Douglas Arner, Janos Barberis, Ross Buckley

Two major challenges have arisen for financial services since the Global Financial Crisis (GFC) of 2008.  On the expense side, post-crisis fines have exceeded US$200 billion, and the ongoing cost of regulation and compliance has become massive.  On the revenue side, competition from new start-ups companies may well put up to US$4.7 trillion of revenues at risk.

The GFC accelerated the evolution of Financial Technology Start-ups –FinTechs – which in the last 5 years have attracted over US$80 billion of investment capital. FinTechs run the gamut of new platforms for P2P lending, robo-advice, payments, credit scoring, and meeting compliance obligations. Yet with all the growth this sector has experienced, and all the hype that surrounds it, it has failed to solve the very problem from which it emerged: financial market instability. But that now could change with RegTech emerging from FinTech.  

RegTech platforms to date have primarily been designed to help major financial institutions meet the burgeoning, new demands of regulators and policy-makers. Yet RegTech offers regulators much more. It offers a proportionate risk-based approach where access to and analysis of data enables more granular and effective supervision of markets and market participants. This new form of data reporting and monitoring has the potential to benefit macro-level supervision and stability; and this is the vision of Andy Haldane, Chief Economist of the Bank of England:  

I have a dream. It is futuristic, but realistic. It involves  … tracking the global flow of funds in close to real time (from a Star Trek chair using a bank of monitors), in much the same way as happens with global weather systems and global internet traffic. Its centerpiece would be a global map of financial flows, charting spill-overs and correlations.[1]

Yet to date RegTech has fallen far short of this vision. For now, RegTech’s growth has principally been in processes that substantially decrease compliance costs and the potential for regulatory fines. The most immediate practical use has been the development of shared utility on KYC, to better onboard and monitor consumers.

While RegTech is certainly ameliorating the cost burdens of heightened post-GFC regulatory requirements, this is merely an incremental, cost-saving improvement not the paradigm shift envisaged by Haldane. The truly transformative nature of RegTech is currently being seen today far from the epicentre of the GFC. It is India that is leading the way on building tomorrow’s financial system.

The India Stack, an idea originated by a group of Indian IT entrepreneurs and supported by the government and the Reserve Bank of India (RBI) involves four main layers:

• Presence-less layer: unique digital biometric identity
• Paperless layer: electronic documentation protected by digital signature and storage
• Cashless layer: single interface to all interconnected payments platforms
• Consent layer: consent-enabled data sharing framework

Together, the four levels are intended to interact to provide the basis for (i) a FinTech transformation of India’s inefficient financial sector, (ii) access to financial services for India’s entire population, and (iii) opening markets to, and competition among, entrepreneurs, start-ups and IT / ecommerce firms.

In only 5 years over 1 billion Indians have been registered on India’s platform – completing the first presence-less layer and laying the foundation for a new way of doing finance. Technology today means it is no longer necessary to identify people by physical paper-based ID documents. People are defined not by their name on a passport but by their digital identity, reinforced by their day-to-day activity which necessarily leaves a digital trace.

Going from this traditional KYC approach (scanning a passport) to KYC methodology (using personal data for identity) is core to the paradigm shift offered by RegTech. This is why we believe that RegTech’s transformative nature will only be fully captured by a new approach that sits at the nexus between data, digital identity and regulation.

The implications for consumers are cheaper, faster and better financial services. The new KYC standards in India are providing truly extraordinary efficiency gains. Account opening costs have gone from US$5 to 30 cents, account registration time from 90 minutes to 3 minutes, and account issuing from 14 days to 1 day. And, importantly, this means being able to financially include many hundreds of millions of people, and thereby assist the raising of their standards of living.

In advanced economies, the full implications of RegTech for the financial system are yet to be fully scoped or understood. What we do, however, know is that part of the genesis of the GFC lay in a failure to understand the correlation of risk across supervised firms and the “Start Trek Dash Board” would certainly provide the opportunity to identity, estimate and prevent contagion risks. The true potential of RegTech in the West is near real-time, effective financial supervision that identifies risks while they are developing and enables regulators to work with industry to defuse them.

This is a bold and ambitious goal, but the fallout in financial, and more importantly, human terms from the GFC demands we aim no lower. The GFC cost millions of people their life savings, pushed millions more into unemployment and, in parts of Europe, has forced a whole generation into under-employment.

RegTech today offers very substantial cost savings but we shouldn’t satisfy ourselves with these. RegTech implemented with the right vision and purpose, accepting that “people are too big to be failed”, can bring about the stability that our financial systems have been lacking since liberalization began in the 1970s.

Let’s pilot this novel kind of regulatory architecture that is proportionate, efficient and data-driven, and enables supervision in near to real-time, to ‘boldly go where no man has gone before’.

This blog is based on the scholarly article: FinTech, RegTech and the Reconceptualization of Financial Regulation.