Identity crisis: How KYC rules are stunting Nigeria’s financial inclusion

This article was contributed to TechCabal by Kingsley Ndimele and Kehinde Durodola-Tunde.

The 2022 McKinsey Report revealed that the financial service market in Nigeria has a potential yearly growth of 10% and projected revenue of $230 billion by 2025. The Fintech sector in Nigeria contributes 33% of this market. However, the EFinA 2023 A2F Survey states that 28.9 million adults are financially excluded in Nigeria. This exclusion is significantly due to the limitations of KYC regulations from the financial institutions in Nigeria.

Know Your Customer (KYC) guidelines are vital, multi-layered components of financial procedures in Nigeria. They are accompanied by sustained supervision of customers’ transactions and activities. These due diligence and identity checks operations are targeted to counter terrorist financing, money laundering, and other financial crimes in the country.

According to the World Bank Group’s 2018 ID4D Global Dataset, almost 1 billion people lack official distinct identities globally. This is common among people living in developing countries. Nearly 500 million people living in Sub-Saharan Africa lack legal identities. That is 46% of the entire African population. Of all developing economies across the world, sub-Saharan Africa ranks the lowest.

Amidst the Covid-19 crisis, FATF introduced regulations for digital identity for financial institutions to onboard users and offer financial services digitally. Gallup World Poll 2018 data revealed that mobile phone ownership among adults in emerging economies had increased to 83%. The 2022 McKinsey Report showed that one out of every 10 transactions in Africa are now digital. Consequently, fintech startups have become critical players in the African financial services sector. Digital financial services have brought about online KYC verification using integrated API systems to validate identity documents and authentic pictures uploaded or scanned by the user.  

Disrupt Africa’s Finnovating for Africa 2023 report estimated that there are 217 fintech companies in Nigeria. This figure speaks to the significance of identity verification in Nigeria’s financial service sector. Initiating KYC processes is essential but not without difficulties. It is challenging to match seamless onboarding with KYC regulatory compliance. ABBYY Survey 2022 Report revealed that 90% of organisations witnessed their customers switch to a rival fintech because of inefficient onboarding experience. McKinsey reported in a 2022 Survey that 40% of user onboarding time is allocated to KYC procedures.

The KYC regulatory framework is dynamic. Numerous KYC guidelines from different authorities must be adhered to, and they change often. Therefore, adapting to technology and dynamic guidelines is challenging. Incorporating KYC procedures with the current onboarding framework is usually challenging because various systems have different abilities, and data swap needs extra development inputs to function seamlessly without considerable alterations.

After verifying over 100 million identities in Africa in the past five years, Smile ID reports that 80% of fraud attacks in Africa are targeted at national ID documents. There is an absence of cross-border harmonisation. EY reported that the global cross-border payment industry was projected to be approximately $156 trillion in 2022. The need for clear regulations on regional transactions for tier 3 and tier 2 accounts hinders the positive effect of the system on Nigeria’s huge remitter society.

According to the LESG KYC Compliance survey, the average yearly spend on global KYC is US$48 million. Celent predicts that financial institutions worldwide will incur approximately $37.1 billion in 2021 on AML-KYC compliance operations and technology, aside from the cost due to increased customer churn and time investment. In June 2024, KYC regulations by the CBN requested compulsory physical address verification for fintech companies. This applies to every user and POS agent.

For a country with a rural population of over 101 million (according to the World Bank collection of development indicators), proof of address is still explicitly demanded as a KYC requirement for tier 1 accounts in Nigeria. Financial institutions still require specific utility bills (issued by electricity distribution companies) as proof of address for identity verification. This makes it difficult for fintech companies to onboard the unbanked in rural areas who use clan-based address systems instead of house numbers. Most of these rural dwellers are not served by electricity distribution companies.

The Nigerian Electricity Regulatory Commission 2019 Q2 Report showed that 43% of those who have electricity do not have meters for proper bills. According to WASH 2021 Survey Findings, 33% of the Nigerian population does not have water delivered to them. More so, it is not easy to verify addresses in gated estates.

KYC compliance issues, such as a lack of scalable KYC solutions, make cost-effective compliance and holistic maintenance difficult for fintech companies. Traditional KYC procedures, paper-based documentation and manual data entry result in a higher probability of mistakes, inefficiencies and delays. Inaccurate and incomplete data, data privacy issues, and time-demanding and time-consuming KYC procedures significantly affect customer acquisition, experience and retention. 

The EFInA Access to Financial Services in Nigeria 2023 Report showed that approximately 6% of Nigerians are excluded from accessing financial services due to a lack of KYC identity documents. The financial exclusion rate in Nigeria is about 26%, while the rural exclusion rate is approximately 37% (A2F 2023 Survey Report). Some causes of financial exclusion include the NIN Barrier, BVN limitation and lack of access to KYC identity documents. Furthermore, tiered KYC excludes customers without high-value accounts from performing complete financial transactions. Only basic financial transactions are permitted on tier 1 accounts.

Drawing lessons from countries like Brazil, South Africa, Bangladesh, Indonesia, Malaysia, Peru, Egypt, Tanzania, Uganda, Eswatini, and Gabon that have achieved impactful regulations, innovative solutions and effective KYC implementation for their financial institutions, Nigeria needs to introduce new policy innovations and review its existing regulatory Frameworks. To facilitate this, a bill that mandates the identity documentation and digital birth registration of every child between 0-5 years should be passed into law. Proof of Address and utility receipts for KYC verification may be made alternative or absolved for Tier 1 accounts that use clan-based address systems or are unserved by utility firms.

A collaborative effort by regulators, fintech innovators, policymakers, and agents is needed to enable fintechs to launch products within acceptable risk limits and improve their compliance programs to adhere to the new regulatory demands. There should be less focus on KYC processes and more on the corresponding results.  To establish a unified KYC database that mitigates system cost and silos in Nigeria, every existing database managed by private firms, international and government agencies should be harmonised regionally and locally. For instance, South Africa used a consultative approach between key stakeholders to achieve a flexible regulatory KYC framework.

AI may never replace or replicate the importance of agents in serving the underbanked and unbanked population in Nigeria. This is because of the direct interaction and human touch experience they offer Tier 1 customers. The 2024 GSMA Annual State of the Industry Report on Mobile Money revealed the significance of 500,000 agents at PalmPay in contributing hugely to financial inclusion in Nigeria. 

To further improve the accuracy of KYC verification, technological innovations such as machine learning, blockchain technology, iris identification technology, and AI-enabled conversational chatbots should be encouraged to make KYC verification accurate and authentic. Although there are proofs that show some weaknesses of these technologies, these innovations should not be discredited; instead, more advanced identity features should be innovated and layered. 

In conclusion, instead of using the copy-and-paste approach, global innovations should be imported and customised to suit Nigeria’s local context and socio-economic realities. Every successful KYC innovation and guidelines should be compliant, consistent, and conformable to various governmental policies and enterprises. They should be simple, budget-friendly, accessible, user-friendly, error-free, swift, and interoperable with other business technology software and AML and CFT tools. 

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Kingsley is a financial economist and business consultant in Nigeria. He is the Founding Partner of Kingsley Ndimele LLC.

Kehinde is a fintech product manager in the United Kingdom. He is the Founder of BlockMooreHQ Limited.