Digital financial services are clearly impacting banks. But they are also forcing central banks and regulators to rethink and restructure their approaches to becoming resilient, adopting new technologies, leveraging data and constructing an agile operating model, all while providing regulatory services. Hence, regulators need to step up to stay relevant in the digital economy. To continue to be able to fulfill their mandate of ensuring a clean and trusted financial system, protecting end-customers and facilitating market competition, they need to become “next-gen digital regulators.”

Traditionally, central banks and regulators supervise the financial sector to maintain stability, control foreign exchange reserves and in some countries, regulate the operation of payments clearing and settlement systems. However, with the influx of new technology players in banking, they are looking to prevent loopholes in the supervisory scope and address new risks arising through inadequate preventive measures.

Being digitally active and capable is important for regulators. Here’s why:

1. Driving a cashless digital economy. Regulators across the globe are adopting a cashless economy approach—for example, Sweden and South Korea have moved steadily away from cash. Regulators are encouraging financial institutions to adopt digitization for transparency and convenience. This puts additional pressure on regulators to undergo digital transformation for better governance and supervision.
2. Embracing the arrival of new entrants. The financial marketplace is evolving quickly and digital technology is becoming a means of offering faster, more convenient and more cost-effective service, which is proving to be a major competitive advantage. Regulators are now welcoming the arrival of new entrants such as platform giants Google, Amazon, Facebook, Apple and Alibaba. For example, the UK’s Financial Conduct Authority (FCA) is prioritizing data innovation hubs and regulatory sandboxes as key components of the government’s effort to support the development of fintechs and help new businesses understand how existing regulations apply to their ideas.
3. Overcoming the trend of increasingly complex regulatory requirements. Regulators and financial participants have found that reporting has become more complex and time consuming—and that the aggregate cost of providing data is significant. Digitizing regulatory reporting rules may lead to benefits such as more transparent regulations, which is a priority for financial firms.
4. Protecting the interest of the end customer and the country’s citizens. Regulators need to manage the changing customer demand for convenience and an omnichannel experience.
5. Facilitating innovation and market competition by implementing emerging technologies such as blockchain, artificial intelligence, robotics and application programming interfaces (APIs). This will encourage the development of new products and services and help regulators effectively supervise financial markets, identify harm and detect financial crime. Implementing these services requires enhanced capabilities on the part of central banks and regulators.
6. There is a need for a business continuity plan that takes account of crisis and security threats, which impact the volatility of the global economy.
7. The increasing cost of compliance must be managed. A survey of senior staff showed that firms in 2017 were spending an average four percent of their revenue on compliance, which is expected to reach 10 percent by 2022. Regulators must reduce overly manual compliance processes to reduce costs and increase productivity, security, operational performance and quality assurance.

There are five enablers for becoming a next-gen digital regulator:

1. Harness the power of data
Traditional data integration processes are not well equipped to deal with rapidly changing business requirements and requests. Regulators usually have limited data which they receive periodically from insurers, banks, payments providers and other financial institutions. With digitization, regulators can build a robust data platform that is more granular and provides the necessary flexibility to integrate, store and quickly access all regulatory data and metadata. The data integration hub remains constantly in sync with source systems. This ensures agility and flexibility, supports all business functions and leverages the same integrated data sets. It enhances financial insights and improves the compilation of data and research findings.

There are good examples of central banks taking such steps. In late 2018, for example, the European Central Bank launched AnaCredit, a big data project that helps policymakers understand, in real time, what is driving economic behavior. AnaCredit gathers information from Euro-area banks that covers, on a loan-by-loan basis, the funding they have extended to companies—some 70 million exposures each month from approximately 4,500 credit firms. Another classic example of this is the Digital Regulatory Reporting (DRR) project driven by the FCA and the Bank of England (BOE) to explore technology for meeting regulatory reporting requirements. This has the potential of allowing financial institutions to automatically supply the data requested by the regulators, thereby reducing the cost of collection, improving data quality and reducing the burden of data supply on the industry. In addition, the FCA, the BOE and seven regulated firms (Barclays, Credit Suisse, HSBC, Lloyds, Nationwide, NatWest and Santander) have jointly published a viability assessment report on the latest Digital Regulatory Reporting (DRR) pilot. A DRR approach would also require the regulator to publish a digital version—i.e. machine-executable—of its regulatory rules for easy transmission and understanding.

2. Enable innovation
In this era of digitization, regulators and central banks need to promote cross-industry and cross-border collaboration and leverage innovation in order to streamline KYC compliance and the establishment of API standards. Financial institutions can make use of technology to develop systems that allow automated creation of regulatory reports that combine their standardized data and the machine-executable instructions. This will ultimately serve the aim of driving a cashless digital economy by implementing technologies such as DARQ (distributed ledger technology, artificial intelligence, extended reality and quantum computing), robotics and APIs. Systems based on AI, machine learning, natural language processing and distributed ledgers will support automation objectives, enabling seamless payment transactions, lower financial risk and better customer satisfaction. The classic example of this is the Monetary Authority of Singapore (MAS) and the Bank of Canada, which have jointly conducted an experiment on cross-border and cross-currency payments using central bank digital currencies. The two central banks linked up their respective experimental domestic payment networks—Project Jasper and Project UBIN—built on two different distributed ledger technology (DLT) platforms.

3. Drive efficiency
Regulators and central banks need to streamline operational efficiency both internally and externally by enhancing their clearing and settlement infrastructure using cloud and AI, supporting quality and lean processes, and managing innovation. They are renewing their real-time gross settlement (RTGS) and real-time payments (RTP) rails as well, with three main aims: to deliver a new range of payments settlement system capabilities, to adopt a new ISO 20022 messaging standard for richer data and interoperability and lastly, to improve user functionality by means of APIs. The best example of this is BOE’s RTGS Renewal Programme in the UK to offer wider interoperability, better user functionality and strengthened end-to-end risk management of the UK’s high-value payment system. Similarly, Eurosystem is modernizing Europe’s leading RTGS system, TARGET2, to optimize central bank liquidity management across all TARGET services and to adopt an ISO 20022 standard for messaging.

The era of digital transformation has brought many issues into sharper focus, such as the increased threat of cyberattacks, the internal challenges of replacing legacy IT systems and supporting staff, inconsistent risk measures and an inability to aggregate data. New technologies and products are testing the effectiveness of existing processes. Firms need to turn their attention to strengthening operational resilience, improving stress-testing standards, reviewing impact tolerances and refining performance metrics. Having a robust third-party risk-management framework for outsourcing and vendor services is also more essential than ever. Resilience is the new stress test or resolution plan.

4. Communicate effectively
Regulators and central banks need to have transparent risk and compliance communication, with the internal and external components merged with a strong data element. The communication must be systematic, consistent and easy to understand, and it should be bi-directional to ensure advice is received as well. Regulators can use various channels for communication, such as websites, campaigns, social media, conferences and publications.

5. Build a future workforce
The four previous enablers will assist regulators and central banks to craft resilient concepts only if they have digitally active workforces to activate the mechanisms. The next crucial step in this reform is to build the future workforce with the right skills in the right places to keep pace with continuously evolving digital technologies and to increase productivity. A collaborative environment with diverse skillsets and multiple organizations creates a stimulating environment for accelerated learning.

The pathway to a digital regulation strategy

The path to digital regulation requires a multi-step process supported by a long-term strategy and driven by the right data for transparency. The challenge is existential, in terms of both cost and resources. For this reason, to make digital regulation a reality, financial organizations and regulatory agencies must come together to develop the models and interfaces for exchanging data and other information.

The future of digital regulation is coming and with it, greater expectations around data, automated reporting, lower costs and greater transparency. This will fundamentally transform the regulation of the financial services industry.