Banks benefit greatly from digitalisation – whether through an increase in operational efficiency, enhanced responsiveness to customer needs, or improvements in strategic decision-making. Technology companies, such as RegTechs, are a key driving force behind many of these benefits. They harness the evolution of digital technologies for the purposes of risk management and regulatory compliance. RegTechs can enhance data availability, traceability, and/or modularity hence, improving the overall reporting standards (financial, risk, regulatory, and management). It is also possible for RegTechs to facilitate documenting compliance with existing regulatory requirements. But most importantly, RegTechs have the ability to overhaul almost all aspects of risk management at banks and other lenders. Through these benefits, it will be no surprise that RegTechs are a game changer for the credit industry moving forward.
Following the global financial crisis, a great number of new regulations have forced financial institutions to spend significant amounts of time and money on regulatory projects in order to ensure compliance.
Financial as well as human capital has been invested in setting up new compliance and data governance frameworks. Meanwhile, margins in the traditional lending business have decreased significantly.
For the foreseeable future, a turnaround of the current ECB strategy is not in sight. This is one critical driver behind the historically low margins and unprecedentedly high cost-income-ratios.
Such signs indicate that the traditional business model of banks has become out of balance.
At the same time, technological developments have changed people’s behaviour and increased their expectations in terms of the quality, speed and customer-friendliness of the entire financial services industry. The co-evolution of customer expectations on the one hand, and technological capabilities on the other, has spawned the emergence of a multitude of FinTechs, for example:
Even BigTechs like Apple launched a payment solution ApplePay, and financial heavyweight Goldman Sachs is building its own digital consumer lending platform called Marcus.
German companies like N26 or Comdirect bank, both pure online banks, have already realised how important the digital customer experience is. In the absence of any physical product, being digital has become a must for financial services providers. More and more digital products are launched or will be published in the near future, e.g. the Deutsche Bank robo-advisor “Robin” or the Sparkassen Group payment app “Kwitt”.
In back office, however, processes are still predominantly manual in these areas. Especially compliance/finance and risk management departments can benefit greatly from automation. One example is the use of robotic process automation (RPA) in order to save human time and effort for more complex tasks.
Automation is already present in customer acquisition and on-boarding. Numerous comparison websites automatically match borrowers with prospective lenders and transmit their information so that a creditworthiness assessment can be performed. Front office operations have been significantly digitalised and automated in the recent years compared to back office operations.
One clear indicator of this is that the physical interaction between the borrower and the bank has significantly decreased. For example: in many banks underwriting consumer loans is just a simple yes/no decision based on a credit score threshold. Depending on the pricing system, customers may receive a risk-adjusted/-sensitive rate. Based on this rate, they can decide, if they want to accept or reject the offer.
After accepting and completing the paperwork, the loan will be on the customer’s account within a few days – something that could take easily a few weeks just a decade ago.
The lifecycle of a bank loan, however, does not end at the time of disbursal. There is a complex set of back office processes, which are still manual and therefore subject for improvement. RegTechs in particular can support in certain areas such as loan monitoring, analysis, stress testing and reporting.
On the market, there is a variety of different RegTechs, which offer customised solutions, greater automation and highly efficient analysis. Thus, the different bank-teams along the value chain can invest more time in analysing data and respond appropriately instead of only executing repetitive tasks, which are not aligned with the needs of the situation a customer is facing.
Not only consumer loans but also business loans are affected by RegTech developments. Especially complex business loans require more resources with respect to monitoring, continuous analysis, and risk management. Thus, RegTechs can provide a significant economic benefit to a variety of sub-sectors of the lending industry.
Several companies are operating in the field of providing specialised risk management services to banks and other lenders. One for instance is the Risk Research GmbH, who provides a complete end-to-end (origination, controlling, operations and reporting) solution in terms of software and consulting. One of their core capabilities is validation of bank models according to Basel standards and other relevant standards.
Another provider with a far more innovative approach, is the British RegTech Logical Glue. Logical Glue uses neural network-based models to construct autonomously learning algorithms to solve problems ranging from the assessment of creditworthiness to the likelihood of recovering a sum owed by a delinquent borrower. The RegTech prides itself on being able to predictively out-match any conventional model as long as input data exceeds a certain volume and complexity.
Having an effective risk controlling function is extremely important and can affect the whole lending value chain.
Being able to predict delinquencies, risk concentrations and losses, as well as, to measure expected portfolio profitability at an early stage is essential for lenders. It enables them to identify issues and react promptly to events.
Thus, risk controlling is another step of the loan value chain that exhibits high potential for RegTechs to add value. Based on the available parameters, a RegTech can provide different and complex stress tests, as well as, customised analysis.
This enables the production of early warning indicators such as KPIs or KRIs, which automatically trigger loss prevention actions prior to delinquency.
Stress testing and loan analytics are two additional fields in which RegTechs can improve back office processes.
One RegTech, which is specialised in stress testing as a service, is the Dutch company Open Source Investor Services B.V. (OSIS). The OSIS LoanPilot software solution offers the forecasting of multi-year rating migrations, defaults and expected losses considering different macro factors on both the portfolio and loan levels.
Temenos Group AG offers with their Analytics solution another module-based software for Loan Analytics. The software provides the chance to be more analytically driven with different ready-to-use models, KPIs, dashboards, applications and reports, combined with real-time data and predictive analytics.
Using such software allows financial institutions to get a better understanding of their customers’ behaviour, forecasting trends, react faster, better, and overall proactively mitigate the risk of delinquency.
Integrating RegTech solutions can make loans much more profitable, for example by reducing processing time.
Actico offers that sort of solution, among others. The German company is specialised in origination and associated services along the credit lifecycle. Actico offers a broad range of services including capturing and analysing financial statements, as well as, a flexible framework for the implementation of internal ratings and customised scoring models.
Based on an in-depth risk assessment, the Actico platform allows the implementation of complex loan strategies and workflows for loan origination and monitoring. A built-in simulation environment allows platform users to analyse changes of the underlying risk models as well as to ensure their continuous improvement.
Such solutions can provide valuable support in loan monitoring but also in the prevention of fraud. This is particularly critical for business loans since they have bigger volumes than consumer loans and therefore expose the originating institution to greater risk.
There are regulation-versed technology-conservative companies like Optio Solutions from the US, which is focused on recoveries/collections, combining the benefits of automation and statistical analysis with fully transparent, digital operations and intensively emphasised compliance.
Information about collaterals especially for large loans, e.g. mortgages or syndicated credit lines provided to businesses, must be reviewed regularly. Often this process is very complex and time consuming. Thus, costs can be reduced significantly if certain tasks are outsourced to a specialised and efficient vendor.
Besides optimising above back office processes, there are additional areas where RegTechs can contribute a benefit. E.g. in reporting (financial, regulatory, risk and management). With the go-live of the AnaCredit regulation in September 2018 detailed information on loans above 25k EUR must be reported to the regulator.
Gathering this information and assuring data integrity is very time consuming and complex, especially given the fact that financial institutions must comply with the requirements of BCBS239. RegTechs can offer efficient solutions for streamlining the relevant processes while at the same time ensuring the required level of data quality, traceability and modularity.
Another time-consuming back office process is to report on the different portfolios, products, regions, customer types and or any other clusters. These reports must be generated on a regular basis or ad-hoc in order to provide senior management as well as other relevant stakeholders (e.g. loan investors or regulators) with an overview of the current and expected situation.
All RegTechs offer reporting, as a standard service. This eliminates the use of separate spreadsheets, provides flexibility, and produces ad-hoc reporting capability as well as all relevant documentation with minimal effort. A fully fletched risk data warehouse is not available at most banks yet. Such deficiency combined with banks inefficient IT-infrastructure is one of RegTech’s biggest opportunities.
These few examples show the extremes in which a multitude of national and international companies is operating. Thus, RegTechs, even if still at an early stage, have the potential to be a real game changer for the financial services industry.
A greater degree of automation is important for speeding up the credit process and for increasing the quality of underwriting. This enables credit providers to offer better pricing, better terms and better conditions to their customers. As shown earlier, especially in the back office, processes can be improved and streamlined by applying RegTech solutions.
The RegTech market is already highly competitive. There are various RegTechs which provide specialised services tailored to individual bank's requirements. Therefore, before cooperating with a RegTech, alternative providers have to be analysed thoroughly in order to find the best fit.
With the help of RegTechs, financial institutions have more capacity to focus on strategic challenges, outperform customer expectations and improve the transparency of their compliance with all regulatory requirements.
Authors & Contact Persons: Stefan Steinhoff, Nicolai Preuss, Monika Andronova
Banks benefit greatly from digitalisation – whether through an increase in operational efficiency, enhanced responsiveness to customer needs, or improvements in strategic decision-making.