Being an entrepreneur is hard. Being an entrepreneur trying to break into one of the most heavily regulated industries is herculean. Fintech founders launching a new product face so much regulatory red tape that it has the power to change business models or even question the viability of products.
Established financial institutions face similar, if not harsher, regulations. On this backdrop, a new field of regulatory software, or regtech, is changing the way companies operate.
Breaking into the market
Firms in the U.S. have to take into consideration both state and federal regulations. For online companies, who naturally service clients across the US, this adds a prohibitive level of complexity.
The fundamental problem, as in many other industries, is that regulation is having a hard time keeping up with technological developments.
“The current system of bank regulation was enacted in the early 1930s,” states a new report by Financial Innovation Now, a public policy coalition comprised of Amazon, Apple, Google, Intuit and PayPal, that details current state and federal regulatory compliance requirements for new marketplace innovators.
To illustrate how onerous state and federal regulatory compliance requirements can be for new entrants, the report confronts the fate of two hypothetical innovators: a payments security technology and an alternative small business lender.
Registration requirements, license fees, training requirements, staffing rules, and other such regulation differ from state to state. A new lending service will need to register in each state separately, as well as manage reporting and oversight for its activities.
Partnering up instead of going alone
There is no escaping financial regulations. Even if the startup online lender wants to avoid the compliance headache by partnering with an existing bank, it will be subjected to examination by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. In addition, the fintech upstart must open up its underwriting processes to examination by bank regulators and is subject to periodic audits by the bank to make sure that it does not create a risk to the bank.
An online lender also needs to comply with at least 16 different federal laws.
“Although well intended,” the report states, “the underlying laws, regulations and regulatory interpretations are often slow to adapt to technological change, creating barriers to innovators who wish to bring new products and services to market.”
Incumbents feel the pain
Regulatory hurdles are not only a concern for fintech startups. Established banks and multinationals also need to face an increasingly complex and expensive environment of rules and regulations.
According to The Institute of International Finance (IIF), compliance can cost a financial institution over $1 billion every year. Spanish bank, BBVA estimates that for financial institutions, 10-15% of their total workforce is dedicated to governance, risk management and compliance, making these activities a huge cost center.
Regulations are also getting increasingly punitive: consulting firm, McKinsey found that regulatory fines and settlements in 20 large US and EU universal banks increased by 45x in the 2010-2014 period.
It is not surprising that an entirely new industry has emerged to support the compliance activities for incumbents and new entrants alike. RegTech, or regulation technology, allows for agile deployment of compliance solutions, and automates much of the reporting process. The global demand for regulatory, compliance, and governance software is expected to reach $118.7 billion by 2020, according to a Medici report.
Unlike most other fields of innovation, regtech requires cooperation from regulators from the get-go to be successful. Building the right solution requires all stakeholders, financial institutions, regtech vendors and regulators, to work together. In Europe, for example, the FCA opened a regulatory sandbox to firms, providing a safe space for testing innovative products and services.
Onboarding regtech is a slow process because it affects many aspects of the organization. Achieving regulatory agility is key for any future fintech development. As institutions, vendors, and regulators establish best practices, we can expect greater innovation.