RBI Crackdown On KYC Violators Has A Hidden Agenda: Ring-Fencing Fintechs

India's banking regulator has launched a widespread crackdown on companies offering financial services. One key norm around which its actions have centred and where many new age fintech companies have been found wanting is Know Your Customer or KYC rules. However, what has gone rather unnoticed is the scrutiny of Know Your Business (KVB), which is equally under the scanner. Its recent curbs on Visa and Mastercard over vendor payments have shed light on this lesser-known issue.

In February, the Reserve Bank of India (RBI) directed Visa and Mastercard to put on hold business-to-business (B2B) payments for violating the Payment and Settlement Systems Act, 2007. The RBI said that the payments were being made through third parties that did not comply with its KYC rules (for the RBI, KYB is within the rubric of KYC). The banking regulator said certain commercial payments were being routed through commercial credit cards under business payment solution providers (BPSP), which did not comply with its payment and customer identification rules.

While banks and non-bank finance companies have got the stick too, one cohort that has borne the brunt of regulatory action is new age fintech companies. KYB is a pain point for them because they are not equipped to carry out in-depth due diligence and their partner banks are not allowed to share company information with them. While banks are also worried for competitive reasons, the RBI is concerned that the lack of it could potentially lead to money laundering and breaches in regulation. Clients are reluctant to share information because they fear data leakage to rivals. The RBI's recent move indicates that it's wary of letting fintechs stay in the commercial payment space. 

“Fintechs are like the aggregator for the business credit cards and the KYB has not been used properly by the aggregator and that has been one of the key issues,” said Mihir Gandhi, Partner at Payments Transformation, PwC India told The Core. 

 

What RBI wants

The RBI has drawn strict red lines that fintech companies may not cross and has taken to task any that have. Fintech firms such as Enkash, Cred, Paymate, and Zaggle have been providing businesses with commercial credit cards to make payments to vendors and other merchants. Industry veterans believe the recent RBI crackdown is aimed at confining fintechs to personal and retail lending. There isn’t an outright ban on fintechs from participating in the commercial payment business, but the RBI likely wants business payments and KYB procedures to remain with banks. According to a veteran banking consultant, the RBI may soon issue rules on the participation of fintechs in the commercial payment business. 

“When fintechs got approval from the RBI to issue credit cards for payment, the idea was very clear that they would only participate in retail and not in business at all. But later they started doing that and the RBI is not too happy. The central bank will likely come with guidelines for fintechs in the business payment model,” said Ashvin Parekh, banking consultant and managing partner at Ashvin Parekh Advisory Services LLP. 

 

The KYB Puzzle 

Traditionally, only banks in partnership with card service providers such as Visa and Mastercard could issue B2B commercial and corporate credit cards. Fintech companies are new entrants into the business.

Using a credit card from a fintech company is similar to bill discounting. If Business A wants to pay Business B using a credit card provided by a fintech company, it makes the payment to Business B on behalf of Business A. They use funds from a bank which has already done the KYB on both parties. 

For commercial cards for business purposes, BPSPs, corporate credit cards and other B2B financial services, identification and verification is a two-step process. First, banks evaluate the corporate entity, based on their financials. Once they are satisfied with the corporate entity’s financial credentials, they proceed to KYB. 

KYB is a due diligence process conducted by financial institutions and other organisations to verify and assess the identity and legitimacy of business clients or partners. It involves gathering information about an entity's ownership structure, financial history, beneficial owners, and any associated risks. This process helps organisations comply with anti-money laundering (AML) and counter-terrorism financing (CTF) regulations, as well as mitigate potential risks related to fraud, corruption, and other illicit activities. 

KYB involves verifying the details of the company such as corporate PAN, GSTN, Incorporation Certificate, Memorandum of Association (MoA), Articles of Association (AOA), Board Resolutions, and authorised signatory details. Once this is done, banks have to do KYC for the card holders or the custodians of the payment instrument (commercial cards) on behalf of the corporate.

Be it banks or fintechs, a common area of concern is the document verification process. Every bank has its own commercial credit card appraisal policy. They are sector-specific and dependent on the bank’s internal credit rating framework. The process often involves complicated layers that differ from company to company. 

“If a company has several associates, it becomes difficult to verify their every account. Banks have to rely on the information provided by the company (those applying for the cards),” said a senior banker of a public sector bank on the condition of anonymity. 

 

Where Does The Problem Lie? 

A major hurdle for fintech firms lies in the documentation process. Often, these companies cannot conduct KYB procedures as thoroughly as required. Apart from analysing the existing credit exposure of the company, banks and fintechs need details of board resolutions, and a formal legal document that records the decisions made by a company's board of directors. Fintechs, whose business models invariably revolve around ease and efficiency of transactions, believe that the conventional approach makes the process tedious and lengthy but they have no choice but depend on them for the KYB process. 

“In most banks the KYB process is physical in nature, which requires relationship managers of the bank, who is sourcing these corporates, to create credit appraisal notes and submit all the relevant documents mentioned above to the credit underwriters,” said Avinash Godkhindi, MD & CEO, Zaggle, a fintech company which offers commercial credit cards. 

Who then is to be held responsible for completing the documentation for the KYB?  

“It will be wrong to say that the process is difficult. rather the banks and fintech companies are in a rush to increase business and often try to skip some steps,” said Naresh Malhotra, a former senior banker and an independent banking consultant. 

Another difficulty faced by the banks is tracking down the UBO or Ultimate Beneficial Owners of the company as many start-ups and fintechs have venture capital investors based abroad.  A UBO is a person or entity who has a stake of more than 10% in the company. 

 

Gap In Information Sharing

To manage commercial credit cards, fintechs depend on partner banks for KYB information of the counterparties. Gandhi explained that often details of funds spent on such credit cards are missing. On the credit card statement, the fintech is shown as the merchant, but the fintech makes the payment through NEFT, UPI or RTGS where KYB might be inadequate.

“Banks are often not allowed to pass on certain details about the companies due to privacy issues. We can’t share the details of the customers (companies) with any others. That will only be possible when we have the aggregators,” a spokesperson from the Indian Banking Association told The Core. 

Banks can share details of the tax accounts and cash flow only with the due permission of the client (the company in this case). With the RBI reluctant to let fintech expand into commercial lending, it is unlikely they will be allowed access to this information. Fintech companies believe that banks need to work more closely with them to make the KYB process smoother and faster. 

“A wrong entity will not be able to produce before the banks all necessary documents,” says banking consultant Parekh. He says if banks do not identify businesses correctly, then they could get involved in wrong doings such as money laundering. Banks have to verify if the entities have proper tax accounts, details of tax deducted at source, and other transactional information. Dodgy operators would not be able to fool banks easily. 

As of now, however, the efforts are falling in the cracks between data privacy, competition, and competence. 

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