For Non-Banking Financial Companies (NBFCs), KYC and Anti–Money Laundering (AML) compliance is not a one-time onboarding exercise but an ongoing statutory responsibility. The objective of these requirements is to prevent money laundering, fraud, and terrorist financing while safeguarding the integrity of the financial system and protecting customers. As reporting entities, NBFCs are legally required to conduct customer due diligence, identify and verify beneficial ownership, monitor transactions on a continuous basis, and report prescribed transactions and suspicious activities within the timelines specified under law.

With the rapid growth of digital lending, faster loan disbursements, and increased dependence on third-party sourcing and technology partners, regulatory expectations have become more stringent. Regulators now expect KYC and AML compliance to be deeply integrated into business processes rather than treated as a procedural formality. Effective compliance requires robust policies, system-driven controls, proper documentation, audit trails, and consistent application across all customer touchpoints, ensuring that regulatory obligations are met in both letter and spirit.

In this article, CA Manish Mishra talks about KYC, Anti-Money Laundering & Compliance Checklist for NBFCs.

Legal Framework Governing KYC and AML for NBFCs

Core AML Law and Rules

The foundational law for AML is the Prevention of Money Laundering framework, supported by rules that prescribe client due diligence, maintenance of records, and reporting requirements. These rules define what constitutes reportable transactions, how long records must be retained, and what documents and verification steps are required to establish identity and beneficial ownership. For NBFCs, these obligations apply across the customer lifecycle onboarding, servicing, renewals, collections, and closure.

RBI KYC Directions for Regulated Entities

NBFCs must follow RBI’s KYC directions applicable to regulated entities. These directions prescribe a risk-based KYC program, customer categorisation, modes of verification (face-to-face and non-face-to-face), ongoing due diligence, periodic KYC updating, and enhanced due diligence for higher-risk customers. Practical compliance requires NBFCs to convert these principles into operational SOPs, system controls, and exception handling.

Sanctions, Terror Financing and Prohibited Dealings

NBFCs must screen customers and transactions against applicable sanctions and prohibited lists as required under law and regulatory instructions. This includes ensuring that onboarding and servicing do not occur for sanctioned entities and that suspicious linkages are escalated and acted upon through defined internal processes.

Governance Setup: Accountability at the Top

Designated Director and Principal Officer

Every NBFC should formally appoint a Designated Director and a Principal Officer to establish clear accountability for AML compliance. The Designated Director provides board-level oversight and ensures the governance framework is implemented effectively, while the Principal Officer is responsible for operational execution, internal reporting, escalation of red flags, and filing regulatory reports. This structure is critical because regulators assess AML failures as governance weaknesses, not just operational misses.

AML Policy and Risk Appetite

A robust AML policy must be approved by the board and aligned to the NBFC’s product mix, customer profile, geography, and distribution model. The policy should define the institution’s risk appetite, prohibited customer categories, acceptance rules, verification standards, escalation hierarchy, and reporting governance. When this policy is translated into measurable controls system validations, maker-checker approvals, and audit trails—compliance becomes enforceable and defensible.

Customer Acceptance Policy: Who You Can and Cannot Onboard

Prohibited and High-Risk Customer Controls

Customer acceptance is the first line of defence. NBFCs must define prohibited categories (for example, customers with unverifiable identity or unacceptable risk indicators) and set conditions for onboarding high-risk customers such as politically exposed persons (PEPs), complex ownership structures, or high-risk geographies. The acceptance policy must be supported by documented approvals, enhanced verification steps, and strict monitoring, ensuring that business pressure does not override compliance safeguards.

Beneficial Ownership Identification

Where the customer is not a natural person, NBFCs must identify and verify beneficial owners and persons exercising ultimate control. This requires collecting and validating ownership/control information, verifying authorised signatories, and ensuring that the relationship is not being used to conceal identity. Good practice is to maintain clear beneficial ownership documentation, supported by periodic refresh and event-based updates.

Customer Due Diligence: KYC That Actually Works

KYC Identification and Verification Standards

CDD requires verifying identity and address using officially valid documents and applying appropriate verification modes. For digital onboarding, NBFCs must ensure the chosen method meets regulatory conditions, produces reliable audit trails, and prevents impersonation. Effective CDD is not only about collecting documents it is about ensuring authenticity, consistency, and traceability of verification outcomes.

Risk-Based Customer Categorisation

NBFCs must classify customers into risk categories (low/medium/high) based on objective risk parameters such as customer type, product, geography, transaction behaviour, and delivery channel. This categorisation determines the intensity of due diligence, frequency of monitoring, and periodic KYC update intervals. The strongest programs treat risk rating as a living score that adjusts when behaviour changes, rather than a one-time onboarding tag.

Enhanced Due Diligence for High-Risk Customers

EDD is required where risk is higher such as PEPs, unusual transaction patterns, non-resident exposures, complex ownership, or high-risk business segments. EDD typically involves additional documentation, stricter verification, source of funds/source of wealth checks where relevant, senior management approvals, and tighter ongoing monitoring. The legal defensibility of EDD depends on documented rationale, approvals, and monitoring actions.

Digital KYC and eKYC Controls for NBFCs

Non Face-to-Face (NFTF) Onboarding Safeguards

Digital onboarding can be compliant and efficient only when supported by strong controls against identity fraud. NBFCs must ensure that non-face-to-face onboarding follows permitted methods, includes liveness and authenticity checks where applicable, captures adequate customer consent, and produces clear audit evidence. Any exceptions must be tracked and approved under defined thresholds to prevent systemic control bypass.

Video KYC / Assisted Verification Governance

Where video-based identification is used, NBFCs must ensure trained staff, controlled scripts, geo-tagging/logging where required, clear capture and storage protocols, and strict controls to prevent spoofing or proxy representation. Video KYC is not only a technology workflow it is a compliance process that must be auditable and consistent across branches, partners, and locations.

Ongoing Due Diligence: Monitoring After Onboarding

Transaction Monitoring and Red Flags

Ongoing due diligence means monitoring transactions and behaviour to detect suspicious patterns. NBFCs should implement scenario-based alerts and risk-based thresholds aligned with product type such as frequent early closures, unusual repayment sources, rapid loan stacking, sudden spikes in disbursement requests, or repayment behaviour inconsistent with profile. The key compliance standard is that alerts must lead to documented review, conclusions, and escalation where required.

Periodic and Event-Based KYC Updation

KYC updation must be done periodically based on customer risk category and also on trigger events such as changes in identity details, address, ownership/control, contact details, business profile, or unusual activity. A strong process prevents KYC backlogs by using reminders, simplified update flows (where legally permissible), and robust documentation of update attempts and outcomes.

Reporting Obligations: Filing What the Law Requires

Prescribed Transaction Reports and Suspicious Activity

NBFCs must furnish prescribed reports to the relevant authority, including suspicious activity reports where suspicion exists, and other transaction reports as required under rules. This is a strict obligation and does not depend on whether the NBFC ultimately suffered a loss. Practical compliance requires a documented internal escalation process, quality review, timely filing, and strict confidentiality to avoid tipping-off.

Record Maintenance and Retention

NBFCs must maintain records of customer identity, account files, business correspondence, and transaction records for the legally prescribed period and ensure they can be retrieved quickly for audits, inspections, or investigations. Retention is not only about storage it includes integrity controls, restricted access, tamper resistance, and secure archival and destruction policies consistent with law.

Third-Party, Outsourcing, and Partner Governance

Sourcing Partners and Service Providers

Where NBFCs use third parties for sourcing, onboarding assistance, collections, analytics, or technology services, the NBFC remains responsible for compliance outcomes. Contracts must clearly define roles, data access, customer communication boundaries, audit rights, training requirements, and incident reporting. Oversight should include periodic partner audits, sample checks, and strict action against deviations such as document manipulation or misrepresentation.

Collections Conduct and Customer Communication Controls

Collections and recoveries are a high-risk compliance area. NBFCs must ensure fair practices, approved communication scripts, controlled calling mechanisms, and escalation pathways for harassment complaints. Governance should ensure that field collections are monitored and that digital communications remain accurate, non-misleading, and consistent with customer agreements.

Data Privacy and Cybersecurity: AML Compliance Depends on Data Integrity

Consent, Purpose Limitation, and Data Minimisation

KYC and AML require collecting sensitive data, so NBFCs must ensure lawful collection, clear customer notice, appropriate consent where applicable, and strict purpose limitation. Data minimisation and retention discipline reduce privacy risk while improving compliance quality. A compliant KYC program is one where data is accurate, protected, and used only for permitted compliance and servicing purposes.

Cyber Controls and Incident Response

Cybersecurity directly affects AML because compromised systems enable identity theft, synthetic profiles, and fraudulent disbursements. NBFCs should maintain access controls, encryption, monitoring, and incident response plans to detect breaches quickly. From a compliance perspective, the ability to trace who accessed data, what changed, and when it happened is essential.

Compliance Checklist for NBFCs (Explained in Paragraph Form)

Governance and Policy

Ensure the board approves an AML/KYC policy, appoints a Designated Director and Principal Officer, and receives periodic reporting on compliance health. The NBFC should document risk appetite, customer acceptance criteria, escalation workflows, and reporting governance, with clear ownership and timelines for remediation of gaps.

Customer Acceptance and CDD

Implement risk-based onboarding with identity verification, address verification, and beneficial ownership checks where relevant. Maintain a documented rulebook for prohibited categories, high-risk onboarding approvals, and enhanced due diligence triggers, ensuring that exceptions are recorded, approved, and monitored.

Digital Onboarding Controls

If onboarding is digital, ensure permitted verification methods, audit trails, staff training, and fraud controls such as liveness checks and controlled verification steps. Track exceptions, ensure customer consent and disclosures are captured, and maintain evidence that the onboarding journey met regulatory requirements.

Ongoing Monitoring and KYC Updates

Set up transaction monitoring aligned to products and customer profiles, and ensure alerts are reviewed with clear outcomes and escalation. Maintain periodic KYC update schedules by risk category and event-based updates for material changes, preventing KYC backlogs and ensuring accurate customer records.

Reporting and Recordkeeping

Establish a strong internal suspicious activity escalation mechanism and ensure prescribed reports are filed within statutory timelines with confidentiality controls. Maintain records for the legally prescribed retention period with secure storage, retrieval capability, restricted access, and tamper-evident audit trails.

Outsourcing, Partners, and Vendor Risk

Ensure contracts clearly define compliance responsibilities, audit rights, data access boundaries, and customer communication rules. Conduct periodic partner audits, monitor performance, and enforce corrective actions, especially in sourcing and collections where misconduct risk is highest.

Training, Testing, and Audit

Conduct role-based AML training for onboarding teams, operations, collections, and partner managers. Run periodic control testing, sample checks, and internal audits to validate that policies work in practice, and ensure findings are closed within defined timelines with board visibility.

Conclusion

KYC and Anti–Money Laundering compliance has evolved into a core governance and risk management function for NBFCs. It plays a decisive role in preventing financial crime, ensuring customer protection, and maintaining regulatory confidence. A structured compliance checklist helps NBFCs translate legal requirements into practical controls, enabling consistent customer due diligence, effective transaction monitoring, and timely regulatory reporting across all business verticals.

As regulatory oversight becomes more technology-driven and supervisory expectations continue to rise, NBFCs can no longer treat AML compliance as a reactive obligation. Embedding compliance into digital systems, third-party governance, and internal workflows is essential for long-term resilience. NBFCs that adopt a proactive, well-documented, and risk-based AML framework are better equipped to manage operational risks, avoid enforcement actions, and achieve sustainable growth in a rapidly evolving financial ecosystem.

Frequently Asked Questions (FAQs)

Q1. Do NBFCs have the same KYC/AML obligations as banks?

Ans. NBFCs have AML and KYC obligations as regulated entities and reporting entities, but the exact operational requirements may vary based on regulatory classification, products, and risk profile. In practice, NBFCs are expected to implement robust CDD, ongoing monitoring, reporting, and governance comparable to banking-grade standards, especially as supervision becomes more data-driven.

Q2. What is the biggest AML risk area for NBFCs today?

Ans. The biggest risks typically arise in digital onboarding, third-party sourcing, and collections—where speed, volume, and distributed operations can weaken verification quality and monitoring. Weak governance over partners, poor documentation, and inadequate transaction monitoring can lead to suspicious activity going undetected and increase regulatory and reputational exposure.

Q3. When is enhanced due diligence required?

Ans. EDD is required when customer or transaction risk is higher, such as politically exposed persons, complex ownership structures, unusual repayment sources, high-risk geographies, or behaviour inconsistent with the customer profile. The key is that EDD must be risk-justified, documented, approved at the right level, and followed by stronger ongoing monitoring.

Q4. Can NBFCs onboard customers fully digitally?

Ans. Yes, digital onboarding can be done if it follows permitted regulatory methods and includes strong controls for identity authenticity, customer consent, audit trails, and fraud prevention. The NBFC must be able to demonstrate that verification was reliable and that exceptions were handled under a controlled and approved process.

Q5. What are “red flags” NBFCs should monitor?

Ans. Typical red flags include inconsistent identity details, frequent address changes, rapid loan stacking, early closures without clear explanation, repayments from unrelated third parties, sudden transaction pattern shifts, and unusual activity inconsistent with declared income or business profile. Alerts must lead to documented review and escalation where suspicion exists.

Q6. What happens if an NBFC fails to report suspicious activity?

Ans. Failure to report prescribed transactions or suspicious activity can lead to regulatory action, monetary penalties, stricter supervisory measures, and reputational damage. Regulators view reporting failures as serious compliance lapses because they undermine the national AML framework and can facilitate illegal financial flows.

Q7. How should NBFCs manage KYC updation backlogs?

Ans. NBFCs should use a risk-based approach to prioritise updates, adopt simplified update mechanisms where permitted, improve customer outreach, and embed KYC update triggers into servicing workflows. The goal is to ensure records remain current and monitoring remains reliable, while documenting outreach and outcomes to demonstrate compliance effort.

Q8. Are outsourcing partners responsible for AML compliance, or the NBFC?

Ans. The NBFC remains responsible. Partners can perform activities, but accountability for compliance outcomes stays with the regulated entity. This is why contracts, audits, training, monitoring, and strict enforcement against partner misconduct are essential to maintain a defensible compliance posture.