firms must utilize innovative technologies and transition away from a manual approach.
By Laurence Hamilton, Chief Commercial Officer, Consilient
With the existing manual processes in place, financial institutions are left firmly on the back foot in the fight against financial crime. Current UN estimates suggest that 2-5% of global GDP, or $800 billion – $2 trillion is laundered globally per year. As a result, agencies such as The Financial Action Task Force (FATF) have begun encouraging technological adoption through their effectiveness agendas. These entrust firms to tighten their financial crime prevention processes to better identify the global flow of illicit funds through the financial system. To achieve these aims, firms must utilize innovative technologies and transition away from a manual approach. Machine learning (ML) solutions in particular have shown significant promise in reducing the volume of false positives in transaction monitoring, reducing the resource strain of investigation on firms.
Financial firms and regulators face challenges
The appetite for regulatory risk and level of compliance present one of the key barriers to adoption. Firms must consider whether they want to go beyond their base regulatory obligations and potentially open themselves to increased regulatory scrutiny or maintain the status quo. Balancing risk and innovation can be particularly challenging with a perceived lack of technical understanding from the regulators around innovative technology. Making the business case for investment is therefore extremely challenging when firms are unsure how the regulator will perceive changes to their anti-money laundering (AML) practice.
In all aspects of their decision-making, financial institutions must consider whether the potential upsides of technology adoption outweigh the risks of IT system overhaul. Technological transformation projects are extremely resource intensive, and with the associated benefits being difficult to quantify, many struggle to persuade budget holders to make such an investment.
When making fundamental technological changes, firms must consider a number of factors:
- Whether the technology meets the business objectives and regulatory obligations of the firm.
- The integration and training of staff required for a successful change initiative.
- The product cost and the potential to realize long-term benefits from implementation.
A significant challenge that financial regulators face is a lack of internal technical expertise. Assessing the effectiveness of new solutions is challenging with limited resource availability and knowledge, often resulting in a hesitancy to support technology adoption.
Regulators tend to operate a risk-based approach to market innovation. The potential for reputational damage and harm to the markets will often outweigh a desire to support innovative change. The Financial Conduct Authority (FCA) and the Monetary Authority of Singapore have shown a desire to support new market innovations with their sandbox and tech sprint initiatives, yet a culture of risk aversion is still maintained within the market. In general, regulators appear to be more supportive of technological change where they have a greater understanding of the product, so the drive towards better communication will prove pivotal in instilling a culture of innovation.
Overcoming the barriers
Financial institutions should focus on building an ongoing two-way dialogue with regulators as a means of sharing knowledge between the private and public sectors. In doing so, firms can educate regulators on emerging technologies and demonstrate their utility in fighting financial crime. By engaging the regulator along each step of an IT transformation project, institutions can distill knowledge and promote trust amongst supervisors. Firms should choose to preview the new technology with the regulator before implementation and outline how the new technology might identify issues that were not previously known or disclosed. Indeed, if a firm is planning a large-scale implementation of new technology, they often require regulatory approval and a plan to manage the transition risk. Consilient’s federated machine learning solution can support this dialogue with the regulator as it allows financial institutions to more effectively collaborate and share real-time insights without risking the security of the underlying data. As a result, Consilient’s solution promotes dialogue and collaboration between entities, subsequently increasing regulatory confidence in novel solutions.
Upskilling staff and building their own knowledge bases will enable regulators to be better equipped to understand the technological landscape and support firms in their adoption of technology. This will also support regulators to draft legislation and communicate confidently the benefits that technological innovation brings.
Regulators should look to create an environment that is supportive of the adoption of innovative technology. The FCA’s Sandbox initiatives are an example of how regulators can engage with and better understand innovative technology in the financial crime space. Since the inception of The FCA’s Sandboxes, other regulators have followed suit including the Consumer Financial Protection Bureau (CFPB) in the US and the Monetary Authority of Singapore (MAS) through its fintech regulatory sandbox. The regulatory sandboxes enable tech vendors to test their products on real consumers before entering the market. This represents a positive step for other regulators to take as it supports the engagement of regulators with technology, helping grow their knowledge and expertise of potential technology risks and ultimately developing an environment that encourages technology adoption.
Technological solutions enhance both firms’ financial crime-fighting capabilities and engagement with the regulator. With both firms and regulators facing challenges and barriers around the adoption of technology, it may take incremental change and time for things to develop. The barriers constraining both firms and regulators can be removed, however, with engagement and education amongst the biggest facilitators of this.