The Growing Appeal of Embedded Compliance

For decades, the only way for people who suffer from diabetes to monitor their blood sugar levels was to prick their fingers for blood and test the samples up to 10x a day. Since 1999, however, many people have embraced continuous glucose monitors (CGMs) instead — devices that rely on a small sensor inserted under a person’s skin to measure blood sugar levels 24 hours a day, allowing for real-time adjustments when needed.Not only did the introduction of CGMs make it easier for diabetics to monitor their glucose levels, but they also added a level of accuracy that was previously lacking. As the banking industry struggles to keep up with ever-changing and increasing rules and regulations, many organizations have begun taking a similar round-the-clock approach to compliance. Many financial organizations have started embracing embedded compliance as a way of ensuring constant oversight and monitoring of their day-to-day activities through a regulatory lens.Understanding Embedded ComplianceEmbedded compliance is essentially the real-time automation of regulatory decisions and compliance oversight. It combines artificial intelligence (AI) and sophisticated algorithms to aggregate financial institution regulations in a way that allows organizations to step up their compliance oversight and risk mitigation by flagging potential issues before transactions occur. Embedded compliance allows for automation of things such as Know Your Customer (KYC) processes — identity verification at the time an account is opened, and screening for cross-border transactions and anti-money laundering (AML). Much like the way that embedded banking services are integrated into the websites and apps of businesses, it is incorporated into a financial institution’s existing systems and processes. It is not just financial institutions that have begun to embrace embedded compliance. As criminals continuously find ways to exploit more sophisticated technologies, cross-border money laundering has become a bigger problem — one that central banks are turning to embedded compliance to help combat. Embedded Compliance for Cross-Border TransactionsOne of the biggest issues financial institutions face regarding cross-border payments is the patchwork of regulatory and compliance rules that exist between jurisdictions. Differing rules not only enhance the likelihood of noncompliance, but also slow transactions. To address these issues, the Bank for International Settlements (BIS), the Reserve Bank of Australia, the Bank of Korea, Bank Negara Malaysia, and the Monetary Authority of Singapore recently collaborated on a proof-of-concept known as Project Mandala. This project uses embedded compliance to apply country-specific policies to real-time monitoring of cross-border transactions and is expected to lower the cost of such transactions while increasing their speed. "Mandala is pioneering the compliance-by-design approach to improve cross-border payments without compromising privacy or the integrity of regulatory checks…. We are optimistic about the potential of these early results to enhance cross-border payments,” said Maha El Dimachki, Head of the BIS Innovation Hub Singapore Centre. Embedded finance and banking as a service (BaaS) continue to become increasingly important revenue sources for the banking industry. According to Alloy’s 2024 State of Embedded Finance Report, on average, embedded finance partnerships account for 51% of the revenue and deposits of sponsor banks. Though 94% of sponsor banks believe it is important for their organizations to invest in compliance technologies, 90% find it difficult to meet compliance requirements for embedded finance. Specifically, sponsor banks struggle with their inability to control or audit the way partners handle their own compliance efforts. Given these realities, embedded compliance is the natural next step. However, embedded compliance is not without its own challenges. Challenges of Embedded ComplianceSome of the biggest challenges facing embedded compliance include difficulties incorporating it into outdated legacy systems, mismatched technological infrastructures, and the overall lack of clarity regarding how regulators will ultimately monitor such systems. Another major concern is the reputational risk that compliance violations could mean for organizations. As with all AI-based technologies, there is the possibility that the risk of inaccurate data sources could unknowingly introduce biases and incorrect results, providing financial institutions with a false sense of greater control than they really have. On top of these things, regulators are heightening their scrutiny of embedded banking, overall. More than a quarter of enforcement actions brought by the Federal Deposit Insurance Corporation (FDIC) in 2024 were related to embedded banking. As more organizations begin to embrace the benefits of embedded finance and embedded compliance, from cost efficiencies to speed and heightened risk mitigation, community financial institutions should be looking at how these technologies may benefit their own businesses. Until there is more clarity regarding how regulators will approach these technologies, however, community financial institutions need to maintain actively engaged compliance professionals and should primarily use embedded compliance as a supplement to their workforces and an additional layer of risk monitoring.