How to stay creative and innovative, yet compliant with the regulation
Ask people who work in digital banking what they like about their sector, and you will get a wide range of answers. You are likely to get:
» Disruptive technology
» Customer obsession
» Dynamic startup culture
» Focus on innovation
» Accessibility, ability to cater to under-served customers
One answer you are unlikely to get is “striving for excellence in compliance and reg reporting”. The appeal of digital banks is that they are disruptive of the industry’s norms. But this is the very opposite of what is required by regulatory reporting. Digital banks are creative, whereas regulatory reporting as a process is anything but.
Digital Banks vs Traditional Banks
Digital (and challenger) banks come in all shapes and sizes - some are offshoots of big tech companies, others are fintech startups, and yet others provide banking as a service (BaaS) to non-financial institutions via APIs. What they all have in common, however, are the innovative ways they deliver banking services without physical branches. McKinsey defines a digital bank broadly as “a deposit-taking financial institution that provides its products and
services through a digital-first or digital-only business model.”
According to the article, a digital bank has the following characteristics:
» A digital front-end and operations
» A digital-native back-end core
» A structure and culture like those of a technology company
The first two points are technical and easy to verify, yet a business culture is something intangible. But it goes to the heart of the issue. McKinsey offers a definition: “the characteristics of a digital operating model include a horizontal structure, minimal bureaucracy, a nonhierarchical environment with high levels of staff empowerment and ownership, and a test-and-learn culture enabling continuous development of systems, products, and channels.”
Levels of bureaucracy vary significantly between digital and established banks. In traditional established and well-resourced banks, the regulatory and compliance “bureaucracy” has notably expanded over recent years to tackle the increasing demands placed on them by regulators in various national and supra-national jurisdictions.
While regulators in jurisdictions such as Singapore and Malaysia have shown some flexibility or have sought to build a parallel regulatory environment better adapted to digital banks, the vast majority of jurisdictions still apply existing banking laws and regulations to digital banks. Even in the few jurisdictions that have set specific regulatory frameworks for digital banks, the main licensing and ongoing requirements are similar to those for traditional banks.
The situation continues to evolve. The Financial Stability Institute (FSI) recognized, in a paper published in August 2020, that the sector offers significant benefits compared with traditional banking. It concluded: “The overall challenge for authorities is to maximize the benefits of fintech innovations while mitigating potential risks for the financial system”.
The pandemic pushed the issue up the agenda
However, the pandemic accelerated the expansion of digital banking and fintech, setting off alarm bells at the FSI. In January 2022 FSI Chair Fernando Restoy remarked that “The current regulatory setup, consisting of a series of diverse activity-based requirements accompanied by specific rules only for traditional financial institutions, is simply not fit for purpose”. He cited, in particular, specific risks posed by the combination of financial and non-financial activities of big tech companies and argued that “brand new regulatory categories and supervisory procedures” are required to address the challenges posed by the unique business models of digital banks, “including effective mechanisms for coordination among financial, competition and data authorities”.
Restoy also warned of various sources of risk including systemic stress due to excessive indebtedness, liquidity mismatches, third-party dependencies and operational vulnerabilities (such as technology outages), the issuance of new forms of payment such as stablecoins, and various concentration risks.
Regulators around the world are taking note, and it is highly likely that there will be an overhaul of the regulatory framework. Restoy thinks this could mean the creation of new regulatory categories and supervisory models. Digital banks and fintechs, with their slimmeddown bureaucracies and flat hierarchies, will not be well-placed to deal with this shock to their business models.
Focus on what you do best
All of this is likely to be a distraction from what digital banks and fintechs do best: serving customers, identifying opportunities among underserved market segments and growing the business. What Moody’s Analytics has learned over the years is that the regulatory burden never goes away – it gets more complex over time and requires constant maintenance. This also applies to traditional banks, and it will apply increasingly to financial institutions following the new business models too.
However, we have also learned that meeting regulatory requirements is not simply a business overhead. The work done to satisfy the regulator is also extremely valuable for internal management of the bank, providing insights that enable the optimum trade-offs between risk and growth such as leveraging the ECB’s Internal Capital Adequacy Assessment Process (ICAAP) to establish more effective and profitable risk-based pricing.
Moody's Analytics offers a “regulatory compliance-as-a-service” solution that enables you to stay compliant continuously, without needing to worry about change. We monitor the regulator’s updates and deliver them to customers in a timely way – for traditional banks and now increasingly for digital banks, too. This saves financial institutions the need to employ large permanent in-house regulatory compliance teams or to set up project teams to address new
issues as they arise. The costs are transparent and predictable.
Our regulatory software automates the whole regulatory process end-to-end from calculation, validation to submission. This enables you to understand and control your regulatory reporting process with features like calculation transparency, data lineage, variance analysis and smart adjustments. The solution is simple to integrate, easy to use and, an important attribute for digital banks on a rapid growth path, it scales very easily.
In short, Moody's Analytics has embraced and learned regulatory reporting so that banks and fintechs like yours don’t have to.
Contact us now to see our solutions in action!