FEBRUARY 10, 2023
10 min read
Over the past several years, banks and financial institutions (FIs) all over the world have either partnered with or launched their own fintech companies to be applied to various business areas. Such an approach has already improved the lives of millions by promoting financial inclusion and integrating digital services into the everyday routine. Meanwhile, most solutions used to focus on customer-facing aspects. Now, more and more companies are taking heed of back-end processes. Compliance with new financial services regulations is one of the top priorities since failure to abide by a hefty penalty, operational inefficiency, and client attrition.
Before the 2008 crisis, a bank would have to handle about ten regulatory changes a day, while in 2017, this figure rose to 185. Nearly a third of financial executives state that they spend over 5 percent of their annual budgets on compliance. Meanwhile, the expenses of American banks rose by over $50 billion per annum after the passage of the Dodd-Frank Act.
Considering the volume and severity of regulations, the size and consequences of penalties, together with the pressure coming from innovative entrants and fierce competition, it’s no surprise that regtech solutions have quickly gained traction.
What Is Regtech and Is It Really the Next Big Frontier
In simple terms, the regtech definition presupposes using emerging technologies and analytical tools to facilitate regulatory processes and legal compliance for businesses through automation. Currently, companies mainly utilize cloud computing, predictive data analytics, machine learning (ML), natural language processing (NLP), robotic process automation (RPA), and data transfer protocols. However, among the emerging regtech trends, we can see distributed ledger technology (DLT), voice recognition, and geographic information system (GIS).
What is regtech specifically? Even though reg tech was generally recognized in 2015 and was called a ‘fintech buzzword,’ it first appeared in 2010 and has already come a long way. More than 300 regtech startups were established in the period from 2010 to 2016, and they were introduced to deal with impending regulations like GDPR, MiFID II, PSD2-Open Banking, and 4MLD. Most solutions were based on open APIs and SaaS models. But what’s interesting about this phase 1.0 is that companies had a tough time scaling, integrating with legacy systems and other solutions, and meeting the timescales. Consequently, the second phase is on the rise, and it’s promised to be more collaborative with domain specialists, banks, and regulators to avoid previous complications.
The transformative potential of regtech products has been augmented by over $3.7 billion in regtech investment in 2018, demonstrating a threefold increase in contrast to 2017. In general, expenditures for regtech platforms are projected to surpass $115 billion in 2023.
What Are the Growth Factors for Regtech Companies?
When we started our discussion on what is regtech in banking, we’ve already mentioned a few agents driving the emergence and success of new lines of business. No doubt, constantly evolving banking regulations, together with ever-increasing bills to ensure compliance, place the biggest pressure on the financial services sector. But working closely with fintech startups and reputed banks, we’ve identified one more contributor. All three determinants are immediately interconnected, so let’s review the overall chain of actions.
Regulation of financial markets and institutions is booming. Financial regulators in the United States include The Federal Reserve, National Credit Union Administration, Federal Deposit Insurance Corp., Securities and Exchange Commission, Office of Thrift Supervision, and more. There are also state bank regulators, namely the Federal Communications Commission, Commodity Futures Trading Commission, and Consumer Financial Protection Bureau. Additionally, we shouldn’t ignore the U.S. Congress, Senate, President, various committees, as well as separate security and insurance bodies.
Each entity has its own requirements, standards, and restrictions with tight deadlines. We aren’t even talking about the amount of information. For instance, the Dodd-Frank Act mentioned above totals more than 22000 pages, and the European MiFID II comprises approximately 30000 pages. On average, around 45 new regulatory-related papers are issued every week, thus challenging financial firms.
The costs of compliance are soaring. Considering the number of entities and the frequency of legal updates, it’s hardly surprising that keeping compliant with these fast-paced requirements is an uphill task. Today banks are forced to adopt new technologies, update their systems and operational processes, and hire new talent or upskill in-house to manage compliance. Financial institutions are estimated to spend about $780 billion per annum globally on differences in financial services risk and regulation. Meanwhile, 10-15 percent of employees are already engaged in risk management and compliance team, and those numbers are expected to grow further.
Regtech enables companies to avoid penalties. Banks paid over $300 billion fines after the 2008 crisis. One of the latest cases is the situation with Goldman Sachs and its $45 million fine for violating the MiFID regulation.
All these complications and fallouts are projected to continue and only become more confusing and unsustainable. As the legal burden increases, business owners can no longer regard back-office automation of banking supervision and regulation as a ’nice to have’ feature but see it as an integral part of their long-term strategy and ‘must-have’ functionality.
Classification of Regtech Companies Based on Their Focus Areas
Like the fintech disruption of the financial service industry, top regtech startups promise to disturb the regulatory domain by offering highly sophisticated solutions to the ever-increasing legal requirements in the banking sector. Currently, the regtech market can be divided into five different segments, depending on the expertise of industry participants, including:
#1 Regulatory reporting
This category of regtech firms collects personal data from various sources within a company to draw up generic reports for asset management or compliance purposes. They’re mainly powered by big data analytics, cloud, and real-time reporting. Among the maturest regulatory reporting top regtech services companies are Vermeg, BearingPoint, CME Group, Sensiple, and others.
#2 Risk analysis and management
Firms leverage big data to assess and unleash the operational risk of fraudulent activity, market abuse, and other inappropriate actions at the transactional level. The goal is to detect, prevent, and anticipate existing and potential threats. The biggest regtech companies in this segment are Finastra, Promapp, Ayasdi, SecondFloor, and more.
#3 Identity management and control
Regtech solutions accumulate and consolidate information from numerous sources to build a profile of an individual, institute, or counterparty, confirm and verify their identity, and classify them according to business rules or legal requirements. They take on due diligence, AML and KYC bank regulation procedures, and anti-fraud analysis and disclosure. The list of the best regtech companies includes NICE, Accuity, Fenergo, Kroll, and others.
#4 Regulatory intelligence
Firms analyze and facilitate regulatory changes to ensure that policies and procedures seamlessly adapt to varying qualifications. They track both current and future regulations. The regtech compliance products are offered by BottomLine, Broadridge, Darktrace, AxiomSL, Pershing, FlexTrade, MetricStream, and more.
#5 Transaction monitoring
Regtechs take advantage of AI and distributed ledger to monitor and analyze transactions in real-time to detect potentially fraudulent operations and suspicious activities. This segment mainly comprises AML regtech solutions, and among the biggest providers are Feedzai, Sysnet, AppZen, IdentityMind, iSignthis, and others.
The adoption of regtech compliance solutions is still in its infancy, but it has already demonstrated a high demand in areas with heavy fines or harsh sanctions, including but not limited to anti-money laundering (AML) and know your customer (KYC) checks. Large companies tend to cover several market segments, combining solutions and turning into one-stop shops for their clients. Additionally, businesses continue discovering new niches and testing new regtech use cases, so now you can find solutions that cover business continuity and resilience, reconciliations, regulatory inventory and policies management, information security assessments, and more.
How Regtech Compliance Solutions Help Banks Thrive
Regtech in financial services is critical for the industry that spends billions every year on compliance. Collecting, analyzing, interpreting, and complying with numerous regulations force FIs to spend enormous resources. Today, just as the business community is counting on regtech to help with legal compliance, so too regulators are betting on regtech to assist with monitoring and execution.
If integrated properly, banking regtech solutions have the potential to tick all the boxes since it not only brings down operating expenses and mitigates risks, but also improve efficiency, reduce the likelihood of errors or penalties, and help companies keep up their reputation. And it’s important that financial institutions are willing to invest and revamp their specialist skills to manage the technological risks beforehand. Recently, around 67 percent of companies globally have extended the required skill set within their risk and compliance function to address the challenge associated with fintech, regtech, insurtech innovations, and overall digital disruption.
Regulatory authority will change the financial services industry in 2022, and this tendency is here to stay. Banks’ compliance is slowly becoming a competitive advantage since converting raw data into valuable insights improves customer care, unleashes new acquisition channels, and pushes up sales. Currently, there are top five fields within the regulatory compliance risk management that are most likely to be influenced by regtech, and they are:
- Compliance monitoring — 68%;
- Onboarding and KYC — 60%;
- Financial crime, AML/CTF, sanctions — 58%;
- Regulatory reporting — 53%;
- Data capture, management, and utilization — 52%.
Despite all the benefits of regtech mentioned above, it’s not a silver bullet, and it can’t solve all the issues associated with governance and enterprise risk management. No matter if we’re talking about regtech for regulators or the private sector, in both cases, it requires financial assets, skilled human resources, and access to data. It can advance efficiency and increase automation for businesses, but regulators also employ some of these tools to enhance their productivity and continuously grow their legal requirements. Consequently, the eventual outcome may not necessarily be viable.
Finally, any software development process is based on the human interpretation of system requirements or laws. The design of algorithms for regtech software is no exception. Engineers are mainly guided by lawyers, who explain what should be embedded into tools or algorithms. Programmers build technological solutions trying to anticipate and cover all potential scenarios following on from lawyers’ explanations. Existing biases and value judgments may affect software behavior and decision-making.
Getting Started with Regtech to Reign in Compliance in the Financial Services Industry
The regtech landscape is quickly evolving, and it’s becoming one of the key levers for success. Meanwhile, to facilitate the implementation and further scaling, there are three simple steps that teams should take:
- Preliminary gathering of information to recognize your strengths and weaknesses. At this stage, it’s crucial to identify potential use cases, and define technical and functional requirements, along with the specifics of your financial business. The outcomes will help you choose the most suitable solution and achieve the determined goals faster.
- Acquaintance, KPIs, and onboarding. Starting with the implementation of a Proof of Concept (PoC) is critical, both for your in-house teams to understand the solution and for the regtech provider to get to know your business specifics and data. The goal is to make sure that the selected software provides all the necessary functionality and define measurable KPIs for each milestone.
- Sustainable industrialization and further innovation. For business owners, it’s important to create appropriate sharing and working conditions as early as possible to prevent any constraints associated with system architecture, internal processing methods, required skill sets, or security measures. Such an approach may ensure smooth scaling, shorten time-to-market, and facilitate team and expertise management.
These days, fintech, regtech, and the reconceptualization of financial regulation hold much promise, and it’s up to banks and other financial institutions to produce a proactive strategy and thus preserve a competitive edge.
The regtech segment is maturing, and currently, every regulatory technology in place is transformational in nature. Technological advancements create new opportunities, change user behavior and experience for the better, and help regulators and businesses create a more secure and resilient ecosystem that is capable of discovering and preventing negative doings, be they unintended or fraudulent.
Regulators are also leveraging technology to augment their supervisory functions, and this business line is quickly proliferating, evolving into a separate segment called suptech (supervisory technology). Also regtech vendors are evolving. The digitalization of regulatory processes results in better efficiency of government authorities. It encourages more tight alignment with regtech startups to lessen the compliance burden for banks at the end of the day.
In the long run, following the examples of BaaS or PPaaS, we expect to see the proliferation of regulation-as-a-platform models that will make it easier for companies to perceive and comply with new regulations. Meanwhile, this line of business will initiate the raising of various groundbreaking solutions, like intelligent regtech advisors, that are so necessary for the private sector and regulatory bodies.
Dashdevs is the leading fintech consulting and banking app development company with over six years of experience in the domain. It provides all the required knowledge and skills for startups and well-established organizations to support their growth, facilitates new developments, and streamlines operations.
What are the technologies in RegTech?
RegTech employs various cutting-edge technologies to provide greater efficiency in meeting regulatory compliance. These include, but are not limited to, artificial intelligence, big data, cloud computing, and machine learning. As a result of RegTech’s automation, mistakes are now far less likely to occur.
What are RegTech capabilities?
RegTech’s extract and transfer load solutions allow for the swift separation and organization of messy and interconnected data sets. It utilizes analytic tools to rapidly generate and distribute automated reports, and these reports may be used for a wide variety of regulatory objectives.
Is RegTech a FinTech?
Regulatory technology, or regtech, is a subset of financial technology that aims to improve upon or “disrupt”, the status quo by developing and deploying innovative solutions to the challenges of meeting regulatory standards.