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Banking, Regulation and Big Data…Too Big to Change?

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matt shaw

By  Matt Shaw, Associate Partner – Crossbridge, the financial markets consultancy

A bitter pill to swallow matt shaw
In 2012 many investment banks find themselves in a situation where profits have been flat or in decline for the last 2 to 3 years and now they must incur mandatory costs for the next 2 to 3 years in order to implement a raft of regulations, compliance with which will reduce their profitability yet further.  Putting issues of timing, extra-territoriality, regulator’ capacity, economic and political diversions (such as the US Presidential Elections and the Euro-crisis) to one side, it is clear that the financial services industry is entering a period of sustained reform.

Jamie Dimon, chief executive of JPMorgan Chase, estimates that Dodd-Frank alone will add an additional $400m-$600m to the firm’s annual cost base.  By some estimates, the return on equity of the banking sector as a whole will fall from about 20 percent to around 12 percent, which does not provide investors with a great deal of compensation for the volatility of the capital-markets.  Already depleted change budgets, for at least the next few years, will mainly be spent on US, European Union and global regulatory reforms.  These variously seek to address some of the systemic stability issues which have come to light during the recent financial crises and combined, they affect almost every area of the financial services industry – the wholesale, retail and insurance markets, from individual and corporate customers, to buy and sell side participants, to trading venues and infrastructure providers.

Under observation
Regulators are starting to put much more emphasis on the quality, richness, volume and transparency of the data they receive from financial institutions and are using this as a proxy to enforce additional and more robust controls, and increased substantiation, that regulated firms are adhering to policy, providing full disclosure and complying with the law.

By mandating the use of the unique Legal Entity Identifier (LEI) on all trades, regulators are effectively forcing firms to clean-up their counterparty data structures and values and the internal linkages with the various front office businesses which enable counterparties to trade.   Over the next few years it seems regulators are moving towards a global single view of counterparties, but exactly how market participants will obtain and register their LEI is not yet finalised.  It is another matter as to which sovereigns, governments, corporates and individuals will accept this scrutiny into their banking transactions and intrusion into their privacy.  There are competing identity schemes being put forward by different regulators (unfortunately), although LEI seems to be approaching a ‘tipping point’ and if it is adopted by one of the major European or Global regulations, it will surely become the industry standard.  LEI could become the ‘passport to trade’ for market participants who fall under the regulations (which is most).

There are similar initiatives to create global identifiers for standardised derivative products and their underlying contracts and this too may become more feasible as regulators force more and more OTC products onto exchanges and through central counterparty clearing.  As with LEI, we could see the formation of centralised securities and contract registries.  What will this do for financial innovation and the creation of new products?  Of course, it remains to be seen how and where the market for specialised bi-lateral contracts and structures (to meet a specific risk profile and market view) will persist in the new environment…but the demand will be met.

In theory at least, improved identification should lead to improved classification and linkage of transactions, counterparties and products and this is what drives many risk and accounting provisions, controls, limits and reports.  Given enough computing and manpower, local and global regulators (and by implication the firms they regulate) should be able to build a more detailed picture of the network of transactions and risk concentrations across different products counterparties, industries and countries, but do regulators really expect to turn top-down surveillance into bottom-up sousveillance?

Where does it hurt?
Underpinning much of this change is data – the information which is used to identify, classify and enrich a firm’s transactions and to consolidate, control and report on its books and records.    At the data level the different regulations (Dodd-Frank, EMIR/MiFID2, FATCA, Basel 2.5/3, Recovery and Resolution Planning, CASS, and IFRS to name a few) often come crashing together.   If we focus instead on the different data domains, we can see common patterns start to emerge.

Transaction
  • Near real-time (15 minute) derivatives trade reporting, utilising new ‘global’ identifiers. Huge volumes of cross-industry ‘trade repositories’.
Party/Legal Entity
  • More robust identification and more extensive classification schemes will need to be applied.
  • More detailed relationships (e.g. agent, principal) may need to be stored for more granular (fund-level) credit risk calculation and disclosure.
Internal Legal Entity Structure
  • Holding company, subsidiary, special purpose vehicle, and branch ownership structures require clarification for insolvency planning and (potential) segregation of wholesale and retail businesses.
Product/Inventory
  • More extensive identification and categorisation is needed to support treasury and finance accounting changes; more sophisticated risk analysis.
Accounts
  • Customer and Ledger accounts will need additional controls putting in place to limit trading and investment activity, segregate collateral and assets, apply new taxes and withholding regimes, and report more off balance sheet assets.
  • Transactions and balances may need migrating (novating) and collateral netting improvements made as OTC trades shift to central counterparties.
Book/Organisation Structure
  • Firms need to understand the impact on lines of business for insolvency and segregation planning.
  • New regulatory capital, funding and liquidity charges may also result in transaction migrations from Trading to Banking books in order to seek more cost efficient booking models.
Location
  • The location of any, or all, of the above data elements may need to be known in order to comply with extra-territoriality clauses and for insolvency planning.

Figure 1 shows some of the data improvements and changes firms might be expected to make.

Whether they have a leading edge service-oriented messaging infrastructure or a dual-key and reconciliation-based information architecture, Crossbridge believes that firms need to review their data lifecycle quality, ownership, standards and flexible storage solutions, and map these onto their book of work, in order to identify where cost-savings can be achieved.  We recommend a consistent approach to the delivery of data solutions, from developing business rules to data and structural enhancements, to BAU process and capture updates, through to data remediation and migration.  Figure 2 shows some of the trade-offs to be considered.

Remediation/Migration Population reduction versus complexity of BAU process updates.
Client Focus Impact on new and existing client lifecycle service from the group, division, line of business and platform perspectives (with regional variations).
Risk Appetite Non-compliance risk assessment (data quality and false positives/negatives).
Cost/Benefit Cost-benefit analysis of data quality (fitness for purpose, not perfection).
Enterprise Solution Buy (vendor), build (in-house/open-source) or partner (externalise).

Delivering coherent and cost effective solutions is made difficult given that data organisations need to support project focused ‘point deliveries’ with fixed compliance deadlines.  The situation is further complicated by inflexible or monolithic data capture, storage and distribution platforms and unclear ownership amongst the many suppliers and consumers of the data.

A miraculous recovery
Some technology start-ups (Google and Facebook included) start with a data model and subsequently develop their business models on top.  Since their business models are under threat, maybe it is time for banks to develop data models to retro-fit to their already well established (but often multi-faceted, multi-vendor) business and operating models?  It is often said that there is no competitive advantage to data.  Maybe, maybe not, but a firm-wide focus on data quality can reduce operating and transaction costs, improve risk aggregation and management, and optimise balance-sheet and inventory utilisation.  More and more firms are starting to view data as an asset and understand the importance of data quality as an enabler not just for regulatory compliance, control and reporting processes, but also for integration, differentiation, reputation and profitability enhancing initiatives.

Complex financial product accounting, risk analytics and valuation models are becoming increasingly commoditised – companies like FinancialForce.com and OpenGamma already offer highly modular, scalable, fault-tolerant, cloud-based (or ready) accounting and risk management platforms.  Could it be too long before we see the emergence of Microsoft Azure Ledger, Google Financial Risk Analytics, or Amazon Transaction Banking?  If banks overcome their ‘not built here’ syndrome they could begin to work with trusted and proven platform service partners who promise to cut operating costs and ‘not be evil’.   As more OTC products become standardised on exchanges, algorithmic trading and STP will be used to drive down the ‘cost per trade’.  Could a ‘big data strategy’ steal the march on regulators and competitors and allow a firm to refocus on value creation activities, such as trading and hedging strategies, structuring and contract origination, advisory, sales and marketing?

As we have seen above, regulators are beginning to force the issue with more prescriptive identity and classification schemes, which will result in the externalisation of firms’ trade, counterparty and product information in centralised regulatory repositories.  Vendors such as Avox (a commercial subsidiary of the DTCC) are already starting to realise the value in this model as they match, merge, validate and re-distribute counterparty data to and from a number of large banks – they offer a ‘Counterparty in the Cloud’ service (although the matching algorithm is a little more ‘fuzzy’ than for iTunes).  It is not a great leap to envisage them (or a competing vendor or consortium) leverage the standardisation afforded by the LEI and extend their business and data validation teams to provide a shared KYC and client on-boarding service.   Although anti-competition and risk concentration concerns would need to be addressed, the benefits to clients are clear; they will only have to go through the standard regulatory KYC ‘passport application’ process once and then negotiate legal and commercial ‘visas’ with each of the firms with which they wish to trade.  Maybe some aspects of the global markets’ client on-boarding process will be outsourced yet further and delegated back to the governments, regulators and credit ratings agencies that mandate these ‘approved’ classifications, ratings and identities for counterparties and products.  If you are going to demand ID, you have to issue the passports.

www.crossbridge.co.uk

Banking

Over a quarter of Brits now have an account with a digital-only bank

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Over a quarter of Brits now have an account with a digital-only bank 1

Over a quarter of Brits now have an account with a digital-only bank 2 The number of Brits with a digital-only bank account has gone up by a percentage increase of 16%

Over a quarter of Brits now have an account with a digital-only bank 3 Almost 1 in 6 Brits (17%) plan to open a digital bank account over the next 5 years

Over a quarter of Brits now have an account with a digital-only bank 4 The top reason for opening an account was the convenience of banking online for the third year running

Over a quarter of Brits now have an account with a digital-only bank 4However, 16% of traditional banking customers who aren’t planning to switch said their bank had been helpful during the COVID pandemic

Currently over a quarter of Brits (27%) say they have at least one bank account with a digital-only bank, according to personal finance comparison site finder.com.

This is a percentage increase of 16% from last year when 23% of Brits said they had an account with a digital bank. It is also over 3 times the amount of Brits who had one in January 2019 (9%).

Finder’s 2019 research found that 24% of Brits intended to have a digital-only account by 2024. However with 27% now having an account, Brits have gone digital 3 years earlier than expected.

A further 17% of Brits intend to join them over the next 5 years, with 11% planning to do so over the next year. This could mean that 44% of Brits could have an account with a digital bank by 2026. If this percentage were applied to the UK adult population, it would equal almost 23 million people.

The top reason for opening an account continues to be convenience that digital-only banks provide, for the third year running (26%). The second most common reason was that users needed an additional account and setting up a digital account seemed to be the easiest option (20%). Customers also wanted to transfer money more easily (19%), making this the third biggest priority.

People wanting a trendy card is still driving signups as well, with 1 in 10 (10%) existing, or future, customers citing this as a reason to get an account.

Despite the increase in digital-only banking customers, the numbers who aren’t considering one have actually risen. Last year, 23% of respondents said they aren’t considering a digital-only bank account, but this has risen substantially to 42% in the latest survey.

This is likely a result of increased customer loyalty, 58% of those without a digital bank account said they felt as though their incumbent bank had treated them well and therefore had no desire to open a digital bank account. Additionally, 16% felt as though their incumbent bank had performed particularly well during the pandemic.

Over a third (36%) of those without a digital bank account said they had not decided to bank with digital providers because they preferred to be able to speak to someone in branch.

Digital banks are still most popular with younger generations, 46% of gen Z say they currently have a digital bank account, with a further 28% intending to get one over the next 5 years. This would mean that by 2026 just under three quarters of gen Z (73%) could have a digital bank account.

To see the research in full visit: https://www.finder.com/uk/digital-banking-adoption

Commenting on the findings, Matt Boyle, banking specialist  at finder.com said:

“This research shows that digital-only banks are here to stay, with the number of users in the UK rising for 3 years straight. On top of this, Starling and Revolut announced this year that they have made a profit for the first time, really demonstrating that digital banks are starting to become a serious part of the banking furniture.

“The pandemic has also played a role in the rapid digitalisation of the banking industry, with those who had never experienced online banking having no other choice but to take their finances online. It seems that Brits are starting to realise the convenience that can come with digital banking and this is reflected in our research.”

Methodology:

Finder commissioned Censuswide on 6 to 8 January 2021 to carry out a nationally representative survey of adults aged 18+. A total of 1,671 people were questioned throughout Great Britain, with representative quotas for gender, age and region

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Banking

The Impact of the Digital Economy on the Banking and Payments Sector

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The Impact of the Digital Economy on the Banking and Payments Sector 6

By Gerhard Oosthuizen, CTO Entersekt.

New banking regulations, digital consumers, the eradication of passwords, contactless technology – these are just some of the trends that will shape financial services and payments in 2021, writes Entersekt CTO, Gerhard Oosthuizen.

Since the outbreak of COVID-19, traditional businesses have been compelled to further undergo the digital transformation to meet the needs of a consumer base largely confined to their homes. Indeed, we estimate that there has been a 30% growth in the digital space. With this acceleration towards a digital world, banking, transacting and payment trends have and will continue to be redefined into 2021.

We have witnessed a rising number of digital first timers. That is, people signing up for online banking and e-commerce, whilst progressively shifting away from traditional channels. Businesses that have previously depended on walk-in stores and having a physical presence have also had to recognise that online transactions are now the new norm, and to adjust accordingly.

Whereas in the past, registering a customer for a service could take place in a shop, a booth or a branch, today it has become more important than ever to have a remote digital registration option available as well. Even working behaviour has changed considerably, with many businesses accommodating for remote working in the long term.

This is what sets the scene for 2021 – people expect to work from home as well as carry out their transactions from home.

Banking and Payment Trends in 2021

The use of contactless technology is undeniably growing, but on top of more people tapping with their cards, we are also seeing much more engagement with QR payments. A technology already frequently employed in Asia, we know QR codes can work. It would enable consumers to authenticate themselves when making a transaction without needing a PIN pad. More importantly, it allows consumers to gain complete control of their transactions from their own device and have an overall richer experience. Recognising this, we anticipate noteworthy developments in QR and NFC-enabled tap and go payments over the next year.

In light of FIDO (Fast Identity Online) and the ever-expanding network of FIDO-compliant solutions, we also expect the emergence of entirely passwordless systems. Organisations will likely begin enlisting customers by way of biometric authentication through devices and digital identities that already exist, such as banking apps. Long gone will be the days of having to remember numerous passwords, only to forget and reset them again. That is the idea anyway.

In 2021, there will probably be a pronounced adoption of delegated authentication as well, whereby

Gerhard Oosthuizen

Gerhard Oosthuizen

merchants as opposed to traditional issuing banks will take the reins of authenticating e-commerce payments. In this way, consumers will be offered a greatly improved online shopping experience with a simple and intuitive checkout that acts as an extension of the retail brand.

The Challenge of PSD2

While each of these transitions will undoubtedly introduce growing pains, PSD2 will be among the most challenging. Europe is already going through PSD2 now, implementing a number of regulations that is opening up competition in banking and electronic payment services. However, on the 1st of January 2021, these regulations will take a legal effect. At the end of the first quarter, so too will another set of regulations concerning 3-D authentication of card-not-present payments. Europe is simply not prepared to make this leap into “open banking”. As such, banks will face a tough year of struggles with regulators and competition from non-traditional quarters.

In fact, the process towards becoming PSD2-compliant is often arduous for banks and recoups hardly any additional revenue. Many banks see it as a competitive disadvantage as they are being forced to open up their systems and processes for the likes of Google, Facebook, Apple and many smaller niche fintech operations. Their valuable client data risks being taken by a challenger and used to on-board their accountholders.

Regardless of the commercial opportunities that open banking may provide, fraudsters will also endeavour to take advantage of this change and the weaknesses that will appear as systems open. With money moving faster, the faster it can be stolen too. We will likely see some reaction to this in 2021 as fraud returns to being a top priority for banks. Yet, whether through regulatory pressure or by market forces, open banking will become the new normal – and the world needs to prepare for this. Hopefully, many lessons will be learned from Europe’s experiences in 2021.

Next year is going to be about change – and managing that change without alienating already unsettled consumers. Organisations that have customer experience top of mind will emerge as winners, but they must nonetheless expect additional pressure from regulators, new competition, ever more digitally-demanding consumers, and no slowdown in technological innovation.

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Protecting the digitally-excluded: biometric identification ensures access to payments in a cashless world

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Britons embrace biometrics but over half will abandon applications if not fully digital

By Vince Graziani, CEO, IDEX Biometrics ASA

The events of this year have exacerbated a number of challenges for vulnerable members of our society. Fears over health have been compounded by the accelerated digitisation of activities in their daily lives, such as video calls with family, shopping online and mobile banking – activities they may have already been daunted by. Chief among these evolutions has been the pronounced lean away from the use of cash. With many not comfortable with the complexity and security of digital payments, banks must explore an alternative in the form of biometric identification.

COVID-19 and subsequent lockdown restrictions have not only made the handling of cash difficult, but even unsanitary. As a result, many retailers have either stated their preference for digital payments, or indeed forbidden the use of cash during transactions. As a result, the UK cash machine network, Link has reported a 55% drop in ATM usage over the course of 2020.

Meanwhile, in the US, a similar decline in cash has led to a rapid rise in digital payments and mobile payment apps, thanks to comparable regulations and an increase to the contact less payment limit of up to $250. According to recent research, 28% of US shoppers would avoid a retailer that doesn’t offer contactless payment options. That hesitation is causing a shift to digital payments, with the US mobile payment market expected to rise to $130.3 billion in 2020.

When the adoption of technology is accelerated so suddenly, it’s understandable that those vulnerable, older or even just reluctant and sceptical members of society aren’t thought about enough. The resultant fear of leaving vast swathes of people behind means we need a new touch-free payment solution that helps to comfortably and securely bridge their transition away from cash.

Who fears the transition, and why?

The idea of digital exclusion isn’t necessarily a new concern. In the UK, Which? has long been calling on the government to protect cash as a payment option, knowing that its eradication could negatively affect vulnerable members of our society.

Despite the concept of going cashless advancing, as many as 27% of UK consumers still operate only in cash, while across the Atlantic, 70% of US citizens regularly use cash. Looking globaly, research by the Global Index has explored the nascency of countries including India, Mexico, Nigeria and Pakistan in transitioning from cash to a digital banking system, finding that 1.7 billion adults around the world lack a bank account, while around 1 billion still pay their bills in cash.

Across the board, there is also a notable percentage of consumers who, while being banked, may struggle to maintain their financial independence. Old age or physical and mental health limitations can make the current transition difficult.

What if you can’t remember your PIN or your online banking password, or even your signature?

Banks must be aware that a wholesale veer away from cash isn’t going to suit or benefit all of their customers. They must therefore seek alternative options that still adhere to the  trajectory towards touch-free payments, while addressing the above digital exclusion challenges that some will face during this transition.

A secure and convenient payment option

Rather than making payment transactions a game of memory or self-controlled security, the banking sector should look towards the benefits of biometric authentication. When incorporated into a bank card, fingerprint authentication offsets the need to put people under pressure to note down, secure, remember and then input various passwords, PINS or usernames. Instead, biometric authentication, through fingerprints, automatically and categorically links a person to their finances in the most understandable and seamless way possible.

For retailers it would ensure that the evolution away from cash can continue seamlessly; also meaning they’re less likely to lose out on an entire segment of the customer base. But, more importantly, for consumers, it provides a more safe, secure, immediate and convenient payment method that balances the positives between cash and digital payments.

It’s an ideal balance that relieves pressure on the digitally excluded. Vulnerable members of society will firstly be spared from a growing need to invest in expensive smartphones, or to learn complex digital banking features in order to carry out purchases.

Additionally, at a time where cash is potentially harmful to health, and equally at risk from a security perspective in the longer-term, they are able to make a safe step forward without any of the innovation headaches that might come with it.

The enrolment of biometric payment cards can even now take place remotely in people’s homes, making the transition even more seamless than the idea of extracting cash from ATMs.

Going beyond payments, biometric smart card solutions can also serve as the direct and unequivocal identification many would need to open a bank account, build credit and enhance their financial footprint, as seen in India’s Aadhaar biometric ID programme.

The solution to a prolific challenge

As we move away from cash and towards a world of digital payments, biometric payment cards provide the ideal balance of security, convenience and hygiene for touch-free transactions, without having to rely on expensive smartphones, mobile banking, or PINs.

Banks and payment providers must now embrace biometric payment cards to provide consumers with a secure and easily accessible means of touch-free payment. In doing so, financial exclusion will be one less critical factor to worry about as we transition to a cashless society.

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