It is not about start-ups taking pieces or whole links of the banking value chain and doing them more efficiently – for example with peer-to-peer lending or correspondent banking – but by doing something totally different.
In the case of the Promontory deal, digital disruption via AI would not just make compliance more efficient but different in nature. With AI monitoring in real time and even pro-actively, banks might actually operate differently.
Just as so-called ‘robo advice’ could potentially disintermediate much of the financial advice industry, AI in risk and compliance could fundamentally shift the business.
(Which is not to say the cost efficiencies by doing the same things better are not significant. For example, National Australia Bank has estimated the cost of regulatory compliance has risen from $A86 million annually in 2012, to $A177 million in 2013 and $A265 million in 2014. Westpac says it spent $A300 million on compliance last year.
(In announcing the deal, IBM said more than 20,000 new regulatory requirements were created last year alone and the complete catalogue of regulations is projected to exceed 300 million pages by 2020, rapidly outstripping the capacity of humans to keep up.
(Today, the cost of managing the regulatory environment represents more than 10 per cent of all operational spending of major banks, for a total of $US270 billion per year.)
AB quoted an industry expert saying “I immediately thought of all the lawyers and former government regulators that work at Promontory being replaced by computers. If truly the purpose of this acquisition is to take the human knowledge and effectively store it in AI or Watson, it will have a huge effect on this industry."
Of course, there are considerable grounds for reasonable scepticism. Self-driving cars, the internet-of-things, home help robots, are all amazing and promising technologies but still too rudimentary to truly replace humans – and hence reshape how we do things.
Just a trivial example at the bank where I work: the email system is monitored by an automatic invigilator who prevents offensive emails being sent on the bank’s systems. Fair enough.
However, it means I can’t send an email with the infamous quote from Singapore founding father Lee Kuan Yew about Australia’s possible position in Asia because the system won’t allow the adjective white in front of the noun trash.
Nor can I precede a common word for a cavity with the indefinite article lest it be interpreted as code for a particularly obnoxious person.
Watson is no doubt a very bright boy but the nuance and cultural intangibles necessary for risk and compliance are profound. Indeed, the lessons of history are that it is culture – a particular human quality – which is more effective than particular regulation in improving behaviour. That said, Watson should be less vulnerable to prejudice and unconscious bias.
Nevertheless, regulatory technology – ‘RegTech’ – is one of the hottest albeit niche opportunities in the whole fintech ecosystem.
In a new paper by three law professors, Douglas Arner and Janos Nathan Barberis from the University of Hong Kong and Ross Buckley from the University of NSW, FinTech, RegTech and the Reconceptualisation of Financial Regulation, the authors argue “RegTech developments are leading towards a paradigm shift necessitating the reconceptualisation of financial regulation”.
Their findings emphasise that digital disruption is not just about greater efficiency in existing processes but new processes altogether.
“RegTech to date has been focused on the digitisation of manual reporting and compliance processes, for example in the context of know-your-customer requirements,” Arner, Barberis and Buckley say.
“This offers tremendous cost savings to the financial services industry and regulators. However, the potential of RegTech is far greater – it has the potential to enable a close to real-time and proportionate regulatory regime that identifies and addresses risk while also facilitating far more efficient regulatory compliance.”
What is true for RegTech is true more widely with digital disruption. It is not about technology, it is about completely rethinking the path to desired outcomes.
Arner, Barbaris and Buckley talk of a lack of ambition but it is more probably a lack of comprehension harking back to Henry Ford’s famous insight that consumers didn’t think they wanted a car they wanted a faster horse.
Moving from horses to cars, in these authors’ opinion, entails from moving from KYC – “know your customer” – as the focus of regulation and compliance to KYD – “know your data”.
“As our financial system moves beyond KYC to KYD we will move into an entirely new regulatory paradigm that will have to deal with everything from digital identity to data sovereignty and that will have the potential to extend far beyond the financial sphere,” they say.
RegTech is one of those advances which we will overestimate in the short term but underestimate in the long term. At some point in the not-too-distant future, the focus of the inevitable political inquiry into financial institutions will be why they didn’t manage their data and analytics properly – and hence potentially damaged their customers – rather than why they didn’t manage their people.
Andrew Cornell is managing editor at BlueNotes