Regulation fatigue? The root cause and how to fix it

Pete McIntyre, the liquidity expert

Written by Nick Applebee

April 9, 2024

We cannot simply say that regulation is bad. Of course we need rules: You are forbidden to open the plane door while cruising at 35,000 feet. People (generally) don’t smoke at gas stations. If you want to keep a fox outside, you need a pen. The alternative is spiraling planes, devastating explosions, and dead chickens.

Regulation assumes that you will always have:

Foxes – people likely to exploit the system
Chickens – everybody else just trying to get their job done

Finding the balance to safeguard from potential exploiters and to support those simply doing their work highlights the complexity of regulatory frameworks. 

“The paradox of regulation in any industry – it could be in medicine or aviation or civil engineering –  is that the regulator doesn’t want the process to be a tickbox bureaucratic process. It should be a genuinely value-added process. Whenever we learn things of benefit individually, that makes both the individual company and the industry stronger.”—Moorad Choudhry, Chairman, DCRO Stakeholder Supervisory Board, Author, “The Principles of Banking”

In the financial industry, there are contrasting arguments regarding the necessity and extent of regulation.

Some say that the foxes should guard the henhouse – that individuals with vested interests should be responsible for regulating the industry. But this could lead to conflicts of interest or regulatory capture.

Others would be happier with enormous chicken yards, with free foxes, and free chickens – where firms operate without significant constraints. The drawbacks here involve rampant confusion and potential exploitation.

If we narrow our focus to banks, treasuries are grappling with much more than the stress of keeping the sneaky foxes from their chickens. There is the increasing speed and volume of data, and, yes, the drive for compliance balanced with the desire for competitive advantage. 

Philip Deeks, head of KPMG’s Regulatory Insight Centre, sheds light on some of the problems with tick boxes and reporting requirements:

“Regulatory pressure remains high, and firms are becoming more vocal in their challenges to policymakers, increasingly citing the impacts of regulatory compliance on profitability and competitiveness.”

The question is: how can your treasury harness its wealth of data to ensure compliance, maintain stability, and gain a competitive advantage. While still giving shareholders returns? That sounds like a tall order.

The root cause of regulation fatigue

We had the pleasure of talking to respected Treasury expert, Moorad Choudhry about this tricky subject. Choudhry has combined a 35+-year career in top financial markets with an MBA, a PhD, and a parallel career as a finance professor. We discussed how alongside the push for innovation comes the weight of regulatory compliance—a burden that has grown exponentially over the years. From the implementation of Basel III guidelines to the meticulous reporting requirements of the Prudential Regulation Authority (PRA) to name but a couple, financial institutions are navigating a labyrinth of rules and obligations. The pressure has piled up for several reasons:

  • Financial Crises: Regulatory bodies around the world have implemented stricter regulations to enhance banking stability and mitigate systemic risk, including the interconnected nature of different sectors and how behaviours can create impacts on financial stability. 
  • Faster settlement and real-time payments: This compression of time increases the potential for operational errors or market disruptions to have immediate and widespread impacts. Regulators need to adapt regulations to address these heightened risks. 
  • Complexity of Financial Products and Services: Regulators aim to keep pace by addressing new risks and ensuring transparency and accountability.
  • Globalisation: initiatives like Basel III, establish global regulatory standards for banks, and aim to promote consistency and effectiveness across different jurisdictions.
  • Consumer Protection: Regulations such as the Consumer Financial Protection Bureau (CFPB) in the United States and similar agencies in other countries aim to safeguard consumer interests and promote financial literacy.
  • Technological Advances: Digital banking and cryptocurrencies have introduced new challenges and risks to the financial system. Regulations now address cybersecurity threats, regulate fintech firms, and ensure the stability of emerging digital financial services

Back to farming. Imagine you’re a farmer tasked with maintaining a large chicken coop. Basel III dictates your coop’s size, strength, and security features. You must also ensure it’s fortified against any potential risks. And you need a plan for recovery, even while a hurricane is still tearing through your hen house.

Then, courtesy of the PRA, there’s the meticulous record-keeping and oversight necessary to manage your farm. Every chicken’s health, every egg laid, every expense incurred—all must be meticulously documented and reported to ensure compliance.

You can see how this means less time to find buyers for your eggs. As Choudhry says:

“Try and find a Treasurer or any senior exec in a bank who spends less time than he or she used to on regulatory compliance. They spend a lot more time now. Compared to 20 years ago, it’s changed a lot.”

Quick facts

  • In the US, for a bank with $50 billion in assets, the estimated regulatory costs amount to approximately $4.16 million per year. This cost is equivalent to the expense of having an additional 52 additional FTE, with the assumption that the average annual compensation for an individual is around $80,000.
  • In Europe, approximately 78% of financial institutions regard the rapid change in reporting requirements and ad-hoc, non-standardized reporting requests as significantly impacting costs.
  • Processes such as the ICAAP (Internal Capital Adequacy Assessment Process) and ILAAP (Internal Liquidity Adequacy Assessment Process), alongside the development of comprehensive recovery and resolution plans, have become very time- and resource-intensive undertakings.
  •  According to a recent Cost of Compliance study, this translates into an exorbitant 20.4 billion euro in compliance costs across all EU institutions . The main drivers for these costs are:
  • Complexity of the requirements
  • The amount of data reported
  • Internal data extraction and calculations

The reality gap

Choudhry argues that regulation fatigue starts with a reality gap; that the one-size-fits-all nature of many directives fails to account for the characteristics and risk profiles of individual firms, leading to material inefficiencies. He says:

“For smaller institutions, it would be welcome to see some slight easing of the operational burden that comes from the current regime, because, relative to their resources and share of the balance sheet, they have to spend a lot more time and money on compliance than a larger bank does. I welcomed the PRA’s “Strong and Simple” regime. It would be beneficial to the industry as a whole to see more in that direction.”

Additionally, the implementation of recovery plans has faced criticism. While these plans are theoretically designed to help banks bounce back from financial turmoil, practical experience has revealed their limitations. Choudhry says that in 2023, five banks in three different jurisdictions failed without their recovery plans being triggered at all, let alone being successfully executed. This demonstrates perfectly the gap between academic theories supporting regulatory frameworks and the actual challenges of real-world banking crises. This disparity leaves Choudhry and others debating the practical value of such compliance requirements, given the time and money involved in producing them, with some arguing that they offer little real-world utility in times of actual financial emergency.

The visibility gap

The Boston Consulting Group has identified three challenges that make it harder and more costly for banks to meet their responsibilities:

  • A fragmented data and IT landscape.
  • Visibility gaps
  • Outdated modelling tools

According to BCG survey data, only 50% of bank treasurers have daily visibility into their entire banking book. Inadequate data can result in blind spots, causing delays as treasurers struggle to access crucial information. Moreover, a lack of integration means that essential functions like cash flow forecasting or valuation may be duplicated across different systems. This leads to data reconciliation challenges and operational risks. 

Existing modelling tools often lack flexibility and struggle to process unstructured information or synthesise data from both internal and external sources. The European Central Banks says that a “key success factor for efficient compliance management is the quality of IT tools. Some recent incidents have shown that a weak IT infrastructure for compliance monitoring (e.g. alert systems) could make it more difficult to identify risks.”

The adoption of real-time data is on the upswing, especially given the volume, depth and quality of data that regulators are demanding. We have also seen regulators demand that banks be able to report liquidity metrics at high frequency (Intraday) and short notice (less than 24 hours) both in BAU and stressed times, to prevent added pressure around ad hoc requests in an already stressful period. 

A growing number of bank departments are concluding that they require real-time data to do their jobs more effectively, including those in treasury, front office, risk, and operations.

Fixing regulation fatigue

Here is the story of a leading multinational bank with reporting headaches and process issues. The firm introduced a powerful tool called Realiti. This is the only software that can give companies real-time data, even if they’re dealing with millions of transactions every hour and have thousands of different accounts.

This clever software was seamlessly implemented with minimal intrusion into the firm’s infrastructure. The move completely changed how the company saw and used data and has already saved $millions. Here’s how:

– Automated Processes: The process of data extraction, aggregation, and reporting is automated. This has reduced manual effort and errors, saving time and resources.
Real-time Reporting: The system can generate reports instantly upon request, demonstrating the bank’s ability to monitor liquidity in real-time without the need for manual intervention or complex calculations.
Regulatory Compliance: By providing comprehensive reports, the bank can satisfy regulators’ requirements regarding liquidity monitoring. This includes demonstrating an understanding of monthly liquidity peaks and troughs, as well as conducting trend analysis.
Understanding Normal Behavior: The bank can use its rich data to understand what constitutes “normal” behaviour, which is imperative to identify when things are abnormal and can react accordingly to the firm’s playbook.
Risk Management: By analysing lead indicators, counterparty risk, and sector risk, the bank can make dynamic decisions to mitigate against potential issues.
–  Improved Control: The bank can monitor and manage outgoing payments to optimise intraday liquidity and control counterparty risk.
– Predictive Analytics: By looking forward, the bank can proactively identify potential challenges, risks or opportunities and adapt in real time.

The changes brought about by Realiti aren’t just about improving technology; they have transformed how the bank manages its money, mitigates risk, and increases revenue.

The facts

BCG research and benchmarking data show that digitisation, including superior data management and process automation, can enhance average net interest income (NII) contributions by 10% to 15% while reducing treasury operating costs by an average of 20% to 30%. Choudhry summarises the importance of digitisation in providing accurate, real-time information saying:

It’s a simple statement of fact: it’s all about accurate, real-time information presented to me in a way I can understand. It’s not just the real-time nature. And it’s not just the accuracy of it. It’s the presentation of it in a way that I can understand. Plus, the board of directors and the C suite, they need to be able to see that information in a way that is instantly understandable, and accessible. So they can then make appropriate decisions. That’s the important thing.”

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