Published on August 28, 2018 by Deepti Kapoor
The great financial crisis of 2007-08 exposed the vulnerabilities of the financial services (FS) industry, highlighting the weak risk management framework and lack of regulatory governance. The industry has been hit by multiple instances of compliance breach and frauds, resulting in huge payouts. Globally, banks have paid USD 321bn in fines from 2008 to 2017, which sets to question the existing regulatory compliance approach of financial institutions (FIs).
Further, evolving regulations since the financial crisis poses compliance challenges before FIs. Fortunately, as the FS industry has adopted digital operations, combining regulations with technology (or Regulatory Technology [RegTech]) is a natural extension.
The Meaning Within
The Institute for International Finance defines RegTech as “the use of new technologies to solve regulatory and compliance requirements more effectively and efficiently.” It is a spectrum of technological tools and solutions that help mitigate risks, improve compliance, and streamline processes. RegTech applies the latest technology to answer compliance questions, understand obligations, interpret large data volumes, and compute findings. It also helps predict regulatory and compliance risks by leveraging advanced analytics techniques, such as machine learning and artificial intelligence.
RegTech Service Areas Attracting Investor Money
The FS industry exhibited strong investor sentiment in RegTech growth in 2017. RegTech funding reached USD 1.04bn in 2017, growing at a CAGR of 10.8% between 2014 and 2017.
Mapping Investing Activity by Service Area and Technologies
Source: Grant Thornton
Driving the Wave of RegTech
The following factors lead the way for RegTech growth.
A 492% increase in number of regulatory changes from 2008 to 2015: RegTech helps FIs to keep up with regulatory updates, including changes in consumer and data security regulations, such as revised Markets in Financial Instruments Directive (MiFID II) and updated Payment Services Directive (PSD2)
Reduction in regulatory compliance cost by curbing time, effort, and errors through automation: RegTech builds compliant and efficient business processes. According to strategy consulting firm, Quinlan & Associates, blockchain technology could cut annual costs incurred on AML in the banking industry by USD 4.6bn
Cutting multi-billion non-compliance fines: From 2012 to 2016, the cost of misconduct for the largest 20 global banks hit USD 359bn, up 32% compared to that from 2008 to 20125 , stressing the need to implement RegTech solutions
Rise of omnichannel digital engagement: Compliance and risk exposure have increased due to the high volume of customer business interaction via the web, social media, and digital channels. This has intensified the need for an agile technology to tame the tremendous volume and complexity of client-entrusted data
Not a Smooth Ride
RegTech integration faces few roadblocks, such as the below.
Synchronization: Although RegTech looks promising, its providers face the challenge of synchronizing the global regulatory environment to create a common set of rules across regulatory jurisdictions
Interpretation: Another challenge they face pertains to accessible guidance for institutions interpreting regulatory requirements. This is handled by local customizations, which can leverage the competent RegTech ecosystem
Adoption & Implementation: Balancing domain expertise and technology is faced with challenges, such as integration with legacy systems, scalability, return on investment, and the need for cultural change. The evolving compliance taxonomies and risk nuances make it worse for a pre-defined technology product to address all underlying regulatory, compliance, and operational risks
Infrastructure: Regulators will have to migrate to a digital supervisory process to cope with the increasing data volume and build a robust automated regulatory compliance process. The adaptation to the newer digitalized infrastructure might make existing platforms unsuitable for the changed regulatory framework
Future: Innovation to Level Up the Game
Despite the challenges, FIs worldwide are adopting RegTech because it allows them to clear the challenging regulatory hurdles and achieve operational efficiency by minimizing costs, automating tasks, and reducing resources. The FS industry spend on regulatory compliance is expected to reach $ 120bn in the next four years.
Early adopters have started embracing the RegTech opportunity. According to the second global survey by Thomson Reuters Regulatory Intelligence, respondents registering a positive view of RegTech innovation and digital disruption increased to 75% in 2017 from 42% in 20166 . Using the MiFID II as a test case, ING and Commonwealth Bank of Australia completed a RegTech project for simplifying information processing and regulation implementation in February 2018 .
As the industry is shifting towards a more data-driven and granular approach, FIs should also focus on building processes by combining domain expertise, business processes, and technology. The next-generation RegTech solutions will be influenced by cognitive technology, real-time analytics, and robotics. And, RegTech might become the forerunner in reforming the financial sector regulatory space.
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About the Author
Deepti Kapoor is a member of the Consulting and Corporate practice with experience in the research and consulting industry. She has supported private equity funds, financial institutions and stock exchanges on a range of assignments and engagements across sectors.
Deepti’s expertise is in secondary research projects involving comparative performance analysis, data collection, and benchmarking. She holds a Bachelors of Technology.
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