Digital Banking Regulatory Compliance — The Ultimate Guide [2024]

As digital banking has surged, so have the complexities of regulatory compliance.

When developing a product for the digital banking space, therefore, having a deep understanding of regulations and compliance is essential. 

How can you architect a product to ensure that it adheres to financial regulations and compliance? 

Having an understanding of how regulatory compliance functions across the world of digital banking is a good place to start. With the information in this article, you will be able to:

1. Choose an ideal market for your solution
2. Architect your solution to align with regulatory compliance
3. Establish a realistic timeline for launching your fintech solution in a new market

Let’s get started. 

What is compliance in banking?

Compliance is the state of meeting rules or standards. In the context of banking, it is the process by which a bank and its employees follow and adhere to all of the regulations, standards, and ethical practices required by the financial regulators of a specific region.

A bank defines its own internal and external compliance practices to ensure that it is always in line with regulations. 

The role of compliance in banking

What is the role of compliance in banking? The compliance branch of a bank serves as an internal check of sorts, much like Internal Affairs in a police department. 

This department not only defines the internal practices that ensure compliance but also runs regular checks to ensure that practices at a firm are in adherence with regulatory requirements. 

In digital banking, regulatory compliance must often be “built into” financial software and solutions. Much like a human employee at a bank must align their habits and tasks with regulatory compliance, the functions and tasks executed in software must adhere to protocols. 

Types of compliance in banking

While compliance has the high-level goal of detecting and addressing any deviations from regulation, there are several different types of compliance that need to happen at a bank. Compliance has to address:

• security
• risk management (investments, portfolios, etc.)
• how customer information is processed
• ethics and conduct
• data reliability

With regards to the latter, compliance gets an added layer of complexity in the digital world. 

Since digital profiles are anonymous and digital transactions can be cross-border, digital transactions have the potential to lead to money laundering. 

As such, digital banks must ensure that they address AML risk, or Anti-Money Laundering risk, in their compliance protocols. 

Service providers in the digital banking space must focus on methodologies that can ameliorate the risks of phishing and malicious software and also handle virtual currencies in as consistent and ethical a manner as possible. 

Digital Banking Compliance: Global Regulations & Changes

Digital banking Regulatory Compliance is constantly changing. Therefore, businesses and online banking service providers must keep track of all the changes. Below, we've highlighted some of the most significant updates announced in 2023 or set to be released later on.

CFPB's proposal on open banking

In the United States, the CFPB’s proposed rules, released between late 2023 and January 2024, take a phased approach to enabling customer financial data access for customers and authorized third parties. The regulations apply to a limited set of data providers, specified financial products, and services.

According to those rules, when a data provider receives a request from a consumer or an authorized third party for “covered data” in the provider’s possession (or control), the provider must make the covered data available in an electronic machine-readable file. Thus, consumers and authorized third parties can retain it.

“Covered data” includes the following:

• Transaction data (individual transactions and the payment amount, date, pending or authorized status, rewards credits, payment type, payee or merchant name, fees, and finance charges)
• Account balance
• Information to initiate payment (actual or tokenized account and routing numbers required to process a transaction)
• Terms and conditions
• Upcoming bill information
• Basic verification data (name, email address, address, and phone number associated with the financial product or service)

PSD3

The European Commission's Payment Services Directive (PSD3), which will be finalized by early 2025, is set to adapt to the ever-evolving electronic payment niche. Some of the most notable changes in the finalized version include the following:

• Data Sharing. Businesses will share more extensive data with issuers, utilizing behavioral and environmental factors to improve security measures.
• Fraud Prevention. PSD3 will suggest a substantial change in liability for fraud cases, holding different entities accountable (like schemes, technical service providers, and payment gateways) if they fail to integrate Strong Customer Authentication.
• Authentication. PSD3 will offer more flexibility, allowing the use of two factors from the same category for SCA. It will also ensure a more adaptable authentication approach.

Crypto regulation

Regarding crypto regulation within online banking compliance, the HM Treasury has highlighted a two-phase approach:

Phase 1

This phase covers the issuing and custody of fiat-backed stablecoins in the UK. It also regulates payment services associated with these stablecoins within the payment chains, expediting legislative processes.

Phase 2

The second phase, scheduled for late 2024, aims to expand the regulatory scope to include multiple activities related to crypto assets. These are investment, issuance, exchange, lending, risk management, borrowing, leverage, and safeguarding.

Buy-now pay-later (BNPL)

The UK government has eventually published the draft legislation that grants the Financial Conduct Authority (FCA) the power to handle companies that offer interest-free installment credits. This change aims to protect customers from potentially unburdened access to lending via BNPL schemes.

Mastercard Rules: AN 4569 Revised Standards

The AN 4569 Revised Standards have become a notable change in digital banking regulations. The update reveals new growth opportunities, improves customer satisfaction, and puts businesses in a favorable position in the competitive financial landscape.

Implementation Challenges

Companies, including fintech businesses, banks, and payment processors, must ensure their systems and platforms comply with AN 4569's enriched merchant data requirements. Possible challenges include system updates, data compatibility, training, and stakeholder coordination.

The data required by AN 4569 features the following:

• Merchant's name
• Business address
• Contact details
• Logo

Digital Banking Compliance: Modern Practices and Tools

Along with digital banking regulations, it's necessary to follow the industry's current best practices and changes to deliver high-quality services to customers. Below, we've highlighted the main trends and tools you may implement in your apps or services to make them more secure, efficient, and user-friendly.

Utilizing AI algorithms

AI-powered tools and technologies like computer vision, virtual assistants, and natural language processing are becoming increasingly popular among online banking and fintech companies. With their help, you can cover the following goals:

• Increase security
• Automate data processing
• Make behavior-based investment predictions
• Implement human-like interaction with customers
• Streamline financial reporting
• Detect fraud

The most significant benefits of integrating AI into a fintech business include cost efficiency, higher quality of the analytics and reports, and enhanced customer experience. 

Know-your-customer (KYC) verification solutions

Smart KYC solutions are technology-driven systems for automated and enhanced banking customers' identity and risk profile verification. They ensure digital banking Regulatory Compliance and anti-fraud purposes. Such advanced systems utilize AI and machine learning to automate verification. Apart from basic identity checks, this technology incorporates complex document verification and biometric analysis mechanisms.

Thanks to that, digital bank customers can upload documents and pass the biometric verification via mobile devices to open accounts remotely.

Finally, banks comply with anti-money laundering and other regulatory requirements with KYC. Such solutions handle risk assessment and regulatory reporting more efficiently.

Robotic process automation (RPA)

RPA involves software robots or bots that automate routine and repetitive tasks. RPA automates tasks like data entry or online banking compliance reporting in digital banking. It even covers more complex goals like mortgage processing.

RPA bots' tasks range from data entry and validation to report generation, compliance, and customer service. Their core purposes are to speed up operations and automate repetitive routines.

Cloud computing

The adoption of cloud computing in digital banking has significantly accelerated in recent years. It provides scalable and cost-effective data storage options. Also, this solution ensures faster deployment of new banking services and improves data analytics capabilities. 

Utilizing blockchain technology

This decentralized technology ensures that every transaction is transparent and secure. Blockchain eliminates intermediaries and reduces costs, making it a game-changer for digital banking. 

Banks use blockchain to develop new products like digital currencies and enhance the speed and efficiency of cross-border transactions. 

Who regulates the financial services industry?

Different entities regulate financial services from one country or region to the next. 

Given the cross-border nature of much digital banking, it can behoove an organization to start small, developing a solution that focuses on one country or region first before expanding.

The following are the major regulatory bodies that oversee financial services in some of the major markets around the world. 

In the US

Given the size of its economy and that economy’s impact on global markets, it may come as no surprise that there are several different entities that oversee and define regulation in the country. 

One of the most dominant is the Federal Reserve Board, which maintains responsibility for liquidity and credit via open market operations and interest rates. 

The Federal Deposit Insurance Corporation is perhaps the second most relevant to banks. It was established in 1933 in response to the Great Depression and insures deposits at several thousand banks across the country. 

The Office of the Comptroller of the Currency is yet another entity that defines federal regulation in the US. This agency regulates and supervises charters to any bank that operates within US borders. 

The Securities and Exchange Commission, established in 1934, enforces all federal laws related to securities, including the stock exchange. 

Finally, the Consumer Financial Protection Bureau, or CFPB, ensures that bank protocols related to customers and customer transactions are ethical and protect consumer interest.

In the UK

Within the UK, now of course separated from the EU, the Financial Conduct Authority (FCA) regulates all financial services. It does so in partnership and consultation with HM Treasury. This organization serves as the conduct regulator for over 58,000 financial services firms in the UK, as well as its financial markets. The FCA also sets specific standards for about 19,000 firms and serves as a prudential advisor to about 49,000. The FCA defines protecting consumers and markets and promoting competition as its operational objectives.

In the EU 

Within the EU, a consultative group comprised of advisors from countries across the EU draft regulations for the financial services industry. 

This group, known as the Expert Group on Banking, Payments and Insurance (EGBPI), first defined its current regulatory process in 2001 based on the proposals reached by the comprehensive Lamfalussy Report. 

The report focused on ways to make financial services more agile and effective and included a Level 1 and Level 2 of regulations. Level 1 involves establishing basic laws, while Level 2 involves the technical implementation of measures across the EU. 

In the aftermath of the global financial crisis in 2008, however, the EU established significant revisions to its Level 2 set of regulations.

In Switzerland

Switzerland has maintained its position as a financial powerhouse by maintaining its autonomy from the larger European financial system. 

As such, the Swiss Financial Market Supervisory Authority, aka FINMA, oversees the small country’s financial regulations. 

The Bottom Line

Choosing an initial market and understanding what kind of regulations exist there is the main task for banking/financial institutions looking to develop digital banking solutions. 

Given that banking applications are not very agile, you can estimate six months to one year when entering a new market before gaining momentum. 

With the increasing complexities of regulations around the world, starting small can benefit any digital banking enterprise. 

Smaller markets with simpler regulations are a good place to start. This allows a digital banking solution to work out kinks and establish market share before expanding. It also helps to ensure that the solution adheres to all regulations. 

Make one market your solution’s priority from the start so that you can start clean and not waste time ‘treading water’ in bigger and more complex markets.