Addressing Sebi's 38th Foundation Day last month, Nirmala Sitharaman railed against the myriad KYC norms spooking retail investors. 'It is the shared responsibility of all stakeholders to ensure that no citizen has the need to repeat the same KYC verification journey across multiple financial products and platforms. We must all work collectively towards it with a sense of urgency,' she said.
The FM's remarks were spot on. However, solving dysfunctional KYC is only tackling the symptom, akin to treating fever instead of the underlying malaise. It reflects the sad truth about India being a low-trust economy and, consequently, one with high friction. Contrast this with Singapore or Dubai, both of which showcase zero friction as their calling card. While fixing KYC may alleviate some of the problems, the real solution lies in breaking the circle of mistrust.
A key reason for the lack of trust is the legacy of regulatory overreach. A manifestation of this was the notorious 'licence raj', in turn a fallout of the government's misplaced ideological belief that it - and not entrepreneurs - is best placed to direct investments. This led to skewed policies, including a prohibitive income-tax. The marginal rate of I-T was 97.5% in the 1970s, which incentivised tax evasion and creation of the parallel, or 'black', economy.
This structural erosion of trust in the economy worsened because, to date, India has failed to differentiate between high-trust and low-trust actors. When good behaviour is not rewarded and bad behaviour is not meaningfully penalised by regulators, the system is forced to deploy blanket controls like KYC and mandatory OTPs, which have emerged as the substitute for trust.
In more mature economies, trust is built through a combination of incentives and soft-touch regulation. For example, in the US, a good credit history ensures cheaper loans. In the UAE, a driver with a clean driving record gets a discount on accumulated traffic fines, and so on. In other words, responsible behaviour leads to better terms, greater access and fewer barriers. Over time, these calibrated incentives create a virtuous cycle where trust encourages better behaviour and, in turn, better behaviour earns even more trust as a reward.
In India, the pattern works differently. Instead of beginning with trust and rewarding good conduct, the system starts from a position of suspicion. Regulatory overreach is a logical corollary. Muscle memory of Indian policymakers has been shaped by persistent concerns around tax evasion, benami accounts, hawala networks, opaque political funding and terror financing.
The system, therefore, treats everyone alike. Consequently, high-trust customers rarely receive meaningful benefits like extended I-T return window, faster dispute resolution or lower friction in onboarding.
When good actors are treated the same as bad actors, trust does not compound. Worse, regulation tightens with every infraction. Unsurprisingly, verification has emerged as the gateway to participation and scrutiny precedes approval, opening the door to scalpers and middlemen. This, however, creates friction and exacts a huge economic cost, especially in terms of efficiency and productivity.
The good news is that in the post-Aadhaar era, KYC can be undertaken digitally. Yet, here again, while it solves for the exhausting rigour of paper-based KYC, it does not fix the core problem: lack of trust.
The good news is that GoI seems to be cognisant of the shortcomings of a low-trust economy, especially its ability to incentivise the expansion of the parallel economy. Passage of the two rounds of Jan Vishwas (Amendment of Provisions) Bill by Parliament, with the objective of reducing regulatory cholesterol, signals GoI's intent to accelerate India's transition to a transparent rules-based economy, as opposed to the existing exceptions-based regime. Further, the digital rails India put in place since the rollout of Aadhaar provides an incredible opportunity for the country to leapfrog.
In no time, India has acquired a biometric identity system for over 1.3 bn people, backed by instant verification APIs and e-KYC capabilities, reducing friction by replacing bureaucratic paperwork with an automated infrastructure. This has transformed the landscape, enabling seamless digital bank onboarding, instant SIM activation, rapid fintech scaling and direct welfare transfers at an unprecedented scale.
Trust, based on data verification and identity rails - Aadhaar, UPI, DigiLocker, Account Aggregator, etc - is gradually enabling India to replace social trust with a digital trust infrastructure. India can leverage this digital verification architecture to leapfrog and evolve into a trust-based economy. Solving this societal dimension of a low-trust economy will be similar to the dramatic makeover India managed in payments using the digital public infrastructure.
Not only does this enable frictionless e-KYC, but it also provides freedom to customise verification - provide incentives for good behaviour. It is this ability to reward good behaviour that is the basis for high-trust societies. When citizens see tangible benefits from responsible conduct, trust compounds across the economy. When they don't, systems remain defensive. India's challenge is not to abandon verification but in complementing verification with differentiation.
