RegTech is the management of regulation, compliance, reporting and monitoring through technologies like big data, data mining, artificial intelligence and blockchain to provide robust, reliable and effective solutions.
The technologies offer data on money laundering activities and help to reduce the risk of financial fraud. However, regtech is facing some challenges like operational barriers, lack of recourse, high cost and cumbersome process of automating manual procedures.
After the global financial crisis, regulators started to focus more on the compliance element in the business and thousands of rules and provisions were introduced all around the world. According to the Financial Conduct Authority (FCA), about £189.8 million has been paid against the regulatory violations. The cost of doing compliant business is higher, which is why all global regulators are showing interest in blockchain technology for regulatory purposes.
Whether it is a big bank like HSBC or a small organization, the cost of compliance is high, and getting higher with time. Currently, all the global financial regulators are putting efforts to collaborate with organizations that employ software-as-a-service (SaaS) or cloud computing technologies to assist businesses in complying with laws more efficiently and cost-effectively.
This article aims to discuss various regtech use-cases in compliance and the application of blockchain technology in the regtech ecosystem.
Blockchain is a decentralized distributed ledger consisting of blocks that contains the records of transactions stored using cryptography. Aside from payments, blockchain allows banks to streamline complex procedures and improve internal processes.
The traditional banking industry has been dragging its heels so far, which is understandable given the stakes in terms of costs and services. However, 90% of European Payments Council members recently indicated that blockchain technology in regulatory compliance will fundamentally transform the business by 2025. It appears that distributed ledger technology will replace or modernize aspects of the financial system soon.
Currently, blockchain technology is mostly used as a distributed ledger for cryptocurrencies. However, for the banks, blockchain technology offers various benefits like automation and intermediary redundancy. For example, the use of blockchain reduces the number of intermediaries involved in issuing financial instruments.
Moreover, banks can use blockchain regulation technology to provide transparency of their operations to their users, offer cross-border transactions in real time and faster processing of payments. Blockchain also helps accelerate back-office settlements, inter-bank transactions and reduce the overall cost of doing business.
According to research by German fintech firm Cashlink, using blockchain technology to automate activities like correspondence, validation and manual updating of bond documentation may save at least 35% of issuance expenses during the life cycle of a bond.
Blockchain technology can improve productivity and save money by making it easier and safer to transmit information across financial institutions by storing client information on decentralized blocks to comply with regulations. Here comes the role of blockchain in regtech. However, it will still take time to develop the blockchain system for banks.
Blockchain is formerly playing a major part in driving the regtech revolution, thanks to its multiple benefits: increased translucency, decentralization, briskly and more cost-effective processing through automation and enhanced security through cryptography.
A regtech ecosystem consists of a group of companies that use computing technology, offer SaaS to help businesses comply with regulations efficiently and lower sumptuously. RegTech is also recognized as a regulatory technology as regtech companies unite with financial institutions and regulatory bodies, using cloud computing and big data to share information.
A bank that receives vast amounts of data may find it too complex, precious and time-consuming to comb through. A regtech establishment can analyze complex information from a bank with data from regulatory failures to predict implicit trouble areas that the bank should concentrate on.
By successfully creating the analytics tools demanded by banks to comply with the laws and regulations, the regtech companies save the bank's time and capital. In this way, the banks implement an effective analytical tool to conform with rules set out by financial authorities.
Nonetheless, the cost of implementing regtech services for banks is still high as hundreds of new compliance rules originate every year. So, banks have to comply with the novel rules to avoid getting into a situation where they are penalized by the regulators.
Financial regulators and service providers are looking for the best and most cost-effective solutions to help the banks and other financial institutions comply with the rules and do business in a compliant regulatory environment.
As blockchain is already disrupting the conventional ways of doing businesses, thanks to its benefits in terms of enhanced transparency, faster procedures, decentralized and most importantly, cost-effective nature.
In essence, blockchain provides the solutions for the existing problems faced by financial institutions in terms of Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations. As the transactions in the blockchain system are immutable, they cannot be changed and altered, providing transparency regarding AML and KYC compliance.
Customer onboarding screening, enhanced due diligence, transaction monitoring, blacklist screening, change in customer prospect status are the areas where blockchain technology plays a crucial role in handling AML and KYC-related issues.
Customer names can be screened through the automated regulatory compliance system; data can be verified in real-time, and compliance officers can automatically monitor transactions. The Danish banking solution is an example of implementing regulatory technology that aims to improve conventional payments related to significant card systems by using KYC data and compliance information with the help of blockchain technology.
AML and KYC
All the financial institutions are required to collect the customer data like IDs, employer’s data, expected business activities before doing business with them, which are a part of KYC and AML compliance procedures.
Traditionally, all the relevant data needs to be verified through independent sources and updated regularly or when the expected business activities change. Abiding by all these procedures manually is time-consuming and costly for the business. Blockchain applications already provide AML software in the cryptocurrency space where all KYC is handled efficiently and cost-effectively.
Similarly, the identity management crisis is another issue for the banks that needs to be stopped and prevent fraudulent activities. Current KYC systems frequently rely on a third party to authenticate a user's identity, which adds another layer of data sharing and risk to the transaction.
This antiquated practice may be addressed with trustless blockchain technology, which allows users to authenticate their identity securely while still maintaining control over their data. Additionally, blockchain can help verify the identity of a politically exposed person through biometrics analytics and social media analytics.
The second significant service offered by regtech providers is monitoring the clients’ transactions in real-time.
Machine learning and artificial intelligence technologies algorithmically observe the behavior of clients while doing transactions and develop patterns to alert the compliance team if it finds any suspicious activities or red flags. Companies like Skry and Elliptic are developing this kind of solution.
Skry offers a data platform that offers regtech for financial services institutions and allows law enforcement agencies to generate real-time business intelligence and risk assessments from blockchains and decentralized applications.
Elliptic is a blockchain analysis tool that delivers anti-money laundering software to financial services and crypto exchanges. In addition, law enforcement has utilized the company's forensics tools to track Bitcoin terrorist funding.
Storing the data and then retrieving it can be challenging for internal use like auditing and operational use, but failing to protect it against hackers is also the key concern of financial institutions.
Despite their necessity, KYC processes are inefficient, involving time-consuming and labor-intensive manual processes, duplication of work and the possibility of error.
However, with blockchain, each time a KYC transaction occurs at a participating institution, the most up-to-date information is entered into the shared distributed ledger, allowing different institutions to rely on the same checks and information up to a certain level. Unlike a bank or financial accounting system, the ledger is distributed to all computers in the chain rather than being centralized.
A blockchain KYC utility could also provide authorities with a clearer knowledge of how users have been onboarded and how the underlying KYC information has been applied. Companies like PeerNova monitor data quality and manage exceptions across internal and external data sources for financial institutions.