ONCE again, a major mis-selling scandal has broken out, with 13 high street banks and credit card issuers facing a £1.3bn redress bill for mis-sold card protection policies. No amount of financial regulation seems to stop the flow.
Until 1986, there were no mis-selling scandals. The sales of financial products were regulated by contract law and a few pieces of primary regulation, just like the sale of everything else. If a product was not fit for purpose – in other words, if the product did not do what it said on the tin – then it would be possible to get recompense. If the product was simply not fit for the buyer, then caveat emptor (buyer beware) held. But is it right that we treat financial products differently from other purchases?
Regulating the sale of financial products and promoting a compensation culture creates a number of serious problems. First, the regulation of financial advice means that there is a lot less financial advice available. It is more difficult for people to find out about the suitability of financial products, except from the regulated professionals who make a living from selling those products or advising about their suitability. The barriers to entry into the advice market are higher because of the costs of regulation. Secondly, businesses no longer have such a stake in developing a good reputation for fair dealing, selling suitable products to customers and so on.
Jonathan Macey at Yale University has just written a book about the importance of reputation in financial markets – The Death of Corporate Reputation. He shows how, in the past, a good reputation was vital for gaining access to US financial markets. But in today’s highly regulated markets, corporate reputation does not really matter to customers. Regulation is supposed to look after customers and, if that does not work, there is always a compensation payout.
And this leads to the third problem – customers have no incentive to be discerning. Before we buy a car, we might consult What Car? or Honest John in the Telegraph. Before we spend £200 on a holiday, we might go to Trip Advisor and spend an hour or so browsing. Is there any chance of a Trip Advisor for financial services? Is it worth checking the reputation of an insurance company before we invest £2,000 a year with it? No. What would be the point? Why spend time checking other people’s experience of a bank, financial adviser or pension provider when the regulator will do the job for you and, if the company does not do as the regulator wishes, the customer will be compensated in any case?
Regulation comes at a huge cost. Not only does it prevent market mechanisms from improving the quality of service provision, it is arbitrary, ad hoc and complex. It prevents innovation, raises risks to firms and therefore costs to customers, and has excluded large numbers of people from the financial advice market altogether.
We have tried binding the sale of financial products up in government red tape. This approach has failed. Perhaps it is time to let caveat emptor reign and the consumer – not the regulator – be king.
Philip Booth is editorial and programme director at the Institute of Economic Affairs, and professor of insurance and risk management at Cass Business School, City University.