Financial regulators are under immense pressure to drive competition and innovation, while protecting the consumers of financial services from harm. How can these institutions, prone to caution, become more progressive, innovative and agile?
The Alliance for Innovation Regulation (AIR) brought together experts from private sector institutions, fintechs, non-governmental and non-profit organizations, academia, and research and consulting services firms to share experiences of working with regulators to gain a better understanding of the specific obstacles they face in adapting to rapid industry, technology and societal changes.
A deeper appreciation of their challenges – and the wealth of knowledge and perspectives from different areas of the financial services industry in the room – gave us an opportunity to discuss ways that we could work together to turbocharge change among regulators across the globe.
Indisputably, the main challenge for regulators is the lack of resources – whether funding, headcount or specific capabilities – required to keep abreast of fast-moving market developments, a point that many returned to throughout the discussion.
As one participant remarked, this manifests on three levels: individual readiness within an institution; organizational readiness, such as an enabling innovation culture; and system-level readiness, for example an ecosystem to facilitate public and private organizations working together.
Embracing innovation isn’t easy for such risk-averse institutions, even those with more resources. Our group discussed how regulators are severely punished – “visibly, vocally and repeatedly” – if something goes wrong, while not being rewarded if everything runs smoothly. With limited definition of what good looks like and inadequate measurement of macro/societal outcomes, there is little room for regulators to take risks – nor are there incentives to explore the art of the possible.
As a result, some institutions may be prone to what one participant called “innovation theatre”, either intentionally or otherwise. In such situations, regulators may celebrate innovation activities and outputs without a full assessment of the impact of their endeavors, nor sufficient analysis of failed initiatives or missteps taken along the way. Insufficient sharing of specific learnings and errors has also resulted in many regulators taking a cookie-cutter approach and copying each other despite differentiated contexts, which most likely won’t deliver the desired results.
We also discussed how the way decisions are made within an institution can block innovation. Many commented on the tendency of regulators to have a hierarchal structure (commensurate with traditional approaches to cautious and calculated risk-management), with many decisions being taken at a very senior level. While there are good reasons for this, including those connected with regulators’ role as protectors of financial system stability, it means that the time and cost of making even a modestly risky decision can present a significant barrier to experimentation. Consequently, staff may feel compelled to propose “moonshots” because large projects are the ones worth moving up the chain of command. However, hugely ambitious projects also come with a high risk of failure. When such failure occurs, the appetite for innovation and risk-taking may then be further suppressed, reducing further the capacity of the organization for small-scale, experimental endeavors.
For some, innovation means shiny new technology, such as generative AI or large language models. However, the group agreed that innovation is much more than that. It is about the methodology, mindset, culture, collaboration and muscle memory that allows a regulator to experiment, take risks, be courageous, and reward experimentation. Technology is just one tool that helps enable desirable innovation.
Everyone around the table regularly acknowledged that it was not an easy task for regulators to change their approach to innovation. But there are several regulators that are viewed as trailblazers among their peers. For that reason, we felt that it was important to communalize learnings across jurisdictions, as well as collectively brainstorm solutions to these challenges.
There was general agreement that the low risk appetite exhibited by financial regulators could partly be attributed to a lack of understanding of new technology or a lack of knowledge about benefits that an innovation can bring. Therefore, many participants felt that having hands-on experience in using emerging technologies is critical to developing proportionate and supportive approaches. Building capacity by exploring and adopting the technology internally helps raise regulators’ familiarity and understanding of such technologies – thereby increasing their ability to question and manage the risks of these technologies in the firms and markets they supervise.
Surveying market participants as to their needs in terms of regulatory guidance could provide useful insight into market challenges, suggested several participants. While looking at what other jurisdictions are doing is essential, regulators should also listen to their own market as to what isn’t working and what can be done to solve the issue. This is also a good example of the private and public sector working together.
Undoubtedly, there is huge potential in private and public sector collaboration, but it’s not being maximized currently, according to many around the table. One participant suggested that regulators should move beyond thinking of collaboration as a commercial relationship, such as procuring a vendor, to actively creating spaces for open dialogue and engagement.
In addition, the group felt that those regulators that are actively encouraging private sector players to participate in hackathons and sandboxes need to ensure they properly consider and articulate the benefits for those organizations. A fintech participant warned that the ecosystem will start pulling back if regulators become a vortex for drawing on the industry’s capacity and knowledge, without giving something back.
While many articulated the value in peer-to-peer and community learning and sharing, they acknowledged that this requires creating environments where regulators can be fully transparent and feel safe. Regulators need to be incentivized and encouraged to ask for help and reveal the “good, the bad and the ugly” of what they’re doing. Restricted-access online communities, which also have publications, working groups and curated resources, are gaining popularity among regulators.
As many of the challenges authorities face are mirrored in the private sector, the group felt that there is an opportunity for greater transfer learning from different sectors, where there is more experimental and progressive innovation, to bring new techniques into the financial regulatory environment.
While regulators’ limited resources is a multifaceted issue, there was general agreement that working more closely together as an ecosystem can alleviate some of the pain points and begin to create space for greater experimentation. Sharing knowledge, learnings and training between regulators and across supporting networks is already galvanizing a more innovative approach to regulation.
However, all felt that better coordination is needed across the whole ecosystem that supports regulatory efforts. More work needs to be done on strategic alignment, maximizing our impact and leveraging major players, such as intergovernmental bodies, NGOs and philanthropy.
The group also discussed how to enable systems change at a systemic level across multiple markets and institutions. While many of us are focused on systems change in specific institutions or around specific thematics, projects or topics, we haven’t yet learned how to do multi-jurisdictional technical assistance at scale that is effective and long lasting.
While many endeavors deliver value, they can be highly labor- or capital- intensive – restricting the ease of delivering effectively at scale. Therefore, we need greater collaboration on common objectives to enhance the scale, reach and speed at which regulators build momentum in innovation. AIR’s roundtable was the first step in advancing our collective power – join the discussion.
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