The inability of financial institutions to track the transaction lifecycle accurately, and therefore assess counterparty risk, has become an ongoing regulatory concern in the aftermath of the banking crisis. The predominant reason for global regulatory intervention in the current banking system is to address this and reduce systemic risk.

However, it is clear that regulation alone will not reduce systemic risk, merely transfer it elsewhere to other less-regulated markets. Therefore on a macro level the threat to the economy will remain. As the recent banking crisis demonstrated, regulation, specifically Basel II, did not serve to reduce systemic risk and by failing to do so illustrated the necessity for a system that allows the build up of systemic risk to be monitored, and acted upon. 

The downfall of Northern Rock in 2007 was the first major event in recent years to highlight the need for financial institutions to have responsive, up-to date IT systems so that information can be shared, evaluated and acted upon. In 2008, the demise of Bradford and Bingley was, in part, because of antiquated information technology; the bank’s senior decision-makers did not have access to the company’s up-to-date financial figures. The application of appropriate technology can address this, reducing systemic risk and supplementing the regulatory focus that is currently cast upon the industry.

By facilitating greater, more accurate flows of information within and between banks, technology can diminish the threat of bank failure and systemic risk, complementing the regulatory focus that is currently cast upon the banking industry. If counterparty risk cannot be assessed because of deficiencies in the flow of information within and between individual banking institutions, the effectiveness of increased capital requirements within these banks is automatically reduced.

Consequently, developing appropriate and uniform data standards that are universally accepted and adhered to by all actors within the banking system is critical to ensuring that data can be shared accurately and can be analysed by banking institutions and regulators to spot the build up of systemic risk. A key challenge is that information standards and formats differ from institution to institution and finding a means of standardising this information (and facilitating its sharing and analysis) is complicated by the legacy systems (see below) that are in place across most of the established, larger and most systemically important banks. 

The technology industry has a critical role to play in facilitating this shift towards a uniform information standard but it also requires a willingness on the part of the banks to invest in achieving this objective. The resource demands on banks are already acute as compliance costs and a need to stay in touch with an increasingly technology-savvy customer base grows. However if systemic risk is to be reduced, there needs to be further investment in improving the quality and format of the information that they held, and their ability to share it with other institutions and regulators. Failure to spot the build up of systemic risk will ultimately be more costly for banks than it would be to invest in preventative measures now.

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