In the wake of the 2008 financial crisis, a worldwide imperative was placed on administrative establishments to institute more vigilant policing of the financial sector. A global system of over-leveraged investment banks combined with a fundamental lack of understanding as to how risky debt being purchased in large swaths to create a house of cards that inevitably fell approximately ten years ago. The ruin that was left in the wake of the fallout – many homes foreclosed upon, jobs lost, and futures mortgaged – led to a great awakening; the complicated financial sector impacts us all, and regulators must stay as close as possible behind industry trends to protect the population at large.
While regulations were specifically targeting the “too big to fail” investment banks were passed, more adaptable measures were needed. Institutions and businesses have continued to embrace technology to disrupt the financial sector. This economic sector encompasses many fields, from lending to investment advice and management, payment services, and beyond, and the adoption and innovative use of technology to design and deliver financial products and services are known broadly as financial technology or FinTech.
Most forms of FinTech require machine learning, proprietary algorithms, and big data analysis to create platforms that work in real-time to provide a range of services. Some major players in the sector include Ripple, a blockchain-based platform for global payments, Lenddo, a credit scoring service which incorporates social media, and Wyre, which specializes in the space of international money transfers.
RegTech’s Relationship to FinTech
As startups and established players continue to leverage the cutting edge of the technology sector to find innovative ways to streamline financial systems, regulators – the 2008 recession always in the back of their mind – were charged with adapting their systems to an increasingly digitized world of finance. This intersection between technology and the need for regulation is where RegTech – regulatory or regulation technology – emerged. Considered by many to be the “little brother” of FinTech, RegTech constitutes the merger of technology and regulation to address the challenges posed by FinTech’s emergence.
The rise of RegTech is inextricably linked to the proliferation of innovative financial technologies. “In essence, RegTech (Regulation + Technology) as a concept postulates that any disruption of the finance sector via FinTech will be accompanied by the innovation of new financial regulation and ultimately lead to advances in automation,” said John Dwyer of financial research and advisory firm Celent.
Essentially, as FinTech goes, RegTech must follow closely behind. A new service always begs new regulation, and this typifies the relationship between financial technology and the regulatory technology needed to police those using it.
How RegTech Works
At the core of RegTech is automation. More stringent guidelines for reporting by financial institutions was one of the most prominent changes enacted through post-crash legislation. This has meant a marked increase in data which banks and other entities are mandated to pass along to regulatory agencies for examination. These documents are too massive in scale for humans to monitor manually, and RegTech has filled this void admirably by using tools such as predictive analytics and machine learning to flag anomalies and trends to detect and root out illegal or irresponsible activity.
These sophisticated algorithms allow technology to replace a human regulator, who could not do the job as efficiently or effectively. RegTech companies work in combination with regulatory agencies, with cloud computing facilitating the exchange of information between private RegTech companies and the public-sector agencies which employ their services. While FinTech has bred efficiency resulting in lower costs for the consumer, banks and financial institutions have seen unprecedented savings from the growth and increasing sophistication of RegTech.
How Financial Institutions Benefit from RegTech
By creating complex, hyper-efficient systems by which banks can coordinate with regulatory bodies, RegTech has saved financial institutions immensely in both time and money. By outsourcing compliance mechanisms to intelligent systems that conduct oversight at a fraction of the time that legacy systems did, banks can avoid fines and potentially disastrous consequences which arise from unsustainable investment trends and/or illegal activity which, without the assistance of RegTech, went easily undetected in the past.
Some of the irregularities that RegTech firms tailor their technology to detect include money laundering, data breaches, hacks, and other potential catastrophes. By identifying these threats with more frequency earlier in the regulatory process, banks minimize risk to their portfolios and investors while also avoiding the cost from lost funds and data breaches.
“By harnessing technology to improve and optimize a financial institution’s ability to comply with its regulatory requirements and automate the regulatory compliance process as much as possible, RegTech has the potential to bring huge benefits and cost savings to the investment management industry.” Dwyer added.
Where RegTech Applies
RegTech is a broad term, and some of its uses include fraud prevention, audit trail capabilities, and surveillance. It’s important to note that the average RegTech company is highly specialized.
Because financial regulation is such a broad field, one RegTech specialist couldn’t possibly serve as a one-stop shop. Instead, a company addresses one or two concerns facing the financial sector, such as detecting fraud, reducing data breaches, ensuring compliance, etc.
Even though each RegTech business is highly specialized, they combine to form a massive industry that is only going to continue to grow. As a collective, RegTech currently covers the bases of most needs that regulatory agencies demand, and they will continue to adapt to new technologies that arise out of the FinTech sector to fill the void created by innovation.
The Future of RegTech
Specific technologies offer great promise for RegTech, and the blockchain is one of the most intriguing. While cloud computing is the most common way by which critical data is shared between RegTech firms and their partnering financial institutions, the blockchain may offer a more secure, decentralized platform by which records are established, and the information is transferred shortly. This technology provides the potential to develop even greater efficiency than has already been implemented by game-changing RegTech services and platforms.
Many see RegTech as just scratching its potential. They point to large financial investments which are routinely sunk into further beefing up the RegTech sector as the reason for great optimism.
New business models – crowdfunding, to name one – also make it likely that opportunity for bright minds without the capital to make their dreams a reality will be afforded more significant opportunity to enter the RegTech sphere. With greater chance often comes great innovation, and the RegTech industry should always be welcome to new ideas and companies, considering that they must still plan to keep pace, and ideally outpace, the financial technology sector.