Addressing the Top Three Risk Trends for Banks in 2019

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As banks continue to become more reliant on technology, the risks and concerns around cybersecurity and compliance continue to grow. Bank Director’s 2019 Risk Survey, sponsored by Moss Adams LLP, compiled the views of 180 bank leaders, representing banks ranging from $250 million to $50 billion in assets, about the current risk landscape. Respondents identified cybersecurity as the greatest concern, continuing the trend from the previous five versions of this report and indicating an industry-wide struggle to fully manage this risk.

Other top trends included the use of technology to enhance compliance and the potential effect of rising interest rates. Here’s what banks need to know as they assess the risks they’ll face in the coming year.

Cybersecurity
Regulatory oversight and scrutiny around cybersecurity for banks seems to be increasing. Agencies including the Securities and Exchange Commission are focused on the cybersecurity reporting practices of publicly traded institutions, as well as their ability to detect intruders. The Colorado legislature recently passed a law requiring credit unions to report data breaches within 30 days. It’s no surprise that 83 percent of respondents said their concerns about cybersecurity had increased over the past year.

Most of the cybersecurity risk for banks comes from application security. The more banks rely on technology, the greater the chance they face of a security breach. Adding to this, hackers continue to refine their techniques and skills, so banks need to continually update and improve their cybersecurity skills. This expectation falls to the bank board, but the way boards oversee cybersecurity continues to vary: Twenty-seven percent opt for a risk committee; 25 percent, a technology committee and 19 percent, the audit committee. Only 8 percent of respondents reported their board has a board-level cybersecurity committee; 20 percent address cybersecurity as a full board rather than delegating it to a committee.

Compliance & Regtech
Utilizing technological tools to meet compliance standards—known as regtech—was another prevalent theme in this year’s survey. This is a big stress area for banks due to continually changing requirements. The previous report indicated that survey respondents saw increased expenses around regtech. This year, when asked which barriers they encountered around regtech, 47 percent responded they were unable to identify the right solutions for their organizations. Executives looking to decrease costs may want to consider whether deploying technology could allow for fewer personnel. When this technology is properly used, manual work decreases through increased automation.

Other compliance concerns for this year’s report included rules around the Bank Secrecy Act and anti-money laundering. Seventy-one percent of respondents indicated they implemented or plan to implement more innovative technology in 2019 to better comply with BSA/AML rules.

Compliance with the current expected credit loss standard was another area of concern. Forty-two percent of respondents indicated their bank was prepared to comply with the CECL standard, and 56 percent replied they would be prepared when the standard took place for their bank.

Interest Rate & Credit Risk
The potential for additional interest rate increases made this a new key issue for the 2019 report. When asked how an interest rate increase of more than 100 basis points, or 1 percent, would affect their banks’ ability to attract and retain deposits, 47 percent of respondents indicated they would lose some deposits, but their bank wouldn’t be significantly affected. Thirty percent indicated an increase would have no impact on their ability to compete for deposits.

However, 55 percent believed a severe economic downturn would have a moderate impact on their banks’ capital. In the event of such a downturn, deposits and lending would slow, and banks could incur more charge-offs, which would impact capital. This fluctuation can be easy to dismiss, but careful planning may help reduce this risk.

Assurance, tax, and consulting offered through Moss Adams LLP. Investment advisory services offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC.

Why Deregulation Means More Work for Banks

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regulation-8-20-18.pngMany banks are claiming victory over the promise of regulatory reform from bill S.2155, often called the Crapo Bill. However, the celebration and dreams of returning to the way it once was before the Dodd-Frank Act are premature.

There is still a long road for deregulation, with many obstacles. The bill’s limited scope and applicability, coupled with the uncertainty of the regulatory landscape, call into question the breadth and longevity of this so-called regulatory relief. Bankers must realize that any change, whether adding or reducing regulations, translates to extra work.

There’s nothing wrong with being cautiously optimistic about the potential for regulatory relief, but bankers should gain a deeper understanding of the details before declaring victory. Banks that work to comprehend the scope of the bill’s effects, the potential for political shifts, and what deregulation means for management will be better equipped to navigate the unpredictable regulatory landscape.

The nitty gritty: a not-so-sweeping reform
Many in the industry view the bill as enacting regulatory relief – and that’s where their understanding ends. Those who have properly digested the bill— whether bankers themselves or their regtech partners—have realized it isn’t the sweeping reform some claim. In reality, the bill is only a limited set of reforms, with restricted applicability and several distinctions based on asset size and product mix.

There is also confusion around timing and deadlines. Sections of the new law contain various effective dates, ranging from May 28, 2018, to three years from the enactment date. However, it is important to understand that regulatory relief differs from traditional rulemaking when it comes to effective dates. Typically, an effective date represents a deadline by which all implementation must be accomplished. For regulatory relief, the date represents the deadline by which a burden should be lifted or reduced.

Because of this discrepancy, questions remain around when the reduction of regulation is required versus when it is optional. This ambiguity is problematic, as some bankers will make changes right away, while others will wait until forced to do so. Complicating matters, software and technology updates won’t be readily available, causing friction in processes.

Furthermore, where provisions of the bill conflict with existing regulations, there is uncertainty about how the regulations will address these conflicts. How examinations will be conducted while there are inconsistencies between law and regulation are unclear at the time of this writing.

The unpredictable political landscape raises questions
Washington’s tendency to deregulate banking is not a surprise. The current leadership has created a “pro-business” sentiment that favors limiting regulations. But political whims can change quickly. With midterm elections in November, there is potential for a regulatory shift in the other direction. Some reforms and regulatory relief promised in the Crapo Bill may never come to fruition, depending on what happens this fall.

Instead of trying to predict political outcomes, bankers should remain diligent about complying with regulations already solidified. For example, CECL will have many ramifications for how banks handle themselves fiscally, and bankers shouldn’t let chatter around regulatory relief distract them from that upcoming deadline. Until we have a more definite sense of the political climate for the next two years, bankers will benefit from focusing on the regulations in front of them now, rather than what may or may not be coming from S.2155.

Deregulation means more work
Even if the trend continues, rolling back regulations isn’t as simple as it sounds. It will take just as long to undo portions of Dodd-Frank as it took to implement the rules. With technology challenges and limited flexibility at even the most progressive institutions, deregulation forces short-term pain without necessarily guaranteeing long-term gain.

With any change, institutions are forced through a complex management cycle. This includes retraining staff, upgrading technology, reevaluating risk and tweaking operational procedures. Significant adjustments follow any deviation from the norm, even with toning down or eliminating rules. Therefore, bankers will have to closely monitor the efforts of their vendors and work closely with regtech partners to interpret and respond to regulatory changes.

Technology can help navigate the pendulum swing of regulation by automating compliance processes, interpreting regulations and centralizing efforts. It has become too much to manage compliance with manual processes and the regulatory landscape is too complex and changes too quickly. An advanced compliance management system can help banks remain agile and ease the pain points associated with reconfiguring processes and procedures.

No matter the path of proposed deregulation, banks must quickly interpret and adapt to remain compliant. Banks that recognize the uncertainty of the current political arena and are realistic about the managing the work associated with the change – while closely collaborating with their regtech partners – will be better positioned to navigate the unpredictable days ahead.

Ensuring a Safe & Sound Banking System

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One of the principal jobs of the Comptroller of the Currency—if not the principal job—is to ensure the safety and soundness of the U.S. banking system. After nine years of economic growth, are regulators looking ahead for a potential downturn? In this conversation at Bank Director’s Bank Audit and Risk Committees Conference, former Comptroller of the Currency Tom Curry shares his thoughts and advice on a variety of issues with Bank Director Editor in Chief Jack Milligan.

Highlights from this video:

  • Risks in the Banking System Today
  • Preparing for a Potential Economic Downturn
  • What’s Changing with Regulatory Relief
  • Developing a Good Regulatory Relationship
  • The Impact of Regtech and Fintech

Cybersecurity & Regtech: Defending The Bank

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How can financial institutions proactively combat the risks facing the industry today? The 2018 Risk Survey—presented by Bank Director and Moss Adams LLP—compiled the insights of directors, chief executive officers and senior executives of U.S. banks with more than $250 million in assets. According to the survey, the worries keeping top executives awake at night align with the key priorities that banks commonly hear from banking regulators: cybersecurity, compliance and strategic risk.

Cybersecurity
Cybersecurity was the biggest concern by far, reported by 84 percent of respondents.

The survey addressed the confidence that executive and directors have in their institutions’ cybersecurity programs, with an emphasis on staffing and overall effectiveness. Access to the proper talent—in the form of a chief information security officer (CISO) or a strategic partner with the necessary skill set—and associated costs are key to a successful program, and 71 percent of respondents revealed their bank employs a full-time CISO.

While technical skills are valuable in today’s business environment, financial institutions must overcome their dependence on skilled technicians who don’t necessarily have the ability to strategically look at the changing technological landscape. The CISO should build an appropriate plan by taking a full view of the bank’s technology and strategy. Without this perspective, a bank could provide hackers with an opening to breach the institution, regardless of size or location.

Institutions building the foundation of a robust cybersecurity program should also focus on three key areas:

  • Assessment tools: Is the institution leveraging the proper technologies to help maximize the detection and containment of potential issues?
  • Risk assessments: Has management identified current risks to the organization and implemented proper mitigation strategies?
  • Data classification: Has management identified all critical data and its forms, and addressed the protection of this data in the risk-assessment process?

Compliance
Compliance was the second biggest area of concern, identified by 49 percent of respondents. It’s an area that continues to evolve as new regulators have been appointed to head the agencies that regulate the industry, and technological tools—dubbed regtech—have entered the marketplace.

More than half of survey respondents indicated that the introduction of regtech has increased their banks’ compliance budgets, demonstrating that the cost of solutions and staff to evaluate, deploy and support these efforts in an effective manner is a growing challenge.

Because the volume of available data and the ability to analyze that data continues to grow, respondents may have felt this technology should have effectively decreased the cost of operating a robust compliance program.

Executives looking to decrease costs may want to consider the staffing required to operate a compliance program and whether deploying technology would allow for fewer personnel. When technology is properly used and standards are developed to help guarantee efficient use of it, the dilemma of acquiring technology versus adding staff can often be more easily solved.

Strategic Risk
Strategic risk was the third largest area for concern, identified by 38 percent of respondents. Many directors and executives are wrestling with what the future holds for their institutions. The debate often boils down to one question: Should they continue to build branches or invest more in technology—either on their own or by partnering with fintech companies?

Fintech companies are a growing player in lending and payments segments, areas that were historically handled exclusively by traditional institutions. That, coupled with clients who no longer value personal relationships and instead prioritize being able to immediately access services via their devices, increases the pressure to deliver services via technology channels.

Financial institutions have entered what many would call a perfect storm. Every institution will need to make hard decisions about how to address these issues in a way that facilitates growth.

Assurance, tax, and consulting offered through Moss Adams LLP. Wealth management offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC.

Regtech: Reaping the Rewards

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regtech-4-24-18.pngAs it evolves, regtech is uniquely poised to save banks time and money in their compliance efforts, and has become a common topic for many in the banking industry. If you’re ready to realize the promise of regtech at your institution, here are a few key steps to take before you start parsing through providers or sending out requests for proposals.

Consider changes to your organizational structure that would place oversight of both legal and compliance transformations under one department. In Burnmark’s RegTech 2.0 report, Chee Kin Lam, the group head of legal, compliance and secretariat for DBS Bank, pointed to his authority over both legal and compliance functions and budgets as a key to the Singapore-based bank’s ability to work with regtech companies.

At first blush, a change to your bank’s internal structure seems like an extreme measure for a precursor to a technology pilot, but that perception misses the big-picture implications of implementing a new regtech solution. If a bank intends to engage meaningfully with regtech, Lam pointed out, there’s a need for an overarching framework for onboarding new technologies to make sure they “speak to each other at a legal/compliance level instead of at an individual function level—e.g. control room, trade surveillance, AML surveillance and so on.”

What’s more, legal and compliance functions are already tied closely together, and any regtech solution would likely impact both areas of the bank. Central management of these two functions can help ensure efficient regtech implementation.

Create a solid, detailed problem statement before you ever look for a solution. Lam suggests identifying the top legal and compliance risks your bank is facing, and working from there to identify pain points for your employees and customers when they interact with that risk area. One way to go about this process is to utilize design thinking, which looks at products and experiences from the point of view of the customers and employees who utilize them.

By seeking out pain points and working through the design-thinking process to find their root cause, bank leadership can identify specific, actionable areas for improvement. As tempting as it can be for an institution to attempt a total overhaul of its regulatory processes, banks should pursue modular regtech solutions to solve specific, defined problem statements instead. As Peter Lancos, CEO and co-founder of Exate Technology, points out in RegTech 2.0, “[f]ragmentation makes a regulatory strategy impossible—especially due to geographic spread and banks having separate teams set up to deal with individual regulations.”

Leverage outside expertise. The risks of implementing regtech can be daunting, so bank leaders need to use every tool in their arsenal to get deployment right. Banks should involve regulators in the conversation early on in the process of working with a regtech company. According to Jonathan Frieder of Accenture in The Growing Need for RegTech, “[r]egulators globally have continued to accept and, ultimately, to embrace regtech” making 2018 “a pivotal year.”

In addition to getting regulators on board, banks should consider enlisting outside assistance from consultants or other regulatory experts. Such experts provide assistance with assessing problem statements or potential regtech vendors. Lancos states that he feels “it is essential for banks to have regulatory expertise support to actually write the rules that go into the rules engine of regtech solutions.”

Regtech implementation is a lot more involved than an average plug-and-play fintech product. However, when a bank considers the cost efficiencies, improved compliance record and decreased customer and employee frustration, the upside of regtech can be well worth the planning it requires.

RegTech: A New Name for an Old Friend

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regtech-3-20-18.pngWith 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.

Looking to Save Money on Compliance? Here’s How

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compliance-1-13-17.pngCompliance in the financial services industry is absolutely necessary but absolutely time-consuming as well. For community banks in particular, pragmatic evolution of the way compliance is handled is absolutely critical for survival in a highly competitive and increasingly complex market.

Recent estimates suggest that over 300 million pages of regulatory documents will be published by 2020 and over 600 legislative initiatives need to be cataloged by a medium-sized institution. Just the scale and pace of the changing rules that community banks need to comprehend, let alone the implications, is paralyzing to say the least. Therefore, the necessity for resource-efficient compliance solutions in the coming years is expected to skyrocket—professionals suggest that the global demand for regulatory compliance and governance software is expected to reach $118.7 billion by 2020.

While compliance certainly looks very expensive, non-compliance blows even a bigger hole in the budget of any company. In fact, financial institutions in the U.S. alone have paid over $160 billion in fines for non-compliance.

Regtech, or regulation technology, refers to a set of companies and solutions that address regulatory challenges across industries, including financial services, through innovative technology. There are about 6,000 technology companies flooding the market with innovative solutions in financial services alone, arguably one of the most complex industries anywhere.

These firms provide access to simpler regulations through a SaaS (software as a service) model, supporting clients in developing the necessary reports and eliminating the need for additional expenditures on consultancy firms and expert services.

As opposed to legacy systems, regtech is agile and ever-evolving by nature. The industry brings together next-generation technologies—blockchain, AI (artificial intelligence), cloud computing, API (application programming interface), biometrics, robo-advisors, etc.—to enable financial institutions, most importantly smaller ones, to operate at a new level of efficiency and release resources for innovation.

Enhanced KYC Efficiency
Almost every financial institution has to have a robust know-your-customer (KYC) identification program in place and perform ongoing tracking and monitoring of customer transactions. All of this includes multiple detailed compliance rules.

To overcome this difficulty, regtech solutions automate those processes to an extent, thereby reducing the cost of managing compliance. Moreover, regtech solutions tailored specifically for online verification bring down the time and total cost of on-boarding, thus enhancing the customer experience.

Substantial Compliance Cost Reduction
Costs are a real problem in the compliance space, and the relative cost of compliance substantially increases with the decreasing size of the financial institution. While banks with assets ranging from $1 billion to $10 billion reported total compliance costs averaging 2.9 percent of their noninterest expenses, banks with less than $100 million in assets reported costs averaging 8.7 percent of their noninterest expenses.

Cost reduction in the compliance department has far-reaching implications. A community bank-focused survey, conducted at the end of last year, indicated that regulatory compliance accounted for 11 percent of their personnel expenses, 16 percent of data processing expenses, 20 percent of legal expenses, 38 percent of accounting and auditing expenses and 48 percent of consulting expenses. Being a technology-driven rather than manual response to a problem, regtech significantly drives down all the above-mentioned expenses, almost eliminating some of them.

Agility, Flexibility and Learning
Normally cloud-based, regtech solutions are agile, which leads to great flexibility and speed of reporting, ensuring a high level of control over information. Application of AI in regtech enriches it with the ability to keep organizations up-to-date on the evolving regulatory environment, thus reducing the risk of non-compliance-case expenses.

Machine learning can identify complex, nonlinear patterns in large data sets and create more accurate risk models. Among the other benefits brought by AI into regtech are handling customer protection and complaints, monitoring of behavior and internal culture in organizations, KYC regulations, real-time monitoring of new regulatory requirements and modification, among other benefits. Banks can use regtech for stress testing, as well as to monitor for fraud and cybersecurity problems.

Security and Reduced Deployment Time
Data encryption and real-time monitoring capabilities make regtech solutions secure. Regtech also speeds up the implementation of compliance initiatives, thus enabling businesses to focus instead on business goals. Being cloud-based, regtech enables organizations to manage and backup data remotely, having it secured at the same time.

Being multi-purpose by design, the regtech ecosystem is highly diverse. There are over 100 companies in the space addressing various specific needs, including CrowdBounder, Suade, Ayasdi and Neurensic.

Given all the benefits listed above and many more, regtech has an astonishing return on investment. Experts in the field suggest that investments in regulatory software can lead to an ROI of more than 600 percent with a payback period of fewer than three years.

Can Watson Solve the Bank Regulatory Riddle?

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You have probably seen recent television commercials where “Watson,” IBM Corp.’s vaunted supercomputer, chats with Stephen King about novels and Bob Dylan about songwriting. And perhaps you remember a few years ago when Watson defeated two highly accomplished past winners of the game show Jeopardy! in a three-way competition. Well, IBM is now focusing Watson’s considerable talents on bank regulatory compliance.

In September, IBM announced that they were buying the consulting firm Promontory Financial Group, which is based In Washington, D.C., and was founded in 2001 by former Comptroller of the Currency Eugene Ludwig. Promontory is considered one of the leading firms providing banks with the information needed to navigate the increasingly intricate web of regulations at all levels of government. Over the years, Ludwig has hired many former regulatory officials, some of whom headed regulatory agencies and financial companies around the world. IBM is not just going to fold Promontory into its financial services practice, however. The company is thinking much bigger than that.

IBM is going to have Promontory’s 600-plus professionals turn Watson into the world’s foremost expert on financial institution regulatory compliance. Watson will then be able to expand its base of knowledge in real time as new regulations are created and studying various scenarios and situation that have developed in real world practice. Bridget van Kralingen, senior vice president, IBM Industry Platforms, described the company’s expectations for the project saying, “What Watson is doing to transform oncology by working with the world’s leading oncologists, we will now do for regulation, risk and compliance. Promontory’s experts are unsurpassed in this field. They will teach Watson and Watson, in turn, will extend and enhance their expertise.”

This can be a game changer if it works as expected. Regulatory compliance costs are growing, and there is no sign that this trend will ever reverse. In the press release announcing the acquisition, the two companies cited a report from global consulting firm McKenzie that found “More than 20,000 new regulatory requirements were created last year alone, and the complete catalog of regulations is projected to exceed 300 million pages by 2020, rapidly outstripping the capacity of humans to keep up. Today, the cost of managing the regulatory environment represents more than 10 percent of all operational spending of major banks, for a total of $270 billion per year.”

Regulatory compliance is a very hands-on process in its current form. Humans have to dig through the data, read the reports and figure out how the new information impacts their institution. If Watson can reduce the human element of compliance, then costs will come down. This could be a huge benefit to community banks as regulatory costs, which account for a disproportionally larger percentage of their overall costs than larger banks. Some of these smaller institutions have thrown in the towel and sold their bank to larger competitors rather than try and keep up with an ever-growing burden and costs of compliance.

Ludwig addressed the potential for the use of artificial intelligence combined with his firm’s existing broad level of knowledge to reduce costs for small banks. “For community and regional banks, this is a potential lifeline,” he said in an interview. “For many banks, it is an enormous burden just to keep up. Watson offers the opportunity to have a world-class partner.”

One of the keys to making this combination work is the fact that Watson is already a known entity that has had a lot of success since “going on” Jeopardy! in 2011. Watson is being used to improve clinical diagnosis and cancer treatment in the medical world, help track water usage in drought plagued parts of California and generate product suggestions for several retailers.

Those who worry that tech giants like IBM are not going to be nimble enough to keep up with the sexy, fast changing world of fintech simply do not understand the banking industry. Bankers don’t care about being on the cutting edge of technology as much as they do having technology and technology providers that are dependable. They want vendors with strong reputations that will have the staff and expertise to deal with problems that crop up at 2 a.m. on a Sunday. In banking, reputation is everything and protecting their reputation is much more important than having a sexy technology.

This combination offers them the chance to have both. Banks that might be reluctant to use compliance programs driven by artificial intelligence from a younger, more nimble fintech firm are going to find it much easier to accept the proven technology of Watson and the support provided by an industry giant like IBM. If the combination of Promontory’s in-depth knowledge basis and Watson’s artificial intelligence do in fact reduce the time used and money spent on regulatory compliance, this will be a tough combination to beat.

Creating Regulatory ’Sandboxes’ to Protect Innovation

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Fintech regulation has presented a confusing picture here in the United Sates for several years now. Various federal agencies have at least some measure of control over fintech companies, and it can be challenging for innovative new startups to figure out which regulatory authority they are supposed to be talking to at any stage of the game.

Because of this confusion, there is a risk that we could fall behind the rest of the world as nations including Singapore and the United Kingdom have taken steps to provide their fintech companies with the benefits of a looser regulatory environment. Both nations have developed what they are calling fintech “sandboxes” to encourage and accelerate the development of new ideas and products for the financial services industry. Emerging countries like Thailand and Abu Dhabi are also promoting their version of the fintech sandbox to attract new companies and investment dollars into their economy.

There are some signs that the U.S. is also moving to relax regulation and encourage fintech innovation. I talked recently with William Stern, a partner at alaw firm whose practice focuses on both banking and financial technology. Stern says he is seeing some positive movement among U.S. regulators on the fintech front.

Stern referenced the Financial Services Innovation Act of 2016, introduced by Rep. Patrick McHenry, R-N.C., in September of this year. The bill creates a program similar to that used in the U.K. and would allow innovative new companies to apply to one or more of the agencies that currently oversee the financial services industry for a waiver of certain regulations and requirements. It would also prevent other agencies from introducing enforcement actions against the companies while the agreement was in place.

Stern noted that for a smaller company facing the full brunt of all the rules and regulations from a multitude of agencies including the Federal Deposit Insurance Corp., the Consumer Financial Protection Bureau, the Securities and Exchange Commission and the Office of the Comptroller of the Currency, it can be incredibly discouraging for a young entrepreneurial company, particularly one with limited funding. Entering into a compliance agreement would allow the firm to move forward, test and introduce new products without falling under the full weight of the combined rules and regulations at various levels of government.

Stern believes there is support on both sides of the aisle in Congress for encouraging financial innovation, but he also points out that the banking industry isn’t necessarily a big fan of relaxed regulation for fintech companies. Allowing smaller fintech concerns to operate without complying with the same rules as banks would place the latter at a disadvantage. Concerns about maintaining a high level of consumer protection have also been expressed.

For his part, Rep. McHenry thinks the legislation is needed to keep companies from leaving the U.S. and taking their innovation to countries with a less onerous regulatory environment. “Innovation in financial services has created more convenient and secure ways to meet the demands of American consumers,” McHenry said in a statement when he introduced his bill. “For these to succeed, however, Washington must rethink its own laws and regulations to keep up with the growth and creativity in the private sector. This bill represents a mindset shift in the way we address financial regulation. Rather than the command-and-control structure of the past, my bill establishes an evolved regulatory framework that encourages financial innovation, all while maintaining our regulators’ commitment to the safety of consumers and our financial markets.”

The bill is still in the early stages of the legislative process and is highly unlikely to be passed this year. McHenry has acknowledged this but hopes it will spark discussions that will carry over into the next congressional session, which will begin in January. The bill will likely face substantial opposition from those who favor greater rather than reduced regulation of financial services—a position generally associated with the Democratic Party—so the outcome of the congressional races on Nov. 8 could have a huge impact on the prospects for passage.

Both the OCC and the CFPB have been encouraging innovators to work closer with them so the agencies can help them navigate the compliance waters. Back in March, the OCC released a paper titled “Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective.” When the report was introduced, Comptroller of the Currency Thomas J. Curry said that “At the OCC, we are making certain that institutions with federal charters have a regulatory framework that is receptive to responsible innovation and supervision that supports it.” The paper outlined eight principles the agency thinks should guide financial innovation and was viewed by many as the first step towards making it easier for innovators to deal with regulators.

As other nations around the world develop and embrace the sandbox concept, there is some legitimate concern that the U.S. will see companies and jobs leave for a more relaxed environment elsewhere.

The Robots Are Coming!

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Actually, to some degree they are already here. Today we can buy robots to do simple tasks around the home, and we increasingly see industry turning to robotics to perform functions that were once done by humans. Robots are faster, more efficient, do not take coffee breaks and are not concerned with work/life balance. They can work efficiently and without complaint, with only occasional breaks for their human overseers to repair and update the machinery and perform any necessary programming.

The use of robots—or at least the technology that powers them—is coming to banking as well. There are many areas of banking that can be improved by the use of artificial intelligence and robots to perform tasks faster and at much lower costs. We’ve already seen how technology can automate and improve the arduous task of regulatory compliance, a phenomenon that is often referred to as “regtech.” Much of the compliance process involves the assembly and storage of an almost endless stream of documents, and that is something best done by machines. Oversight of the lending and sales practices can also be done much more accurately and efficiently through the use of technology and big data than by relying on human involvement alone. In the aftermath of the Wells Fargo & Co. cross-selling scandal, I expect to see more banks employ databases and machines to monitor employees and look for irregularities in sales practices.

I was at the FIG Partners Bank CEO Conference recently, and there was a lot of discussion about using technology and data analysis to improve bank lending programs. Bankers are looking for ways to automate much of the underwriting and funding process for both consumer and commercial customers. While there is still plenty of room to debate the advantages of using automation in the sales process compared to relying on people to bring in deals, there is no question that using big data to streamline the underwriting process has shortened approval times from weeks to just days—and in some cases even hours.

Bankers are also starting to use databases and artificial intelligence to manage their loan portfolios. One banker I spoke with said his bank was using data analysis to continually monitor the current loans in its portfolio. Automated systems can collect data about their customers and compare that against all past borrowers to identify those that might be undergoing financial difficulties. Through the use of artificial intelligence, it is now possible to continually scan the portfolio for signs of loans that may be getting close to stress levels and act proactively to head off problems before they fully develop.

In the low-interest rate, low-growth economic conditions we are currently experiencing, banks are continually looking for a way to raise fee income. One of the favored strategies for growing fee income is wealth management, and right now so-called robo-advising is the hot topic in the money management space. Intelligent systems can continually review and test investment strategies and use the gained knowledge to design optimal plans to manage a client’s money. The cost of machine-managed accounts is often much lower than using a human advisor, and community banks can attract customers and raise their fee income levels by using these programs. Those that do not use these machine managers will need a strategy to compete with them, especially in the tech-savvy millennial market.

Banks can also use data management programs to improve their marketing. By collecting and sorting customer data and history, banks can identify customers that are likely targets for different products and services. Cross-selling is temporarily a bad word in the aftermath of the Wells Fargo debacle, but the truth is that the more products a customer has from a particular bank, the deeper their loyalty to the institution will be and the more profitable the overall relationship for the bank. By profiling customers and monitoring current activity levels in deposit and credit accounts, the robots will spot new needs and opportunities that humans may well overlook.

One area where bankers are reluctant to rely on robots is customer service. While we are seeing mini-branches with ATMs and video links back to the main branch making inroads in some markets, the use of robots in customer facing situations is not something that bankers I have spoken with recently seem to embrace. Most bankers are people just like the rest of us and they have had to endure a customer service conversation with a chat bot that did not go well. Banking is a reputation dependent business and a bad customer service experience can have lasting negative implications on the bottom line. For now, interaction with actual humans will continue to be a big part of the customer experience at most community banks.

The bottom line for most bankers is that if new technology and the use of big data can lower costs and improve the profitability of their institutions, they are generally in favor of adding it to their bank. People will still be a big part of the process for most banks, but the robots and machines will play an ever increasing role.