Economic Theory

Over-regulation risks killing financial innovation at birth

This is an election where the likely outcome is “no change”. There will be no change to the government in office and that government is likely to spend five years doing little except managing Brexit.

In the next five years, it is likely that there will be no radical deregulation – of anything. There will be no simplification of the tax code. Public spending is likely to be squeezed, but only at the margins. Taxes might go up a bit, or down a bit, depending on how rapidly the economy grows. This is not a very exciting prospect and it is also not a good preparation for Brexit.

Such policy stasis will exist despite the fact that changing technology means that there are a number of areas where radical deregulation may bring a surge of innovation. GM crops and other agricultural technologies form one such area; financial services are another.

As the Bank of England’s chief economist Andy Haldane has pointed out, there has been huge growth in the number of financial regulators and the regulatory returns that banks and insurance companies have to make. Regulators seem to generate red tape as an end in itself. Five years ago, the 585 page Mortgage Market Review was followed by 312 pages of feedback and implementation. The result was a mortgage market that worked less well for many people. We now have yet another mortgage market review, but the one certainty is that it will not lead to less regulation. Bureaucracy and compliance are the big growth industries in the City.

Regulators need to take risks with “under-regulation” rather than continually trying to control and perfect markets. Statutory regulation suppresses institutions that can develop within markets and that might be more effective than government regulators.

Would TripAdvisor exist if we regulated hotels like we regulate financial services? One of the great innovations that is happening in markets at the moment is the development of real-time platforms such as Airbnb and Uber that provide information to consumers so that they get the best service from suppliers they have never met before. There are real risks that regulators will prevent innovation that leads to much cheaper products and to entirely new ways of doing business.

It is unlikely that we will get a government that is brave enough to turn the clock back to the 1980s when there was much less government regulation of financial markets. But one obvious way to proceed would be for the next government to instruct the FCA to not regulate financial products in ring-fenced innovative areas. People could then make a choice between the regulated sector and the unregulated sector. That would be a pragmatic way of permitting innovation while still providing protections to those consumers who have become used to them.

There is a glimmer of light – but only a glimmer – with the FCA’s regulatory “sandbox”. This allows the FCA to sanction innovations to take place outside the normal regulatory framework for financial services. However, the guidance for this leads to a situation which is rather like parents allowing their child to go to university, but only if they follow the child and go and live with him in the university hall of residence.

The FCA needs to let go. Innovation may transform our lives and solve many of the problems that regulators seek to manage. And innovation may hugely reduce costs to consumers. It will involve risks. Regulators should allow consumers to take those risks. Perhaps one day, innovation in financial products might be so profound that regulators are put out of a job. That is certainly a risk worth taking.


This article was first published in City AM.

Recommended further reading: ‘Thatcher: The Myth of Deregulation‘.

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

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