Could regulation technology – or ‘reg-tech’ – avert banking failures? This entrepreneur thinks so

(Credit: Unsplash)

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Gayle Markovitz, Lead Editor, World Economic Forum

  • Financial regulation and supervision is in the spotlight as banking turmoil intensifies in the US and Europe.
  • Regulation is likely to be tightened up in the wake of recent events but despite digitization, financial reporting has not changed much in decades.
  • Regulation technology – or ‘reg-tech’ in the industry – is an important tool to strip out the risk of error or bad management while speeding up the exchange of financial information between banks and their supervisors.

Each financial crisis puts a spotlight on banking regulation. It happened in 2008 and some 15 years later, here we are again.

While this banking tailspin is very different to 2008 and there are reasons to hope that it won’t descend into market panic, it’s not over yet and there’s a sense that something’s gone wrong and needs fixing. What happens next is unclear but rising interest rates and fear itself are presenting a very fragile outlook for the days and weeks to come. Regulators have already responded by tightening up supervision.

Regulation technology – or reg-tech as it’s known in the industry – was an innovation that came out of the last crisis. This time around, it might emerge as technology’s answer to better financial reporting and risk management that has the potential to avert the next crisis.

So how does reg-tech work?

One of the weaknesses of a traditional financial regulatory system – whether in the US or Europe – is that it is over-reliant on the judgement and competence of bank regulators. Despite digitization, financial reporting has not changed much in decades. It is based on a system where central banks monitor and supervise the global financial industry based on reporting that is pushed out by banking firms.

In contrast, reg-tech enables what’s known in the industry as ‘pull’ rather than ‘push’ information exchange. So data is pulled from firms, removing the need for reports entirely. This makes financial information exchange faster, more agile and less dependent on supervision or human error.

Reg-tech could therefore enable the financial industry to move to a more regulator-led pull-based system, where information is pulled at source, analysed and modelled in real time with future trends projected continuously, ensuring supervision of the industry remains on point at all times.

Fin-tech CEO and Co-founder of Suade, Diana Paredes, says reg-tech offers a scenario “where news, analytics and calculations are fast and pretty much out of the box”.

The latest banking crisis is seen in part to have stemmed from a wave of deregulation in the US where smaller and mid-size banks operating below a threshold became subject to more relaxed supervision.

What we’re now likely to see is an increase in liquidity reporting, not just in the number of reports but also in the frequency ”— CEO and Co-founder of Suade, Diana Paredes

This rolling back, Paredes says, was a “gross miscalculation”.

“The assumption was that those banks would only need to do monthly reporting, but what we saw with SVB is how fast things can change within 24 hours. That’s the thing that’s going to have to reset massively in US regulation. What we’re now likely to see is an increase in liquidity reporting, not just in the number of reports but also in the frequency.”

The malaise in US banking that has spread to Switzerland, is marked today by a rescue deal for Credit Suisse and fresh fears for the health of Europe’s banks. Despite the more robust Basel III measures in place in Europe, there are hints of contagion and global financial jitters.

Paredes says this and the US situation means that we’re about to see a dramatic change in regulatory activity.

There has been discussion in the past few years around the issue of ‘proportionality’ – where the weight of regulation is measured according to the size of the bank. The Bank of England’s 2020 Strong and Simple consultation paper asked the industry how they would want to be deregulated. This is no longer a likely scenario.

“So it’s going to raise all sorts of huge questions in the regulatory piece. The Basel committee will have to see how some rules need to be reapplied or how guidance should be given around frequency in particular with respect to proportionality and deregulation. And over the next few weeks, many financial organizations will be asked overnight for information.”

She adds that this in itself might trigger contagion on the back of rumours and loss of confidence.

Here’s where reg-tech could play a part, she explains. “Regulators could have straight access to banks and do a lot of this analysis without notifying the markets or making any kind of panic around it. It would be a very interesting concept for supervision.”

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