In researching banking and regulation around the globe, I have seen a changing trend of regulation. Traditional macro-prudential regulation is no longer satisfying the concerns of regulators and Governments. Regulators have an unenviable task of ensuring a robust financial system in a VUCA world where the future is unpredictable due to Volatility, Uncertainty, Complexity and Ambiguity.
Innovation is threatening the stability of what used to be boring and solid. WePay and AliPay cost Chinese Banks $22bn in transaction fees in 2015. AliPay raised $100bn in deposits in under 12 months, when it took DBS 50 years to achieve the same result. At the time DBS was a regulated bank, AliPay was not. Grab, the Uber of South East Asia has become a digital bank with 85 million customers. PayTM in India has achieved $480m revenue in 8 years. The regulators are playing catch up to this changing world.
So how do regulators, regulate a system that is going through such rapid change. By the time policy is drafted, we have already moved on to the next event. When the regulators start enforcing areas such as responsible lending, they are getting into an ambiguous area. Their actions have an unintended material impact to the fundamental business of the sector.
Now regulators are responsible for ensuring competition and ensuring the robustness of the system. Where fintechs are coming into the mix with limited capital and new business models that are outside the context of what regulation was written for.
Then on top of all this, is the entrepreneurial way of institutions is to game the system. Now regulators are facing teams of high paid lawyers challenging the rules. Such as ASICS court loss on responsible lending.
The solution is meso-prudential where the focus is on structures. Meso is about the structures connecting the micro level to the macro level. Every breach, every risk comes out of the engine room of the business. The best way to ensure stability is to ensure the structures are right rather than checking the results of those structures.
By default, regulators are moving this way. In Europe there is a focus on reviewing the veracity of second line controls in banking. Making sure the risk controls in the engine room are appropriate. In Australian, regulators are being pushed to ensure the profitability of superannuation funds. There are suggestions that regulator staff actually sit inside banks and so on.
It is not for a regulator to assess commercial decisions around profit and risk mix, so this more granular approach is a huge problem. There is a move is to put more accountability on the external auditors, but it is also not their role to assess commercial decisions. The only way that regulators can delve to a deeper level in financial institutions, is to focus on the structures. If the structures are robust, the outcomes are more likely to be robust. Hence the evolving move to meso-prudential regulation.
This is leading to a shift on the regulated entities side, where directors and executives now have to know their business to a deeper level than before to meet meso-prudential regulatory model. This is where KYB – “Know Your Business” or another view “Know Your Basics” will change the way institutions manage risk, compliance and strategy.
The VUCA world is forcing regulators and financial institutions to rethink the way we ensure a robust financial system and KYB is playing an important role in the process.