By Joseph Moss, International Banker
As regulators and supervisors strive to remain abreast of the rapid changes that the financial-services industry is undergoing at present, they are increasingly looking to technology to assist them in efficiently supervising financial markets, promoting financial stability and simplifying regulatory and supervisory processes. And with recent periods of severe banking stress, such as the Global Financial Crisis (GFC) of 2007-09 and the banking crisis of 2023, being at least partly attributable to failures in banking oversight, the growing deployment of SupTech (supervisory technology) tools has been essential for ensuring the robust and resilient supervision of the sector.
A portmanteau of the words supervisory and technology, SupTech involves the use of technologies by regulatory and supervisory bodies to deliver innovative and efficient solutions to support a more effective, flexible and responsive supervisory system for financial institutions, business operations and markets. These technologies have most commonly included artificial intelligence (AI), machine learning (ML), natural language processing (NLP) and blockchain, all of which are being utilised by authorities to enhance the efficiency of supervisory and regulatory processes and thus more effectively monitor for risky or potentially nefarious banking behaviour.
Sounds highly similar to RegTech (regulatory technology), right? After all, SupTech covers the regulatory-compliance sphere, which has massively benefitted financial firms seeking to leverage tech-based solutions to fulfil their regulatory obligations. But while RegTech is employed by financial institutions, SupTech is used by the regulatory and supervisory bodies themselves to ensure that regulations are being met by the financial institutions under their purview. Nonetheless, both sectors are closely related and are thriving thanks to advances in data analytics and the increasing power of IT (information technology) infrastructure, including processing capabilities and cloud computing, which are enabling meaningful insights to be gleaned from vast sources of data.
SupTech helps regulators and supervisors perform a number of key tasks related to financial supervision more efficiently and effectively, including risk detection and management, data analytics and management, compliance enforcement and financial-transaction monitoring. This improved efficiency can lead to profound savings in costs, time and human energy, which can be diverted to more complex, higher-value tasks. Such solutions can also improve the accuracy of such tasks and reduce error rates, generating further savings associated with not having to resolve as many errors.
Indeed, SupTech is gradually being leveraged across an expanding number of key supervisory areas. According to the University of Cambridge’s “State of SupTech” 2024 report, which garnered feedback from 127 financial authorities across 97 countries on 6 continents, as well as a questionnaire completed by 23 qualified SupTech vendors, prudential supervision remained the focal point, with 66 percent of respondents with a SupTech solution prioritising it, followed closely by anti-money laundering (AML), counter-terrorist financing (CTF) and counter-proliferation financing of weapons of mass destruction (CPFWMD) (62 percent) and consumer protection and market-conduct supervision (54 percent).
By enabling real-time reporting vis-à-vis periodic obligations (such as quarterly or annually), SupTech can prove critical in detecting fraud and money-laundering activities much earlier. “Supervisory technology reduces reporting time, increases data granularity, and amalgamates data into a single place for easier analysis and review. All of this improves the amount of information supervisory bodies have—and increases how quickly they can process—and act on—this information,” Unit21, a fraud and AML platform, explained.
“When a new fraud scheme emerges, SupTech can be used to ensure supervisory agencies are aware of it. Not only that, but they can determine how frequently it’s occurring, how often it’s successful, and more about the behaviour of the fraudsters involved,” added the fintech (financial technology) company, which specialises in fighting financial crime, noting that such information can then be leveraged to develop best practices to prevent this new crime method. “In this way, SupTech helps supervisory agencies achieve their objective of promoting trust in financial institutions and markets.”
Given such benefits, then, many of the world’s leading financial supervisory entities are seeking to integrate SupTech solutions into their operations, including the European Central Bank’s (ECB’s) Banking Supervision division, which was launched in 2014 to supervise banks in a consistent and standardised way throughout the euro area. In November 2023, the unit published an article detailing the SupTech tools that were in development in collaboration with national supervisors to address several pressing needs.
Athena, for example, is a web-based platform that helps supervisors find, extract and compare information from a corpus of millions of articles, supervisory assessments and bank documents. “Athena has an intelligent search engine at its core and employs natural language processing techniques, automated optical character recognition and translation capabilities that help reduce manual tasks for supervisory assessments,” the ECB’s November 2023 newsletter on SupTech highlighted. “In the future, Athena will further exploit the power of large language models to provide summarisation and question-and-answer capabilities.”
The newsletter also mentioned Heimdall, a custom-made tool for fit and proper assessments that has been in use since June 2022. “Heimdall streamlines and enhances assessments through automatic machine reading of banks’ fit and proper questionnaires, supported by automatic translation, textual analysis, process automation and data analytics capabilities,” the ECB added. “This helps to improve the quality of assessments, as the manual workload is further reduced and supervisors can focus more on complex cases.”
But while SupTech solutions are undoubtedly being rolled out with increasing frequency, are they achieving the desired objectives of regulators, such as reducing fraud or detecting excessive risk-taking by banks?
A recently published study uses unique data from the Central Bank of Brazil—a global leader in SupTech adoption—to analyse the impact of supervisory scrutiny triggered by the central bank’s SupTech tool (SupTech events) on banks’ risk reporting, credit allocation and broader economic outcomes. The study by Professor Hans Degryse and PhD candidate Cédric Huylebroek, both of Katholieke Universiteit Leuven, and a Central Bank of Brazil economist, Bernardus Van Doornik, uncovered three major results:
- Improved risk reporting: Following SupTech events, the banks that are impacted reclassify a higher proportion of their loans as nonperforming and increase provisions for expected loan losses by around 20 percent. This suggests that SupTech-driven supervisory scrutiny pushes banks towards making more disclosures of previously unreported credit risk.
- Risk-adjusted credit allocation: Banks that are subject to SupTech events consequently reduce their credit allocations to less-creditworthy borrowers by nearly 5 percent, thus improving the quality of their loan portfolios.
- Limited economic spillovers: Although such credit tightening by affected banks will constrain the economic activity of less-creditworthy firms, the overall spillover effects on the real economy are limited. As such, concerns that supervisory scrutiny could inadvertently destabilise economic growth can be alleviated.
“Overall, our results underscore how SupTech—or risk-based supervision more broadly—can strengthen regulatory compliance by fostering a better alignment between banks’ internal risk management practices and supervisory objectives,” the study concluded. “In addition, our study provides novel empirical evidence that moral suasion—long recognised by policymakers as an essential element of the supervisory toolkit—can effectively change bank behaviour.”
A 2020 report by the Financial Stability Board (FSB), moreover, found that both SupTech and RegTech tools could prove crucial for promoting the financial sector’s stability. “For authorities, the use of SupTech could improve oversight, surveillance and analytical capabilities, and generate real-time indicators of risk to support forward looking, judgement based, supervision and policymaking,” the report noted, adding that RegTech could improve compliance outcomes, enhance risk-management capabilities and generate new insights into the business for improved decision-making. “SupTech is a strategic priority for an increasing number of authorities. Based on a survey of FSB members, the majority of respondents had a SupTech, innovation or data strategy in place, with the use of such strategies growing significantly since 2016.”
Such results thus lend support to SupTech’s increasingly important role in supervising banks effectively. Indeed, in a keynote speech at the Supervision Innovators Conference 2024 on September 18, 2024, ECB Supervisory Board member Elizabeth McCaul discussed the central bank’s strategy for a Single Supervisory Mechanism (SSM) through 2028, one that recognises that the people involved in banking supervision are becoming inextricably linked with SupTech.
Since the inception of European banking supervision, the ECB has built up and continuously improved its core IT systems, McCaul observed, including launching various SupTech initiatives. As such, the ECB has recommended shaping a “new common strategy” covering both its core IT systems and its SupTech tools, as well as their integration. “We aim to instil a culture that supports the adoption of our SupTech tools and embeds advanced technology into regular supervisory processes. We are convinced that having a clear user focus in all our technological activities and ensuring an enhanced user experience will encourage the take-up of our tools,” McCaul added.