Dealing with the zombie myth that regulation causes financial exclusion and stifles innovation

As I was saying the other day, the consumer credit industry is using the same tactics and arguments as the investment industry to push for regulatory ‘reform’. Assertions about overregulation creating financial exclusion, stifling financial innovation, and undermining competitiveness of UK financial sector. It’s all here in this manifesto from the Finance and Leasing Association FLA Manifesto 2024 (adobe.com)

There is even the predictable assertion that the Financial Ombudsman Service (FOS) is overstepping its remit. While at Which? back in the day, we campaigned for the establishment of an independent FOS. The FOS was established in 2001. Since then, I’ve heard this assertion repeated regularly.

Progress is under threat

The problem is that the Government is listening to these arguments. There is a clear financial deregulation agenda underway and the Government has imposed a secondary growth and competitiveness on the main financial regulators. Regulators will now have to champion the growth and competitiveness of finance. And, of course, this gives industry lobbies a great opportunity to assert that regulation is harming growth and competitiveness of the sector.

In key areas, the progress we have made over the years in protecting consumers and cleaning up financial services is under serious threat. Worryingly, Labour – almost certain to form the next government – fully supports this deregulation agenda and champions the financial sector even more fervently than the Government. Politicians from both major parties seem to have forgotten the painful lesson from history that allowing finance to become dominant and prioritising growth in credit leads to crises.

Regulation does not cause financial exclusion

Let’s get this straight. Regulation does not cause financial exclusion. Exclusion happens because people don't have enough money to buy financial products and a for-profit finance industry cannot serve millions of consumers.

It is true that prior to meaningful consumer protection being implemented, financial firms did sell higher volumes of unsuitable and costly investment and consumer credit products.

But, selling high volumes of unsuitable, rip-off products is not inclusion. What regulation has done is ensure that financial firms sell products on fairer, more sustainable terms. Regulation has exposed this reality that the commercial financial services industry just cannot serve large sections of society on terms that make sense to both consumers and the industry.

We do need to find ways to promote access to affordable, appropriate, and sustainable credit for those the market currently cannot serve. We should look at ways of enhancing the way data is used so that lenders make better decisions. We need to develop alternative, non-profit forms of credit provision. The answer is definitely not to reduce consumer protection to artificially reduce costs for the for-profit lending industry.

It is true that consumers are turning to unregulated credit such as buy now, pay later (BNPL). But, again, the answer is not to weaken consumer protection on regulated products. The growth in BNPL is a repeat of the growth in payday lending. Payday lending exploded because it was poorly regulated. We should learn the lessons and level up consumer protection, not level down.

We have a regulatory system which is slow and unresponsive to emerging threats mainly because the FCA has to wait for government to give it powers to regulate ‘innovations’. It doesn’t have to be this way. We could move to a system of purpose-based regulation where general categories of financial activity are defined in law and ‘innovations’ are presumed to fall within one of those categories with the FCA fast tracking consultation on the detail of regulation.

Nor does regulation stifle innovation

The argument that regulation stifles financial innovation is risible. There is a big difference between socially useful innovation that meets consumers’ needs and a proliferation of products that are just variations on a theme, or 'innovated' to create a sales and marketing opportunity for firms. I cannot think of any genuinely socially useful financial innovations that regulation has prevented from getting to market.

If anything, regulation helps improve the quality of products and services as it forces firms to think about the potential harm that an innovation might cause. Let’s hope the FCA robustly enforces its flagship Consumer Duty initiative and stands firm against these claims that regulation is stifling innovation and competitiveness.

The myth of regulatory ‘burdens’

What about these claims that regulation adds costs for firms and customers, that regulation is a ‘burden’? This is another complaint I’ve heard on a regular basis over the years. This argument is disingenuous or just reflects a lack of understanding of how the cost of doing business has been conflated with regulatory costs.

Much of the detail in the regulatory handbook has been driven by industry demands for the FCA to clarify and codify what regulation is intended to deliver. It is remarkable that the financial regulator has to tell financial firms what well run businesses should be doing.

Moreover, even if the FCA did not exist, firms that are well run would still have to follow the rules and guidance currently codified in regulation – the difference being that this would be internalised rather than externally codified by the regulator. So, the idea that actual compliance costs can be significantly reduced – at least for well run businesses – just doesn’t stand up to scrutiny. ?

Finance lobbies complain about the FCA being too prescriptive and not giving enough direction on what firms are and aren’t allowed to do. I explain this in more detail in this article. Will the FCA's Consumer Duty have a long-term impact? | LinkedIn

Conclusion

So, the zombie myth that regulation causes exclusion and stifles innovation is resurrected yet again. In the past, campaigners have seen it off. Unfortunately, this time politicians from both main parties have fallen for this myth and think that regulation is a major barrier to financial inclusion, innovation, and competitiveness. For the first time in a long time, I am genuinely worried that the progress we have made in making financial markets work is at risk of being reversed. Let's hope I'm wrong.

February 2024