Regulatory compliance has long been regarded as one of the drier aspects of banking, but it is rapidly becoming a significant area of technology investment for financial institutions of all sizes.
It’s so big that it is projected to expand to a market size of $87.17 billion by 2028 — at least five times bigger than it was in 2020, when the market size was valued at $15.68 billion, according to market analysis firm Verified Market Research. That’s a CAGR of almost 24% in the space of just seven years.
And the number of companies chasing that growth is swelling: According to an analysis by Deloitte, there are now over 500 regtech companies currently serving the marketplace.
RegTech Is Not Just for Fintechs and Challenger Banks Anymore
David Donovan, head of financial services for research and analyst firm Publicis Sapient, says, “Widespread adoption of regtech is a significant trend, moving beyond its initial use by challenger banks and fintech companies to now include traditional banks, law firms and real estate firms.”
In fact, while overall spending on tech has relatively plateaued remained flat since 2020, spending on regtech has greatly increased as part of the overall tech spend for banks, says John Meyer, senior director with Cornerstone Advisors. “Spending on digital and core systems takes a big chunk [of the overall tech budget] but has been largely flat. But we have seen rising spending on regtech.”
“Spending on digital and core systems takes a big chunk [of the overall tech budget] but has been largely flat. But we have seen rising spending on regtech.”
— John Meyer, Cornerstone Advisors
Seattle Bank, for example, has two growth initiatives that have spurred investment in regtech solutions: Partner banking — through which it partners with fintechs and non-financial companies to provide banking services — and CD Valet, an online marketplace that connects consumers to financial institutions to compare and open CDs.
“We are looking for solutions that mitigate risk, prioritize our team’s efforts and provide real-time information,” says Josh William, EVP and head of partnerships at Seattle Bank and CD Valet. “Real-time monitoring and reporting are critical, so we can flag activities or stop transactions early on. In a digital world, compliance needs to be based on what’s happening now, not what should have been prevented in the past. Regtech solutions get us closer to that goal.”
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Seattle Bank also leans heavily on regtech to minimize compliance risk, but it’s tricky. Williams says his team has needed to be critical and highly selective of the regtech fintechs to partner with. For instance, Seattle Bank is investing in a marketing compliance regtech that will be efficient in monitoring, but also comply with data privacy concerns.
“This platform will help our compliance team keep up with growth and identify and remediate problems faster, before a single instance of noncompliance has the chance to become a more chronic issue,” he says. “We see it as a complimentary effort to our compliance team that will provide early warnings and help prioritize our partner review and education.”
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Digital Innovation Driving the Need for RegTech
The digital transformation of financial services is a primary driver for the need for regtech solutions for banks. For example, the rise of the metaverse introduces new challenges and opportunities in regtech, particularly in areas such as digital identity and know-your-customer (KYC) processes, says Publicis Sapient’s Donovan.
“In a digital world, compliance needs to be based on what’s happening now, not what should have been prevented in the past. Regtech solutions get us closer to that goal.”
— Josh William, Seattle Bank
Digital e-commerce processes have evolved significantly in the last decade, so much so that consumers don’t even need to navigate to a website or an app to make purchases. Now, consumers can buy a product in-platform on social media or a live-stream as they’re watching a video about the product.
Banks and other payments providers must be able to accurately identify who they are interacting with across the entire digital spectrum. It isn’t as simple as a customer coming to a website and entering payment information to purchase a product or service anymore. “This surge in the digital transformation of financial services and the subsequent increase in risks such as fraud and data breaches,” is creating the need for more regtech solutions, says Donovan.
The regtech marketplace has also seen a drastic increase in solutions that utilize artificial intelligence to help banks deal with this increase in fraud and the associated compliance risks, says Meyer of Cornerstone Advisors, adding there are many regtech solutions using AI for cluster analysis.v”There’s an emphasis on parsing data to determine patterns of behavior and helping to figure out things like, ‘Does this purchase fall in line with previous purchases that this person has typically made?'”
Combatting fraud and a need to help financial institutions comply with KYC and anti-money laundering (AML) statutes is a big reason for the rise in AI-powered regtech solutions, agrees Chris Palumbo, practice lead for Risk, Regulatory and Compliance Advisory Services at North Highland, a change and transformation consulting firm.
“Employing advanced data modeling techniques, such as portfolio credit risk and credit underwriting decisions, could transform how financial institutions manage risks and make strategic decisions,” says Palumbo. Regtech solutions “are revolutionizing compliance monitoring and testing, ensuring more efficient and accurate regulatory adherence.”
Employing regtech solutions to help optimize credit risk will be especially important in the event of a recession — even a mild one — in 2024, adds Meyer. “Advanced data modeling and AI can really help with accurately determining a consumer’s ability to repay loans.”
The popularity of digital banks accentuates the growing need for regtech solutions as these nonbank players often don’t have robust compliance departments, or even backgrounds in regulatory compliance.
“Digital banks are replacing traditional banking, driven by convenience and a variety of features such as global transactions, low feesf and instant transfers,” says Donovan, adding there are an estimated 2.5 billion digital-banking users in the world. “These trends indicate a substantial shift towards more integrated, efficient, and technologically advanced regulatory processes in the banking sector.”
How About Blockchain and Open Banking?
Blockchain — especially when it comes to use cases like central bank digital currencies (CBDCs) — is quickly becoming a hot technology for the banking industry. The proliferation of blockchain though too signals a need for more advanced regtech solutions, says North Highland’s Palumbo, especially in the advance of cryptocurrency regulations.
“Cryptocurrency markets face challenges, including the recent collapse of some major cryptocurrency exchanges,” said Palumbo. “There is a tremendous need for regulatory clarity in order to renew and advance mainstream growth.”
Regtech could actually be an important piece in helping digital currencies become a bigger part of the traditional banking landscape, noted a blog from Finance Derivative.
“Banks tend to be cautious about partnering with digital currency companies due to perceived risks associated with the industry,” reads the blog post. “However, when these companies demonstrate compliance with regulations, it helps alleviate those concerns and makes banks more willing to collaborate.”
Regtech solutions will be vital in protecting consumer data in an era of open banking and information sharing.
The increasing popularity of open banking is another factor driving the adoption of regtech, says Palumbo. “Open banking is anticipated to reach unprecedented interconnectedness, fostering innovation and competition. Compliance and safeguarding customer rights and data will be crucial, with challenges in navigating global sanctions and regulations. Open banking will require advancements in tools for efficient and accurate regulatory reporting.”
Ultimately, banks and credit unions will need to incorporate regtech into every aspect of the business, since every unit of the business is affected by regulatory compliance.
“To best integrate regtech into all aspects of their workflows, banks should strategically collaborate with these innovative regtech providers, leveraging their diverse expertise and cutting-edge technologies to enhance compliance measures, foster data-driven intelligence, and navigate the complexities of the evolving financial landscape,” says Donovan.