistent Monitoring

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Know-your-customer checks are ongoing processes; financial institutions keep tabs on their clients' whereabouts and activity at all times. 

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The relevant authorities are notified of any unusual or suspected transactions in accordance with Anti-Money Laundering (AML) legislation.

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To maintain accurate and up-to-date data, banks periodically ask customers to update their information.

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Types of KYC

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There are various types of KYC methods used to verify customers’ identification. 

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1. Aadhaar KYC

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Aadhaar KYC entails biometric verification, remote authentication with UIDAI data or Aadhaar OTP, or both, for online identity validation.

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2. Paper-based KYC

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The most common way is to physically visit a bank or KYC registration agency to provide documents that verify your identity and address.

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3. Digital KYC

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Digital KYC verification process uses geotagged live photos and Officially Valid Documents (OVDS) uploaded online and then cross-verified for accuracy. Additionally, the KYC status can be reviewed online at a later time.

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4. Video KYC

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Video KYC is a paperless verification process that takes place online. It involves either an assisted or unassisted video review and verification by an agent.

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Documents Required for KYC

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Mentioned below are all the documents that are required for the KYC process.

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For Identity Proof:

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• Aadhaar Card
• PAN Card
• Voter ID Card
• Passport
• Driving License
• Govt-issued document with photograph

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For Address Proof: 

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• Passport
• Voter’s ID Card
• Driving License
• Utility Bills
• Documents issued by government including address details

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Check out the list of ITR documents and the filing process!

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Bottom Line

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In order to avoid fraud, financial organisations implement KYC (Know Your Customer) procedures to confirm the identity of their customers. 

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Data collection, document verification, and risk assessment are all part of it. With multiple types of KYC procedures based on risk levels, it provides security and compliance in financial systems.