Regulations, which impose parameters on the operations of financial firms, are the main vehicle for safeguarding the financial system, but technology will also have an increasingly large role to play. 

What is happening?

The move towards digitisation has been accelerated by the Covid-19 pandemic, particularly with most workforces having to work remotely due to population lockdowns. Banks have long appreciated the use of technology and see it as vital for complying with the raft of increasingly complex and demanding regulatory requirements that sprung up following the 2007–2009 global financial crisis (GFC). 

Reg rage – acceptance

Indeed, complying with reporting requirements alone in the Markets in Financial Instruments Directive (MiFID) II and the Securities Financing Transactions Regulation (SFTR) would be impossible without technology. 

The lockdowns have only served to accelerate the focus on technology-driven solutions, known as regtech, for the regulated. 

Less well appreciated is that supervisors are also taking an intense interest in technology to perform their roles better, in what is known as ‘suptech’. They too are making big investments in this area so they can ultimately carry out supervision more effectively.

The Bank for International Settlements set up an innovation hub to help central banks to understand how technology can help them perform their roles better. Meanwhile, the UK’s Financial Conduct Authority set up the Global Financial Innovation Network with its counterparts around the world for similar reasons. 

Why is it happening? 

The flip side of asking financial institutions to report vast amounts of data via regulations, such as MiFID II, SFTR and Dodd-Frank in the US, is that supervisors themselves need technological solutions to digest, format and analyse it, and ultimately to draw conclusions over whether risks are building up in the financial system through to identifying conduct issues in markets. 

This has necessitated supervisors making their own investments in technology to keep pace with the torrents of data they collect from industry. Currently, much of that data is simply not analysed or used to the extent it could be. 

Suptech 1.0 will likely be about the use of big data, analysis and formatting tools, which will gradually make regulatory compliance cheaper for banks and supervisors alike. It’s about efficiency. It means supervisors can generate bespoke reports far more quickly and easily on particular topics, for example. 

Suptech 2.0 is altogether more interesting, and will partly be enabled by artificial intelligence (AI) and machine learning. This is where supervisors will be able to quickly pick up anomalies in the financial system and deduce whether they are threats or represent misbehaviour. Possibly, suptech 3.0 is where supervisors will have almost complete transparency and oversight of the financial system, being able to instantly make a tweak here and there on, say, certain capital requirements or margins on derivatives transactions to head off potential financial risks. That, of course, is the dream and not all industry experts are convinced that supervisors will ever be able to wield such power. 

What do the bankers say? 

Bankers certainly welcome the more modest goals of suptech, version 1.0, which are about making compliance easier and more efficient. It would certainly enhance the massive investments they’ve made in regtech. 

However, whether they would welcome supervisors achieving complete transparency is another matter. Much would depend on how supervisors would use such powers as, in theory, they could restrict how banks operate and impact their business models to the detriment of profits. 

Will it provide the incentives?

One area that does concern supervisors is that technology could spawn new forms of regulatory arbitrage. The global banks potentially have an edge as they spend vastly more on IT than supervisors, and have an entire regtech industry at their beck and call. 

They could, for instance, use this edge to game the supervisors’ own algorithms or unleash highly complex mathematically driven AI programmes that produce unpredictable outcomes, much like financial engineering did in the run-up to the GFC. 

Will suptech ultimately stamp out financial crises? It should reduce them if used properly, but it won’t end them. Supervisory mandates can be interfered with by politicians eager to gain quick economic wins at the expense of financial stability. Crises emanating from severe pandemics or climate-related disasters also have the potential to wreak havoc on the financial system and there’s not much suptech can do to stop that. However, it is still well worth pursuing. 

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