Regulation
08/29/2016

Cutting Compliance Costs with Regtech


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I was having a discussion about the future of banking with some fellow investors recently and one of my younger and more tech savvy associates opined that fintech companies would soon make traditional branch banking obsolete. It is a provocative idea but I am pretty sure he is wrong. Two decades from now it will still be fairly easy to find a bank branch a short drive away even if it is in a driverless car. Bankers will adapt and banking will become more mobile and more digital, but there will always be a place for banks and their branches in the economy.

Bankers are not sitting in their offices waiting to be replaced. They are finding ways to use new technology advancements to make their business faster, more efficient-and most importantly, less expensive. This is particularly true in one of the highest cost centers in the bank-regulatory compliance-where the automation of that detail intensive process is providing huge cost benefits. Compliance costs have been spiraling upward since the financial crisis led to an avalanche of new regulations, and technology might be the industry’s best hope of bringing those costs back down.

Bankers are starting to see the advantages of big data and analytics-based solutions when they are applied to the compliance challenge. “Although still in the early stages, banks are applying big data and advanced analytics across customer-facing channels, up and down the supply chain, and in risk and compliance functions,” said Bank of the West Chairman Michael Shepherd in a recent interview with the Reuters news service. For example, a growing number of banks are using new technology to automate the enormous data collection and management processes needed to file the proper compliance reports, particularly in areas like the Bank Secrecy Act. This new technology can help regional and community banks address data gathering and reporting challenges for regulatory compliance.

Smaller banks in particular are looking to partner with companies that can help build a data driven approach to compliance management. More than 80 percent of community banks have reported that compliance costs have risen by at least 5 percent as a result of the passage of the Dodd-Frank Act and the expense is causing many of the smallest institutions to seek merger partners. In fact, two of the biggest drivers of my investment process in the community bank stock sector is to identify banks where compliance costs are too high, and where there is a need to spend an enormous amount of money to bring their technology up to date. Odds are that those banks will be looking for a merger partner sooner rather than later.

While banks are looking to make the compliance process quicker, easier and cheaper, they also need to be aware that the regulators are developing a higher level of interest in the industry’s data collection and management systems as well. A recent report from consulting firm Deloitte noted that “[In] recent years regulatory reporting problems across the banking industry have more broadly called into question the credibility of data used for capital distributions and other key decisions. The [Federal Reserve Board] in particular is requesting specific details on the data quality controls and reconciliation processes that firms are using to determine the accuracy of their regulatory reports and capital plan submissions.”

The Consumer Financial Protection Bureau is also monitoring the compliance management process very closely. An assistant director there was quoted recently as saying that the bureau is increasingly focusing its supervisory work on the third-party compliance systems that both banks and nonbanks sometimes rely on. This is the behind-the-scenes technology that drives and supports the compliance process.

There is a developing opportunity for fintech companies to focus their efforts on providing regtech solutions to regional and community banks. The cost of compliance is excessive for many of these institutions and, for some, place their very survival into question. Regtech firms that develop compliance systems that are faster, more efficient and can help cut compliance costs significantly in a manner acceptable to the regulatory agencies will find a large and fast growing market for their services.

Tim Melvin