With all of the buzz around regtech, it’s easy to forget that banks have leveraged technology for compliance and reporting for decades. But thanks to recent developments in data architecture, artificial intelligence and more, regtech is on the rise, and it’s evolving into something a lot more sophisticated.
The definition of regtech is simple. According to New-York-based analytics firm CB Insights, regtech is “technology that addresses regulatory challenges and facilitates the delivery of compliance requirements.” Regtech can be as simple as using an Excel spreadsheet for financial reporting or as complex as using adaptive algorithms to monitor markets. By studying the evolution of regtech, banks can begin to decipher which technologies are aspirational and which ones are crucial to navigating today’s demanding regulatory regime.
Regtech has and is evolving in three key phases, according to the CFA Institute Research Foundation, a nonprofit research group in Charlottesville, Virginia. The first phase was focused on quantifying and monitoring credit and market risks. A powerful illustration of the forces driving this initial phase can be seen in the Basel II accord, which was published in 2004. Basel II focused on three pillars: minimum capital requirements, supervisory review by regulators and disclosure requirements meant to enhance market discipline.
Despite the enhanced regulatory requirements of Basel II, the global financial crisis of 2008 exposed serious deficiencies in capital requirements that spurred the second and current phase of regtech’s evolution. New anti-money laundering (AML) and Know Your Customer (KYC) laws have drastically increased compliance costs. According to Medici, a financial media company, financial institutions spend more than $70 billion annually on compliance. In addition, increased fines for banks, new capital requirements and stress testing have resulted in a heavily burdened banking system. With increased regulatory requirements, we have seen a corresponding increase in technology solutions poised to meet them. The following are a few key areas banks should explore:
- Modeling and Forecasting: Even if your bank is not subject to the Dodd-Frank Act Stress Test (DFAST) or Comprehensive Capital Analysis and Review (CCAR), it should still be able to leverage modeling and forecasting tools to manage liquidity, meet CECL (current expected credit loss) accounting standards and monitor important trends.
- KYC/AML: Regulatory requirements that require your financial institution to “know your customer” when you onboard them often rely heavily on paper-based processes and duplicative tasks. In addition, the Bank Secrecy Act requires banks to perform intense transaction monitoring to help prevent fraud. Both of these obligations can be curtailed through the use of technology, and solutions are available to digitize client onboarding and use AI to monitor transactions.
- Monitoring Regulations: Rules and regulations are being promulgated and revised at a rapid pace. Instead of hiring a cadre of attorneys to keep up, banks can use regtech to monitor requirements and recommend actions to keep the bank in compliance.
Banking is, by necessity, a risk-averse industry. As such, taking a leap with companies that will touch bank data, gather information from back-office software or deploy AI can seem like a scary proposition. Some regtech providers on the marketplace today are new, but some were forged through the fires of the financial crisis, and others are time-tested vendors that have been around for decades. Whether a regtech partner is established or emerging, banks can (and should) hedge their bets by communicating with their regulators and forming a plan to monitor the new technology.
The CFA Institute Research Foundation posits that we are on the precipice of phase three in the evolution of regtech. This future state will be marked by a need for regulators to develop a means of processing the large amounts of data that regtech solutions generate. In addition, regtech has the potential to enable real-time monitoring. Both advancements will require a rethinking of the regulatory framework, and more openness between banks and regulators.
Despite the portmanteau (which is usually reserved for new or unfamiliar concepts), regtech is an old friend to the banking industry. Its future may hold the keys to a new conceptualization of what oversight means. For now, though, regtech represents an opportunity for banks to leverage technology for what it was intended to do: Save humans time, labor and money.