As technology has evolved, we’ve have seen the transition from radios, to televisions, to the internet. And today, we are smoothly and gradually adapting the wonders that is Artificial Intelligence.
Artificial Intelligence, first coined by John McCarthy back in 1956, involves a lot of things ranging from process automation to robotics. Today, it is highly popular among large enterprises of almost every domain, owing to the vast amount of data these companies have. There is an increased demand for the understanding of data patterns which has led to the growth in the demand and usage of AI.
AI processes and techniques are much more efficient for identifying data patterns as compared to humans. The implementation of these processes has brought forth much more improved and efficient methods of solving numerous problems – problems that were almost unsolvable earlier!
These technologies are being used to tackle some of the most pressing issues that trouble financial services sector today, including fraud prevention and regulatory compliance. In his keynote address at the 2018 Payments Canada Summit, Vivek Bajaj, Global Vice President of IBM’s Watson Financial Solutions, highlighted that these technologies don’t have any inherent value of their own unless they are used to tackle specific problems.
In his speech, Vivek explains how the existing financial institutions have terabytes of data on their customers. This data is mostly unstructured and untapped, but if leveraged correctly, it can help these institutions differentiate themselves, leading to the concept of contextual understanding.
As Bajaj puts it:
“In (the) old days, content used to be the king. Today, it’s all about context,” says Bajaj. “It’s all about being able to engage clients in a meaningful fashion, serve them, and protect them.”
In the same way, as these technologies are changing the financial industry, they’re also changing how these financial institutions enforce regulations. RegTech (short for Regulatory Technology), is a subset of FinTech and has grown sharply in the last couple of years. It has attracted numerous startups as well as giants like IBM. Like other areas of FinTech, RegTech, too, doesn’t have an agreed-upon definition. The Institute of International Finance (IIF) defines RegTech as:
“The use of technologies to solve regulatory and compliance requirements more effectively and efficiently.”
This, along with other common definitions, seems relatively limited in the face of the promise that RegTech holds to overhaul not only regulatory compliance and risk management by regulated financial institutions but also the nature of regulation and supervision.
The primary focus of RegTech is on technology-based solutions that solve regulatory and supervisory challenges, including the challenges posed by the ever expansion of FinTech. RegTech makes use of digital data, and computer networks and substitutes old-style processes, organizational and IT structures, analytical tools, and overhaul the process of decision-making.
RegTech can ideally be divided into two categories:
- RegTech for financial institutions
- RegTech for supervisors and regulators, also known as SupTech.
Let’s take a look at RegTech for financial institutions in depth.
RegTech for Financial Institutions
Significant business opportunities for RegTech arise from the trade-offs between the need to stay compliant with the always changing regulations and the necessity to cut costs to remain profitable. Hence, most of the RegTech today focuses on solutions for regulated financial institutions which helps them be more efficient and achieve a greater certainty with regulations and improve risk management, all the while cutting costs. While the RegTech market is still developing, here are the following areas that can be clearly identified under RegTech for financial institutions:
- Compliance: Compliance represents a significant part of RegTech today. The examples include enterprise-wide solutions for identifying and keeping track of changes in the regulatory requirements, both at local and global levels. It also includes solutions for automated real-time monitoring based on the analysis of operational and other data (like employee monitoring, historical email analysis, trade communication analysis, human behavior analysis, and more). Such a type of automated compliance can also be called as “dynamic compliance” because the regulatory requirements are embedded into the IT protocols to ensure continuous compliance. These protocols also confirm whether the data reported is accurate or not. This type of compliance drastically reduces the costs of manual compliance procedures. Many startups and tech giants operate in this area to help institutions keep up to date with their regulatory requirements. These organizations support the financial institutions identify potential financial crimes and manage the risks.
- Identity Management and Control : This is yet another critical area of RegTech. This domain focuses on counterpart due diligence and Know Your Customers (KYC) procedures, anti-money laundering (AML) controls, and fraud detection. For instance, digitization of the onboarding process of partners or clients and sharing of their information, gathering and analyzing the transaction data, and detecting suspicious transactions based on automatic triggers. KYC based on DLT (distributed ledger technology, more on this later) other techniques are also included in this.
- Risk Management: Risk management focuses on tools and techniques to reduce the risk factors and improve the risk management. The idea is to improve the efficiency of the generation of risk data, risk reporting, automatically detecting and monitoring risks according to internal methodologies or regulatory definitions, and performing alerts when pre-determined risk levels are reached. Most of these solutions rely on advanced data analytics using AI or ML. They increase the accuracy and timeliness of reporting and make real-time reporting possible.
- Transaction Monitoring: Transaction monitoring focuses on conduct-of-business requirements. The solutions offer real-time transaction auditing, analyzing, and tracking by using DLT, anti-fraud and market abuse identification system, back-office automation, risk alerts, and more.
What are DLT and Blockchain? How are financial services firms going about it?
Many firms operating the financial services industry must wonder when the era of digital disruption will end, and things will be back to normal again. However, looking at the growth and potential of distributed ledger technology (DLT), this seems unlikely to happen anytime soon. Blockchain and DLT have immense transformation potential, and these technologies are maturing rapidly.
Blockchains is a secure database shared by all parties participating in a distributed networks of computers. It is responsible for recording and storing each transaction that occurs in the system. The transaction can ONLY be saved if there is a “consensus” from all of the computers in the network.
The most notable use of this technology is the crypto-currency – Bitcoin. But the possibilities for the financial firms to go far beyond the current trading practices by adopting this technology are endless. Any lengthy and costly asset transfer process could be overhauled using this technology.
Blockchain and the related technology guarantees the correct ownership history and eliminates the need for intermediaries whose sole role is to verify these transactions. It not only saves time but also saves a lot of money.
The past couple of years have seen significant momentum in the development of this technology and its implementation in the finance sector. Regulatory bodies are kept to keep pace with this new, disruptive model of carrying out transactions. It shouldn’t come as a surprise, hence, that in a recent study conducted by Bain & Co noted that 80 percent of executives at these finance firms firmly believe that DLT and associated technologies will completely transform the financial market.
There is, however, one challenge for financial firms looking to get benefited by this technology – that of security. The permissionless blockchain used by Bitcoin allows anyone is meeting specific needs to submit the ledger. However, this practice of openness is unsuitable for highly regulated industries. That is why firms are increasingly considering private blockchain networks. These networks offer the same benefits as the open network, but also provide the added ability to control who can access the system, submit and read the ledger of the transactions, and who can verify these transactions.
Permissioned networks, however, still have some security concerns at a network level. Minute attention must be given to the level of information required to identify the counter-parties before granting any access positively. In the same context, the EU Agency for Network and Information Security recently published a guide recommending the use of recovery keys, multiple signatures, and libraries of standardized smart contracts.
So, as this technology grows, we’ll come across more and more ways to address the concerns surrounding it. Many financial services have embraced these technologies, and many are looking to do the same. Blockchain and DLT based technologies can potentially disrupt the industry that we know and use. Here are some ways blockchain is and will continue, transforming this sector:
Even though blockchain is a relatively newer technology, it has massive potentials to reduce the fraudulent transactions and is getting a lot of attention since 45% of financial intermediaries like stock exchanges and money transfer services suffer from many economic crimes every year.
Most of the banking and financial systems around the world work on a centralized data repository that is extremely vulnerable to cyber attack because it has a single point of failure. One single breach can give access to all the data, to any hacker. The blockchain, on the other hand, works on the principle of distributed computing. Each of its block has a timestamp and batches of individual transactions with a link to the previous blocks. This technology would surely eliminate a majority of cyber crimes being perpetrated today against our financial firms.
Blockchains can permanently store any digital information, including computer codes. Because of this reason, blockchain enables us to have smart contracts. We can have an automated code to create contracts or execute the transactions once a specific set of criteria is achieved. For instance, delivery of products could trigger the payment of the invoice.
The payment process is something that is undoubted to get overhauled with the adoption of the Blockchain technology. It would enable banks to process payments with higher security and much lesser costs. Payments between organizations and clients, or even inter-bank, will be seamless under the influence of a DLT-based Blockchain technology. Today, there are numerous intermediaries in the payment processing system, which eats up a lot of time. Blockchain will smoothly remove the need for a lot of them.
What we’ve discussed above are just the topmost areas of financial services that are, and will be, seeing a complete overhaul due to the adoption of RegTech and blockchain-based technologies. With time, many more such solution would unfold before our eyes and will make us marvel more at the power of this technology!