Another $20m in the Land of African KYC
What Smile Identity’s $20 million raise foretells about identity tech in Africa.
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KYC is not optional yet it is broken.
Wherever there is a sovereign country, there are likely KYC and AML rules.
Paper identities like birth certificates and government addresses are used by the financial industry to try and prevent economic crime. The way we use these identities in finance is called KYC.
These regulations; Know Your Customer (KYC) standards and Anti-Money Laundering (AML) measures which are meant to create a fair, fraud-free financial system have quite frankly become a nuisance.
Their existence is justified by the purpose they serve. One of making sure that people are actually who they are claiming to be.
In essence, the standard KYC/AML process for finance companies involves individuals or businesses providing:
Basic Details (name, gender, marital status, mobile number, and date of birth)
Government-Issued Identity and Address Proof
Other Risk-related details (e.g banks are mandated to also ask customers for other details that can include income, occupation, education, etc.)
Suspicious Activity/Transaction Report (a regulated framework on KYC/AML for Regulated financial Entities that elaborate risk checks and maintenance of reports to track any suspicious activity)
Most of the global financial system is built on paper. Financial laws assume these paper processes and most of its defences are designed to prevent paper crime from happening.
To do almost anything in financial services, you need to Know Your Customer (KYC).
It's the law.
The fines and the repercussions for finance institutions not doing KYC aren’t worth it.
Almost all sectoral and local financial regulators such as the central banks and exchange boards have a set of customer identification requirements or have a Customer Due diligence (CDD) framework for stopping illegal access to the financial system.
We’ve seen how the US, UK and Europe introduced sanctions when Russia invaded Ukraine by releasing a list of named individuals that had to be frozen out of the global banking system. Banks, Fintech companies, and anyone in financial services had to figure out how to comply. So these individuals and companies could no longer trade dollars, euros, or sterling, and any holdings in foreign banks were frozen.
The importance of existing KYC/AML policies is clear, albeit it is also crucial to know where KYC/AML can go wrong and how tech can help.
When measuring the importance of KYC/AML policies there are two issues to consider that get overlooked:
A lot of people do not understand all the interactions that go behind establishing the identity of the customer or the business
And our inability to measure the effectiveness of these policies with much of the information behind closed doors.
The primary role of KYC/AML is to combat the financing of terrorism and deny any illegal access to financial services. This includes arms or drug dealing, human trafficking, and other illegal means.
One big assumption is that we can use paper identities to effectively prevent financial crime. However, reality tells us this isn’t entirely true.
Financial institutions, especially payment companies and ultimately the masses face a lot of challenges as they regularly deal with complying with regulations by financial regulators.
KYC and AML are the basis of global economic policy and law enforcement. Yet they are complicated, tiresome, and inconvenient to financial institutions and users alike.
People have been forging checks and fake identities to steal from banks. Financial fraud is a multi-billion-dollar industry. Various estimates put the total amount lost to money laundering and economic crime annually between $800bn and $2trillion.
At a base level, the best way to prevent the bad guys from accessing the financial system is for banks and finance companies to not give them an account during account opening, by reviewing the documents they submit for authenticity and performing checks for economic crimes, like money laundering, sanctions evasion and corruption, and fraud.
The bank or finance company has to check for all three types of economic crime in the customer's history and reject that customer at account opening.
When a potential customer wants to open an account, they need to provide legal evidence of their identity and proof of address. These legal identity documents are usually issued by the government and include photo IDs like passports, driver's licenses, and national ID cards.
In essence, your “legal Identity” is the one by which your government recognizes you by.
The prerequisite to produce a “legal Identity” backed by the government excludes many people from the financial system, people who do not possess bad motives.
The world bank estimates that over a billion people (the poorest and mostly women) do not have any proof of identity.
For these people, KYC/AML standards are an enabler of mean financial exclusion for them since they have no access to traditional financial institutions and will continue to find it hard to access the financial system especially as digital finance continues to soar, all because of their lack of past records and access to identity documents.
Another issue with KYC/AML is the high costs which run in billions globally. This study suggests that compliance costs are more than a hundred times the funds recovered from criminals. And that banks, taxpayers and ordinary citizens are penalized more than criminal enterprises.
Current KYC and AML processes limit illegal access to an extent but are still ineffective at preventing drug, arms, and human trafficking. It does little to manage tax evasion and child sexual or labour exploitation. When you consider that criminal enterprises retain 99.95% of the proceeds of crime.
Then there’s arguably the biggest issue, that KYC/AML worsens the onboarding experience for finance apps or wallets. When signing up for a new finance app, some of the questions asked like marital status and occupation may make us wonder how relevant these questions are to using our money on these platforms.
The lists of requirements for KYC (video KYC, government identity, etc.) during onboarding for finance platforms for asserting customer identity, continue to be confusing and inconvenient to users.
Current KYC standards are still a long way from being optimal. They come with additional costs for the finance industry and also exclude hundreds of millions of people from the banking system.
For businesses and products alike friction is the enemy. For banks and other types of finance companies, the digital world created a wave of new potential scams and attacks. So we live in a world where a potential high-risk transaction requires further details from a consumer before it can occur, which creates friction. And friction is something that finance companies are incentivized to remove.
We have a world where starting a digital wallet is cheaper and faster than ever. This means that bad actors have a broader surface area to attack.
So how do we react?
Well, risk infrastructure.
Risk Infrastructure is potentially one of the hottest sectors in Fintech. There’s an explosion in demand for KYC/AML solutions that can solve the problem of how financial institutions manage risk.
The biometric and digital identity market in Africa is rife with international companies like Gemalto, Zete's People ID Division, Idemia, Semlex, Biorugged, Veridos and IN Groupe, whose Modus Operandi is to bid for government contracts around the African continent.
However, the market is now attracting local startups from the continent who tend to focus on two main categories; Identity Verification (Authentication) & Digital KYC services.
In Africa, there’s a patchwork of identity tech startups that specialize in e-KYC, while some go much deeper into the financial services account opening value chain by providing Document Verification, and AML & Identity Theft Fraud Detection services.
On the other hand, there seems to be a dearth of identity startups in Africa specializing in Account login solutions (password-less login authenticators) and account Activity services (transaction monitoring tools).
Smile identity, one the top KYC startups on the continent, just raised $20 million in a Series B round taking its total funding to $30 million. This is the biggest raise by an identity verification startup on the continent, only followed by iiDentifii’s $15 million raise last year as well.
Some other interesting identity startups on the continent to watch include Identitypass ($3.3M), ThisisMe ($2.5m), Youverify ($1.9M), and Dojah ($510K).
Traditional KYC isn't an automated process, but with digital identity and e-KYC solutions, there’s some automation which brings significant reductions in compliance costs for finance companies.
In Africa, a lot of people do not have a local identity to pass KYC. The World Bank estimates that 57% of Africans still don’t have a bank account of any type, including a mobile money account, as Africa accounts for half of the people in the world that have no means of identification.
So you have a lot of people, around 550 million Africans, who don’t own bank accounts or mobile money accounts, who contribute significantly to the continent’s underbanked and unbanked population, because they cannot prove their identity, and
Africa's Biometric and digital identity market is estimated to be £1.4 billion by Acuity Market intelligence, while the global biometric market is expected to reach US$82 billion by 2027.
However, I think that the total addressable market (TAM) of identity tech in Africa is understated when you consider that the TAM is fueled by the unbundling of financial services, where consumers have multiple accounts across checking, savings, high-yield, stock-trading, crypto trading, P2P payments, BNPL, etc.
Also, outside of account opening for financial services, there is an exponential market opportunity within every use case that requires the identification of a consumer.
Today, a pressing issue of the digital economy is that of validating digital identities for the onboarding and authentication of users. It is not very convenient to have to upload a picture of an ID every time you want to verify your identity with a new app.
This process is repetitive and has so much friction which results in delays and large costs in customer identity verification and can lead to authentication fatigue.
Many online and even offline services require the legitimate real-world identity of users to offer certain services. Banks for example spend a lot of money every year on customer KYC checks. And let’s not even go into the lengthy visa applications some of us face.
However, we can only get excited about the innovation happening to mitigate reverifying credentials.
For example, in the past, I wrote about the need for digital identity wallets in Africa that can solve this identity verification issue by allowing users to seamlessly interact with various online providers with a completely frictionless experience.
Stored credentials in a digital identity wallet can be easily reproduced and be used to verify the identity of the user, and automatically fill lengthy forms, thereby reducing customer onboarding time significantly and cutting customer acquisition costs.
Digital identities are fundamental to the evolution of fintech, and therefore financial services, so Africa needs a digital identity infrastructure that supports our ongoing transition to the digital economy, not one that stutters along digitising the identification relics of the continent.
It’s an exciting time to watch this space develop, as the companies we identified above, and others yet to emerge, innovate to keep fraudsters out of our financial ecosystem and continue to make identity verification seamless.
There's a large gap between those with access to verifiable identification and those without in Africa. In the coming years, as more investments pour into identity startups we will see the role of digital identity in closing this identification gap, extracting more value from the population explosion, the growth of mobile technology and trade agreements like AFCFTA.
That’s all for now folks 👋
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See you in Week!
- Fosi