When considering the costs of fraud and non-compliance with financial regulations, most people immediately focus on the large headline numbers.

JPM was fined $175m in June 2021 for recordkeeping mishandling.

Wells Fargo was fined $97m in March 2023 for inadequate oversight of its compliance risks.

While these headline numbers underscore the risks and costs of non-compliance, the mishandling of consumer finances and bad actors misleading consumers through their marketing practices can lead to even greater expenses. For instance, Bank of America and Wells Fargo were fined $250m and $3.7bn, respectively, for engaging in harmful conduct toward their customers.

Though enormous fines and large settlements make headlines, the everyday cost and burden of compliance and mitigating risk and fraud weigh heavily on FIs and fintechs. In 2022, the cost of financial compliance in the US hit $46bn, up from $41bn in 2021 and $30bn in 2019 — split across personnel, technology, and compliance practices. Companies are continuously investing in ways to stay ahead of the changing landscape while improving accuracy and time and cost efficiency.

Compliance in financial services is a massive and growing category. There are data governance, privacy, risk, cyber and security concerns, as well as regulatory bodies with differing mandates and rule changes that need to be monitored and enforced.

Fraud is also an unrelenting problem for FIs. Whether it is Zelle and partner banks’ inability to curtail payment fraud or the allegations against CashApp and Chime involving the amount of their user bases made up of bad actors, it’s clear fraud plagues FIs no matter the size.

In fact, Square dropped 22% in value off a Hindenburg Report that alleged 40–75% of Cash App accounts are fraudulent.

The expenses and challenges associated with financial services will continue to rise, and with technological advancements, the necessity of trust and security will only increase. The annual global impact of fraud is estimated to exceed $1tn, and it costs an FS company $4.23 for every dollar they lose due to fraud. This challenge has prompted firms to explore unconventional and previously implausible solutions. For example, some have turned to each other, creating consortium-like structures (i.e., Unit21, Sardine, and Plaid) to build off each other’s data to minimize risk. Numerous solutions are addressing specific compliance, risk, and fraud challenges, tackling pain points such as KYC/AML, data governance, security, identity, payments risk, etc.

Despite significant innovation and offerings, financial services companies still struggle to keep up with evolving risks across compliance and fraud. These challenges are exacerbated by the rapid advancement and proliferation of new AI-powered technologies. This has created greater demand for compliance tools to combat these new and evolving risks. AI proliferation through FIs will cause these challenges to arise even faster than previously imagined.

Financial services may be slower to adopt LLMs and other AI tools as the industry is often more cautious and requires higher accuracy, additional protections in dealing with private and sensitive data, and the need for explainability with data and decision-making. Nonetheless, AI will inevitably have a huge impact on the sector. We see incredible opportunity across several use cases, including, to name a few:

• Accounting & spend management (i.e., Cowboy port co Vic.AI)
• Better risk predictive models for underwriting
• Identity and fraud detection and prevention
• Enhanced personalized consumer finance
• Financial management
• Investing & research

Regulation and compliance have a substantial impact on various aspects of business and decision-making within financial institutions, including onboarding, marketing, new product development, communications, and data security and governance, etc. As AI becomes more widely integrated, particularly generative AI, new challenges, complexities, and risks will emerge. New technologies can present additional regulatory and compliance hurdles. Some of these difficulties can have long-term implications, while others may serve as early ‘training wheels’ as regulators become accustomed to new technologies. This could be as “simple” as the addition of new checks and bottlenecks for companies to remain compliant while aiming to provide the best customer experience service or entirely new regulatory frameworks that impose new processes on how businesses are run.

These changes and uncertainties are driving heightened demand for solutions that alleviate the burden and streamline the process of identifying risks and meeting regulatory standards. Many of the risks are not necessarily new but have evolved and can have larger and more costly repercussions, given the potential exponential impacts of AI. Some of these risks that AI can worsen include:

• Increased risk around identity verification
• Increased regulatory changes make maintaining compliance harder
• Potential for increased fraud
• Managing private data and access with LLM
• Explainability of models
• Ensuring models remain compliant with regulations

At Cowboy, we are excited about the proliferation of AI across financial services. We believe that there will be more incredible founders building innovative products off of the back of AI powered-technology, and we are excited to work with these companies. Whether these solutions include new fintech products/services or new offerings to help mitigate against the increased risks and compliance challenges faced by FIs, we think there is a new wave of opportunity across the fintech landscape, and we are excited to back the builders in this space.

If you are building or thinking about the intersection of fintech and AI or compliance and AI for regulated businesses, we’d love to hear from you! Reach out at Jillian@cowboy.vc

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