Forces driving demand for RegTech

RegTech is getting more attention in the fintech ecosystem this year, alongside the surge in cross-border money transfers and expansion of digital transfer platforms.

Accelerated by the COVID-19 pandemic, the popularity of electronic payments is spiking both the volume and complexity of financial transaction data. More sophisticated digital financial crimes are another side effect of the uptick in electronic transfers, with fast, ecommerce transactions a vehicle for criminals to exploit and cover money-laundering and other illicit financial activities.

These forces are challenging banks and payment service providers to fulfill their compliance obligation to help weed out the financial crime from normal activity.

As a result, financial institutions (FIs) are seeking more technologically advanced solutions to automate transaction monitoring.

Regulatory technology companies, known collectively as RegTech, are improving tools to help manage increased volumes with optimized performance.

Legacy control systems are limited by rules, when the focus should be on highlighting risk factors.

RegTech solutions applying AI and machine-learning technology to big data in cloud environments can help financial institutions and payment service providers ensure their growth trajectory, while enabling a risk-based approach. With enterprise momentum toward cloud-based systems, SaaS cloud-hosted RegTech solutions can especially streamline operations.

Here’s a deeper look at three major forces driving demand for RegTech solutions:  

More action required

With the rise in financial crimes, regulators globally are demanding more action to combat money-laundering.

Some examples of the many recent directives from regulators around the world:  

In the UAE, new guidelines by the central bank from November reflect Financial Action Task Force (FATF) standards. Money transfer firms must maintain effective AML/CFT programs using a risk-based approach to fulfilling obligations, including strong customer due diligence, continuous transaction monitoring, and suspicious transaction reporting.

In Asia, the Hong Kong Monetary Authority (HKMA) is specifically encouraging the adoption of cloud-based RegTech solutions as, more advanced technologies can “identify high-risk relationships, suspicious transactions and networks of mule accounts.”

The EU is also moving to crack down on money-laundering, kicking off a major campaign headlined: #EUstopsdirtymoney. A new EU AML authority will be set up requiring tighter controls across the EU to ensure the private sector consistently applies AML rules and regulations.

Meanwhile, the Bank of Ireland issued new guidelines in June, in line with the European Banking Authority, highlighting the issue of de-risking, noting it is not acceptable for firms to terminate large categories of customers without conducting individual risk assessments to determine whether there are any increased CDD measures which could be applied to allow the customer relationship to be maintained.

Rising costs of compliance

High costs of compliance are also driving FIs to search for new and more efficient solutions from RegTech providers.

The operation of compliance departments and manpower involved in investigations can weigh heavily on the bottom line of FIs.

Rules-based systems can be counterproductive and ineffective in dealing with the rising volume of data, as they are known for triggering a high rate of false positives and a large volume of alerts. As a result, heavy resources must be invested in the investigation processes.

On top of these costs are the fines regulators are imposing for non-compliance. In the past year, fines have already surpassed $1.9 Billion in 2021, according to estimates, a similar level to 2021 but five times higher than the $444m total of 2019.

Growing number of players  

Digital payment platforms and online banks are disrupting the market today, offering lower costs enabled by online-only business operations.

With the growth in the number of financial players, monitoring of money transfer activities is becoming more complex.

Correspondent banking transactions involve a complex sequence of bank participants operating across multiple currencies, with varying levels of completeness in identifying information across transaction participants with different responsibilities across the full path.

Banks are tasked with pin-pointing risk across complex global transactions. For payment service providers, the risk of failing to adequately monitor transactions opens the risk of being shut off by network partners and the ability to grow.

In this environment, banks are faced with the dilemma of reducing business and de-risking payment service providers. Regulators are moving in parallel to bring PSPs under compliance regimes.

More sophisticated Regtech solutions can improve visibility and monitor the entire payment chain in order to detect suspicious activities across the full path.  

In sum, the use of innovative RegTech solutions can help reduce investigation time, bolster financial inclusion and detect the unknown-unknowns.  At the end of the day, RegTech can help financial institutions grow business with new corridors which benefits all players including customers.