Supervisors seem to be continuously playing catch-up with the industry both on regulations and technology. Can we reimagine supervisory technology like ‘digital natives’ and take a ‘digital first’ approach?
The state of financial market regulation and supervision:
Ask any banker about regulations/ supervision, you’ll be told: “it can be simpler – stable regulations, unambiguous guidelines, reduced cost of compliance”.
Ask the government, they’ll say: “we want to streamline banking and financial market regulations – alignment of incentives, robust governance standards, intermediation/product standards, financial inclusion and social welfare initiatives, more real-time and more digital offerings, minimum disruptions, stable financial system”.
And ask the public (the borrowers, savers, traders, investors & transactors), you’ll most likely get the response: “it needs to be strengthened – safety of deposits and investments, transparent and honest financial products, unbiased financial advice, improved trust, and so on…”.
Ask the supervisors themselves, they’ll tell you: “we want to evolve the regimen to be effective while also reducing the burden on regulated businesses – simplified data collection, rationalized forms/ datasets with no redundancies and duplications, clearer instructions”.
Back to basics: understanding the need for regulation and supervision:
Financial ecosystem is the primary mechanism for all economic activity, including intermediation between and among businesses, consumers, government/ public institutions, etc., and wealth creation and protection.
Participants in the financial ecosystem will have their own self-serving objectives/ profit motives, but also come with varying levels of capital, differing views of the future of financial system, and divergent risk appetite. It is natural that the participants in a for-profit business will try to advocate their views and maximize their benefits by optimizing sales, costs, technology, risks and disclosures. This may put the participants and counterparties to unknown/ incomprehensible/ undisclosed/ unnecessary risks and also cause instability to the entire financial ecosystem. Any systemic failures will have enormous impact on the economy and public.
Therefore the need for an independent, impartial, and expert body to oversee the financial ecosystem; therefore the banking and financial services industry supervisors. They are meant to put in place rules that govern the financial ecosystem, ensuring a stable, fair and transparent system which is trusted by all stakeholders.
As consumers and taxpayers, let’s ask ourselves this question: “are banking/ financial market supervisors needed?”. The answer will be an emphatic “YES”. We need a trusted and stable financial system, which can neither be achieved without regulations and supervision, nor by letting the industry self-regulate.
The mandate: supervisory responsibilities
Supervisors of the banking and financial services industry in any jurisdiction are responsible, among other things, for financial stability, oversight of financial institutions to enhance their safety and soundness, ensuring safety and effectiveness of national payment and/or settlement systems, regulating cross-border transactions, monitoring the financial system to prevent abuse of the financial system, promoting financial inclusion, and consumer protection.
Supervisory duties can be summarized as follows:
- Regulations: establishing guidelines and standards for the financial ecosystem and financial institutions to operate in
- Licensing: assessing an entity’s ability to operate in accordance with the established regulations, and authorizing their business establishment and ongoing operations
- Compliance: monitoring to ensure compliance of regulated businesses with the regulatory guidelines, by collecting information from the regulated businesses on a periodic basis and conducting onsite inspections where necessary
Current state: effectiveness of supervisors
Supervisors go to great lengths to ensure they meet their objectives, and we should all acknowledge their good work. Some supervisors who have been proactive have been largely successful, while some others are following the more progressive supervisors from other jurisdictions and following their ‘best practices’.
But is ‘good work’ and ‘largely successful’ sufficient? For such an important function of the economy, shouldn’t we try and be ‘adequate’ and pursue ‘excellence?
The few instances of failure lead to erosion of trust in the financial system. We have witnessed several instances of frauds being discovered after it’s too late to remediate, failure to stop financial institutions from collapsing, inability to prevent mis-selling and predatory practices, crisis caused due to high-risk approach of financial institutions, distress due to incorrect disclosures/ misreporting, etc. And most often, these failures come at the cost of the public / taxpayers.
Supervisors seem to be continuously playing catch-up with the industry both on regulations and technology. It appears that the pace of innovation and change in the industry is far too high for supervisors to cope. In return, the supervisors are continuously releasing incremental regulatory changes that further amplifies the compliance challenge for regulated entities.
Can’t supervisors stay ahead of the game? Can’t they be ‘future-ready’?
The challenges: supervisory technology and approach
Supervisors are having to adjust to the new reality of the banking and financial services industry, transforming from pen & paper and person to person world into a digital world. Financial institutions are innovating fast; even the large legacy financial institutions making big digital moves; new age financial institutions are disrupting the space completely, with products and services that can reshape the financial system, making financial services accessible and affordable, embedding financial products in the flow of life and work. But these rapid changes also bring with them risks not fully understood by the industry or regulators.
Traditionally, supervisors have expected regulated businesses to submit datasets/ returns in prescribed formats (in paper format in the old world, and in digital format in the new world), which is used to determine compliance and identify any areas for further assessment. In a rapidly changing industry, think of the cycle time for regulators to detect some evolving risks, then issuing a consultation paper on their approach to manage such risks, collecting feedback from the stakeholders and synthesising that into guidelines, allowing time for themselves to implement the mechanisms to collect the required data and for regulated businesses to change their systems to prepare and submit the required data… we are talking of many months by which time the said risks may materialize or get amplified several fold, and supervisors may find they are too late to act!
It’s not just a technology challenge. Supervisors should think like ‘digital natives’ and take a ‘digital first’ approach.
The opportunity: a fresh look at supervisory technology
Relying on the regulated entities to self-certify that they are fully compliant is not enough. Supervisors want to, and they should, look at data points to ascertain compliance, look for hidden risks, undisclosed risks, and systemic risks, which is only possible if they get access to more granular data.
But moving bulk-loads of data, like it is currently being done, doesn’t make sense! It is neither fast and efficient, nor fully comprehensible or reliable. It is data that is being ‘prepared’ by the regulated entities as expected by the supervisors.
Almost everything in the banking and financial services industry is digitally conducted and/or recorded. All cross-bank transactions are anyway use standard channels such as SWIFT, open banking network, interbank payment and settlement network. Accounting and bookkeeping standards have been established and largely followed, largely on the lines of IFRS9. Most banking systems are API based, and broadly use common language/ nomenclature, though more structure and standardization is needed.
Data can be intercepted electronically, or digital footprints can be traced as needed. All information that supervisors need is digitally available, if only we know where to look.
Repetitive tasks, which are rule based, can be done by bots/ automated using robotic process automation; this includes checking of financial metrics such as capital and liquidity, risk measures such as exposures and leverage, conformance to customer and counterparty due diligence requirements, transaction monitoring and reporting guidelines. Artificial intelligence and machine learning can enhance the supervisory activities by speeding up the learning and adoption. Natural language processing can help decode the product terms and conditions/ disclosures/ agreement fine print. Analytics can be used interpret language and detect the tone of conversations to detect mis-selling.
Today, technology is versatile, robust and portable. Taking technology to the data instead of bringing data to technology may help reduce the burden on regulated businesses, and also significantly increase supervisors’ speed to action/ reaction. There will still be use cases for which supervisors need data at their end. For such cases, instead of taking a form/ return based approach, supervisors can look to reuse available APIs and systems to directly collect and interpret the data.
Compliance obligation: where does the buck stop?
Regulated entities currently prove compliance post-facto by submitting ‘prepared’ information, going through internal/ external audits and supervisory inspections. Instead, can supervisors take compliance to the regulated businesses and make compliance a real-time function?
Not that the onus of compliance must shift from the regulated entities to the supervisors. Regulated businesses have to confirm to all licensing terms, including all compliance requirements. However, supervisors can be far more effective if they can use technology and act in tandem to manage risks in near-real-time and ensure full-compliance. Regulated entities will need to implement processes and technology to standardize data feeds and manage risks; supervisors can act in parallel to monitor systems and processes for conformity; and of course, regulated entities will be ultimately responsible for regulatory compliance.
Digital supervision: the future?
Before we think of the way forward, it is important to acknowledge that it is impossible for supervisors to shut down legacy and move all digital. Supervisors are extremely critical for the functioning of the economy, and the current regimen cannot be disrupted. A feasible solution is to create an alternate supervisory regimen, one that is fully digital, created ground up to do everything the supervisor is meant to do, without the legacy framework or a large workforce, built with a technology team with SME support as needed. These two regimens can run parallel, for a period of time until the fully digital regimen proves superior to or as effective as the legacy regimen.
After all, such parallel runs are not uncommon; many a time, technology revamp at supervisory side leads to regulated entities submitting data across multiple data collection systems of different generations/ maturities. In the case of adopting a parallel digital supervisory regimen, there will be no need for data to be transferred to the supervisor; instead we take the “supervisory bot” to the data at the regulated business side.
To stay aligned with the industry, supervisors need to open up and collaborate with start-ups/ innovators/ industry associations, creating opportunities to co-create and co-innovate. While doing so, it is also important for supervisors to establish standards for interoperability and portability, not just conceptually, but by creating the frameworks that the industry can adopt.
Author-
President at Verisk Financial | Fintellix
