Regulators and banking supervisors must take advantage of the revolution in regtech to be more effective and efficient.

Huw Van Steenis

“Brevity is the soul of wit,” wrote Shakespeare. If so, then being a bank regulator can’t be that entertaining these days. With the huge growth in reporting requirements, bank supervisors receive reading material that is the equivalent of reading twice the complete works of the Bard each week, or so I found while working on the Bank of England’s (BoE) Future of Finance report. It underscored the vital role that machine learning and data analytics will play as part of a digitally enabled regulator of the future. But how else is financial regulation likely to change as a result of the technological revolution that is under way?

In 2018, BoE governor Mark Carney asked me to lead a review of the UK’s financial system to strengthen the central bank’s agenda, toolkit and capabilities. I focused on three questions: how can technology increase finance’s resilience? How can finance support the transitions we are witnessing? And how can finance serve the digital economy? It was an extraordinarily challenging set of questions and led me to some of the big debates regarding how technology will affect finance over the coming years. Let me pick out a few aspects.

Regulation tech

There is huge scope for the UK to be a world leader in digital regulation and making ‘regtech’ more effective and efficient. It can also capitalise on London being one of the fintech capitals of the world.

Regulation is complex: the BoE’s rulebook is longer than the Old Testament of the Bible, once all the global and European rules are included. No individual can keep up with its updates. Machine-readable rules could ensure better adherence and save the private sector a significant amount of time and money.

The volume of reporting has grown extraordinarily. The system of banking supervision has become highly complex, with the risk of missing the forest for the trees. Machine learning and new data sets can strengthen the BoE’s ability to spot irregularities and get a better picture of the system’s overall health and emerging risks. Routine tasks should increasingly be automated.

Supervisors spend more time on relatively manual gathering and manipulation of information than they do on value-adding activities such as analysis, interpretation and recommendations. A shift will free up resources. New tools will be essential to digest the extraordinary growth in data.

We regularly held workshops to crowdsource ideas: one attendee suggested the regulator of the future should be like sitting on the bridge of the starship Enterprise with systems sifting through patterns.

Current practices are expensive. Consultancy firm McKinsey has estimated that regulatory reporting for UK banks costs the industry between £2bn ($2.45bn) and £4.5bn per year. That is passed on to customers. A new data strategy should take into account both the cost to the regulator and the efficiency of the overall system. With the publication of the Future of Finance report, the BoE announced an ambitious new data strategy and plan of action that has been widely welcomed.

Technology is also shifting traditional boundaries between sectors. Chinese group Ant Financial’s payment service now has 1 billion users, five times more than the largest US bank. Facebook has announced plans to create a digital currency. More than half of all financial intermediation globally now happens outside the banking system. Risks are moving. But this time of transition also creates opportunities for finance to serve customers and the economy better. It also creates challenges for regulators with clearly defined mandates.

Work together

Regulators and the private sector have to collaborate in new ways as technology breaks down barriers. Moving to digital payments without leaving anyone behind will require significant upgrades to broadband and mobile telephony networks. Open finance will require competition authorities, data regulators, financial regulators and lawmakers to think about problems holistically, because opening up data may create unintended risks.

The large number of regulatory projects requiring major technology upgrades would benefit from being coordinated, so that firms can invest in their own technology infrastructure. To improve resilience and support innovation, I recommend the BoE and all financial regulators create an ‘air traffic control’ forum to map out and identify critical junctures for ongoing and major new regulatory projects and their implications for firms’ IT/operational resilience, as well as their impact on innovation.

Flurries of uncoordinated demands from regulators with tight deadlines add cost and risk. They can also promote the patching-up of old systems at the expense of long-term investments in new infrastructure. Every regulator has its own objectives and independence, but sharing information could create a common understanding of challenges and, through feedback, a better understanding of the complexity of implementation. Singapore’s ambition to ask for a piece of information just once across all regulators is what we should all aspire to.

Automated decision-making based on machine learning is one of the most important trends in technology today. Artificial intelligence (AI) and machine learning are expected to become widespread in financial services. So how customers’ data is used – and its security – will assume ever greater prominence. While financial services are arguably already one of the most heavily regulated sectors for the use of data, rules must be revised to keep pace with the emergence of new data sets (including social media), developments in data science and new analytical techniques. Data privacy, and the responsible and legal use of algorithms, will be a huge topic in finance, and the UK should be at the leading edge of its development in finance.

For example, AI and machine learning are helping firms in anti-money laundering and fraud detection. Until recently, most firms were using a rules-based approach to monitoring money laundering. But this is changing and firms are introducing machine learning software that produces more accurate results more efficiently by bringing together customer data and publicly available information on customers to detect anomalous flows of funds. About two-thirds of banks and insurers are either already using AI in this process or actively experimenting with it, according to a 2018 Institute of International Finance survey. These firms are discovering more cases while reducing the number of false alerts. This is crucial in an area where rates of so-called ‘false positives’ of 85% or higher are common across the industry. On the whole, this is a positive step forward.

The way forward

To get ahead of these issues and encourage responsible use of AI/machine learning in financial services, I suggested a joint working group be set up for the use of ethical AI principles in finance, which the BoE and Financial Conduct Authority have created. These responsible AI principles – such as fairness, accountability, transparency, security and responsible usage – could then offer guidance where rules need refreshing. Ideally, this should be across wholesale markets, banking and insurance. This should also include the possibility of collaborations, for example with the Fixed Income, Currencies and Commodities Markets Standards Board.

Regulators should embrace cloud technology, which has matured to the point at which it can meet the high expectations of financial services. It offers the advantages of business agility, faster innovation and cyber defences to provide better services to households and businesses. It also enables large firms to take advantage of the skills and talent in small and medium-sized businesses. Research suggests up to one-quarter of the activities of the largest global banks may already be on the public cloud or software hosted on the cloud.

Given that almost every financial services vendor, and many fintechs, are cloud hosted, indirectly the UK banking system is already highly reliant on the cloud. Looking ahead, up to 90% of banks’ workloads globally could be hosted on the public cloud or software-as-a-service in a decade, according to McKinsey. Policies will need to respond to this emerging reality. If the UK wishes to remain a leading venue for international finance, and ensure UK financial firms are competitive and on a level playing field with new business models, the central bank will need to build expertise and play a leading role, in collaboration with other authorities, shaping use of the public cloud in the financial sector.

I am delighted that many of these suggestions are being taken forward. The BoE, under the leadership of Mr Carney, has been a beacon of wise policies. The new initiatives should continue to play a world-leading role in promoting a diverse, resilient and vibrant UK financial system.

It is also right that we should weigh up the hugely positive aspects of how technology can help finance to serve society better. But we should also harness technology to police the financial system. As Shakespeare also wrote: “All that glisters is not gold.”

Huw van Steenis is senior adviser to the chief executive of UBS, and previously senior adviser to governor of the Bank of England.

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