Industry innovation is moving exponentially, creating new risks. Financial regulatory agencies must respond proactively to the digital transformation if they want to avert crises, AIR CEO Jo Ann Barefoot writes in an article for the Journal of Financial Transformation.

The digitization of finance offers hope of greater efficiency, inclusiveness and fairness, but the technology changes also lead to more risks. Unfortunately, regulators still largely use analog technology stacks, making it difficult for them to keep pace with digital innovation that is evolving exponentially. They must improve risk-detection to respond to the digital transformation if they want to avert the next big crisis.

This was the central message of a new article entitled “The Danger of Linear Thinking in Regulatory Oversight,” authored by Jo Ann Barefoot, CEO of the Alliance for Innovative Regulation (AIR), and published in The Capco Institute’s Journal of Financial Transformation.

“If the past is any guide, policymakers are unlikely to pass new laws to address risks before crises happen. Consequently, it is imperative for the regulators to move aggressively on their own to assess and adapt to the digital landscape,” Barefoot writes. “This means incorporating cutting-edge supervisory technology (Suptech) powered by customized AI, which will allow them to analyze mountains of data.”

Barefoot recommends that regulatory agencies build on the foundation set by recently launched innovation offices, develop Suptech tools to address an agency’s internal innovation needs, undertake efforts to educate personnel about technology concepts, migrate to cloud computing, leverage open-source technologies, adopt a “digital regulatory reporting” (DRR) regime, and commit more resources to take advantage of artificial intelligence (AI) and machine learning (ML), among other things.

“The U.S. regulatory framework, last revised to a significant degree by the 2010 Dodd-Frank Act, has helped keep the financial system safe from a full-blown crisis since the 2008-era mortgage debacle and market implosion,” Barefoot writes. “But that framework is still meant for an analog regulatory structure; one that operates in a linear fashion and responds to linear change in an industry that is more analog than today’s financial services sector.

“This misalignment not only makes consumer safety and financial stability vulnerable, but also risks undermining the benefits of financial innovation.”

Download the full article here.

Find out more about AIR’s Jo Ann Barefoot →

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