Traditionally, banking regulation has been seen as an inhibitor to innovation because of the costs involved with compliance. Since the financial crisis, banks have been forking out vast sums to pay for consultancy fees, extra legal and internal audit staff, and updated systems that can provide regulators with a stream of information on everything from capital and liquidity to the salaries of their highest earners.
The implementation of the revised Markets in Financial Infrastructure Directive (MiFID II) on 3 January 2018 will add further cost and burden to banks and other financial services firms. As the biggest overhaul of European financial services regulation in a decade, MiFID II requires banks to comply with a host of new reporting and time-stamping requirements for their trading activities.
Ultimately, there are only so many projects that any bank can fund and resource, and only so many change windows that can be permitted for system upgrades. Since banks have to prioritise regulation if they want to stay in business, innovation inevitably gets squeezed when it comes to IT spend.
A chance to do things differently
Regulation can clearly be an obstacle to innovation in financial services. At the same time, it can also be an enabler. When sectors, businesses and individuals are forced to act differently, innovation is often the result.
For a bank to turn regulation into a driver of innovation, it needs to assess the regulation in a holistic manner. How does the regulation fit into the big picture of what the bank does? Are there any processes that can be improved during the course of complying with the regulation, to the benefit of the bank and its customers?
If we take the example of the know-your-customer requirements that are intended to prevent money laundering, some banks have used maximum automation to perform these checks in real-time, which allows them to make quicker decisions about loans.
Then there is the Second Payment Services Directive (PSD2), which needs to be implemented by 13 January 2018. This is designed to promote competition in the payments industry, better protect consumers from fraud and encourage lower prices for payments. Yet for banks, it's also a good opportunity to monetise their customer data by offering tailored savings plans or third-party services from suppliers such as estate agents or electricity providers.
Over the next few years, digital transformation and the explosion in big data will increasingly drive banks' innovation agenda. Data is often described as the 'new oil' because of the vast potential it offers to the organisations that exploit it successfully.
Banks have a wealth of data that they can use to create a powerful, personal customer experience going forward. This experience will then be the basis for attracting and retaining customers, cross-selling valuable products and services, and building their brand.
To take advantage of the digital transformation, banks will have to change their traditionally cautious mind-sets. They won't be able to stay ahead of their competitors if they are slow to bring new products to market. Instead they should emulate their fintech rivals - be prepared to launch a product that isn't quite perfect and then refine it in response to customer feedback.
Already many large banks have recognised that their unwieldy processes are limiting their ability to act fast, which is why they have founded innovation labs or entered into a partnership with a more agile fintech rival. For example, Barclays partnered with start-up Wave to execute the first global trade transaction using the distributed ledger technology blockchain.
Safe and secure?
Finally, we should not forget that innovation comes with security implications – particularly if data is involved.
On 25 May 2018, the General Data Protection Regulation (GDPR) will come into force, aimed at strengthening data protection for individuals within the EU. Breaches of some provisions could lead to companies incurring fines of up to €20m or 4% of global annual turnover for the preceding financial year, whichever is greater.
The major innovation challenge that banks will face in the future is ensuring that the additional data they get through innovative digital channels is protected from cyberattack. Inevitably they will have to allocate a sizeable proportion of their IT budgets to penetration testing and audits of security. Due to the scale of the penalties involved, GDPR breaches will inevitably attract the board's attention.
So it seems that while regulation and innovation will remain rivals for IT spend, they also belong together.
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