Published : 1 year ago, on 29/06/2023

Agile and proportionate: regulatory reform and digital transformation in the UK banking sector

By Jonathan Philp, CFA Principal Specialist in Banking and Financial Markets at NTT DATA UK&I

We have learned that bank failures can be contagious and very costly to fix, both in terms of immediate stabilisation measures and the impact on the wider economy and society. The measures taken to improve the resilience of the banking and wider financial sector after the global financial crisis focused to varying degrees on reinforcing loss absorbency through more conservative capital adequacy rules, overhauling market structures, increasing transparency and formalising executive accountability. Many billions have been spent on regulatory remediation in the past decade and a half.

Can this campaign of reform be judged a success? The challenge faced by market participants and supervisory authorities alike is that regulation tends to focus on the symptoms of the preceding crisis. Specific measures may address the proximate issue but drive risk taking elsewhere or create unintended consequences that take time to materialise.

The proliferation of regulatory measures designed to shore up financial institutions has undoubtedly constrained the capacity of the industry in its essential role of channelling capital and liquidity into productive uses in the real economy. Core rules drawn up at the intergovernmental level in direct response to the crisis were extended and embellished in the process of supranational and national implementation.

In the UK, Brexit offers the opportunity to rethink financial services regulation to strike an ‘agile and proportionate’ balance between the prudent supervision of financial institutions and the desire to liberate capital to be directed into productive long-term investment in infrastructure and innovation. The Edinburgh Reform agenda, ‘Building a smarter financial services framework for the UK’, announced by the Chancellor in December 2022, sets out to release capital trapped on insurance company balance sheets under the Solvency II regime, increase the freedom with which pension schemes may investment, rationalise the ring-fencing regime for banks, ease cumbersome MIFID rules and introduce measures to restore the attractiveness of the UK as an attractive place for companies to raise funding.

However, the rapid shift in the economic environment, with a series of severe supply shocks and loose money driving inflation and provoking sharp monetary and fiscal policy responses, has increased the likelihood of vulnerabilities in the financial sector surfacing. Already this year we have seen bank failures in the US and in Europe, and whether the underlying issues in each case were real or perceived, substantial state intervention has once again been required to restore stability. The resolution of these banks required the extension of deposit guarantees and the absorption of failed bank assets and operations by larger peers.

Similarly, the surge in gilt yields in the autumn exposed weaknesses in the liability-driven segment of the pensions industry. Once again, urgent intervention was needed to restore order and to prevent a more dangerous outcome.

At the consumer level, there is mounting evidence that these challenging conditions are driving households faced with inflated food and energy prices and higher mortgage rates to alternative and riskier sources of credit. The new Consumer Duty measures require banks and financial institutions to be much more proactive and transparent in their analysis of potential customer harm right across the value chain, from product management through distribution, servicing and recovery. Similarly, the extension of the supervisory perimeter to include non-banks seeks to ensure that an adequate level of consumer protection is maintained as products such as BNPL proliferate and other disruptive services appear in the market.

The UK is a global centre for fintech innovation, with technology being applied to deliver better versions of traditional financial services and processes or to create completely new propositions across payments, embedded finance, investments and even asset classes. While funding conditions for young companies are now undoubtedly very difficult we expect fintech innovation to persist, forcing incumbents to defend their market positions by refreshing products and innovating in turn.

We see the responsible review and rationalisation of bank and financial services regulation as a distinctly positive development as a means of encouraging growth. Lighter touch regulation can certainly improve the efficiency of investment and innovation, and we look forward to progress on the high-level measures set out by the Chancellor.

However, recent events serve to remind us that the core disciplines of governance, risk and liquidity management and operational resilience remain absolutely critical as banks and financial institutions respond to rapidly evolving market conditions in real time. Here information technology also has a key role to play. Two themes that stand out to us are data and operational resilience.

Responsive risk and liquidity management demands accurate and timely data to support critical decision-making. We see an emphasis on investment in Data and Intelligence to deliver flexible, high-performance architectures, replacing or updating legacy frameworks, integrating new data assets and offering much enhanced analytical and reporting capabilities. Here, the critical success factor, often neglected,  is the drawing together of business subject matter expertise and technical solutioning capability to ensure that challenges and objectives are correctly defined. Financial institutions are partnering with technology vendors and services providers to bring leading-edge R&D to bear to apply machine learning and artificial intelligence techniques, a trend that is very evident in, for example, the financial crime mitigation discipline. On a medium term view, we see interest in harnessing the promise of quantum computing for the most demanding computational challenges.

In the face of evolving regulation directed towards operation resilience through measures such as DORA (the Digital Operational Resilience Act), we expect banks to prioritise investment in this field. Cloud migration continues to be a major theme as banks seek to maximise flexibility and efficiency whilst maintaining the requisite oversight and control. The Information Security discipline continues to evolve as financial institutions seek to address vulnerabilities, respond to emerging threats and apply best practices. Robotic Process Automation offers improved efficiency and reduced operational risks by automating recurring tasks, releasing skilled resources for higher value activities. In each case, the objectives are to reinforce governance, improve resiliency and mitigate vulnerabilities whilst retaining flexibility.

As customer expectations of financial services evolve, and in particular with the increasing emphasis in retail financial services on personalisation, we see a great deal of interest in the capacity of leading-edge user experience (UX) and customer experience (CX) technologies as part of the wider digital transformation agenda. Aggressive, digitally native new entrants have raised the experience bar, compelling incumbents to respond to sustain customer retention to remain competitive and relevant.

At NTT DATA we look forward to supporting our clients as they navigate the obligations and opportunities presented by regulatory change. The imaginative and innovative application of technology will be central to achieving the flexibility and nimbleness that will separate leaders from the pack and enable the UK’s financial services industry to flourish.