“Fintech” - a term that blends finance and technology - has more-or-less become a household word, but can you guess the parts that make up “Regtech”? Since you’re reading this article, you probably already know it’s a contraction of “regulation × technology.” It was developed as an attempt to reduce the costs caused by the regulations in the financial field.
Legal Regulation in the Financial Field
Supervisory agencies are responsible for overseeing financial institutions, such as banks, in each country. In Japan, this is the Financial Services Agency. One easily recognizable example of regulation in the financial sector is KYC (Know Your Customer). Managing customer information that can verify identity such as name and address allows government authorities to more efficiently investigate criminal acts such as money laundering.
After the Lehman Shock in 2008, financial regulation was strengthened worldwide, especially in developed countries. High-risk loans that were originally low credit “subprime loans” were sold by investment banks and credit rating agencies as financial products. Such mislabeling led to the collapse of the real estate bubble and caused a financial crisis. This, paired with strong suspicion of the public towards the financial industry has strengthened financial regulation.
As a result, financial institutions are forced to comply with stricter financial regulations; however, it has the unfortunate side effect of raised costs. One attempt to solve this problem is using “Regtech” technology.
What Can be Done with Regtech?
Regtech aims to conduct online accounting and account risk analysis, monitor trading behavior, manage customer information, and perform auditing. In financial regulation - where records are of the utmost importance - blockchains provide a solution in that it is difficult to falsify records. It is impossible to eliminate the possibility of mistakes caused by human error or data tampering in traditional record bases.
Services for risk analysis of individual accounts, corporations, and government authorities have already appeared. The site “Coinfirm” provides a service that calculates risk for each address used when holding Bitcoins. With Bitcoins, the balance for each address is recorded on the blockchain and there is nothing to connect the address to the holder. Coinfirm checks whether the address is associated with money laundering or illegal trade and stores the information in a database. By entering the address, you can tell whether the corresponding wallet is safe to trade.
The Future of Regtech
Compliance costs are a burden, not only for existing major financial institutions but also for Fintech startups. Previously, Bitcoin Exchanges could be freely established and money exchanged for fiat currency; however, under the revised fund settlement law established in April 2017, it became necessary to properly manage customer information and register virtual currency exchanges. KYC reduces the risk of using cryptocurrency for hiding assets or illegal transactions. In contrast, each bitcoin exchange in Japan must be monitored, at the cost of the Financial Services Agency.
Financial regulation by government authorities is essential to protect customer assets. Yet if it causes stagnation of innovation, it becomes counterintuitive. Regtech allows efficient regulatory compliance by lowering the burden of compliance costs, and so promoting and introducing Regtech further encourages the flow of Fintech innovation.