BANKS are embroiled in another “mis-selling” scandal, but we can be sure that customer behaviour won’t be affected. Few people will switch bank as a result. Regulation means we are indifferent to how our banks behave. Why? Because we know banks will always be fined for their faults, and we know we’ll always be compensated. There’s no incentive for consumers to punish banks they know have done wrong.
It didn’t have to be this way. The concept of mis-selling is actually relatively new. Until 1986, financial product sales were regulated by contract law – the law relating to the sale of goods and services – and, sometimes, some very specific regulation.
But in 1986, those selling a product became responsible for ensuring it was fit for the customer. This new concept was accompanied by meticulous record keeping and mounds of paperwork for each product sale. Advice did not only have to be good advice, but the seller of a product would have to be able to prove that it was good advice at a later date – perhaps ten years later.
The early mis-selling scandals were caused by government. Pensions mis-selling arose directly from the government retrospectively changing privately-agreed employment contracts, which required employees to join their company pension schemes. It decided that employees should be allowed to exit, leaving millions vulnerable to predatory sales staff. Similarly, the zero-dividend preference share and mortgage endowment scandals were artificial creations of a complex tax system.
Nonetheless, the blame for recent scandals – payment protection insurance and interest rate swaps – lies squarely with banks. Arguably, there is now little benefit in being a discerning customer, or understanding the basic concepts of personal finance. At the same time, regulators are using A-level economics textbook terminology by trying to control markets in the name of preventing “market failure”. They need to have a more sophisticated understanding of how markets really work in practice.
Before restrictive regulation, institutions developed within markets to protect customers. These included mutual building societies, insurance companies, as well as maximum commission agreements. These institutions have been rendered unnecessary or, in some cases, made illegal on the grounds that they were anti-competitive. Financial advice is now closed to effective competition and innovation. Its provision has become a bureaucratic process. Where are the innovations? Where is the TripAdvisor of financial products?
Product sale regulation has been a disaster. We have a nation of people with no incentive to understand the basics of financial products. Worse still, these people have no incentive to find out whether the individuals they are talking to have a good reputation or not. As mis-selling crisis after mis-selling crisis shows, regulation has been a failure, offering no alternative to the proper operation of financial markets.
Philip Booth is editorial and programme director of the Institute of Economic Affairs, and author of Does Britain Need a Financial Regulator?