Financial services, financial firms and financial markets are regulated to a greater extent than most other products and services. Financial service regulation goes back centuries
It provides benefits to governments (for example, from direct and indirect taxation of banks) and to regulated financial institutions (which gain where entry is restricted).
Consumer protection is a common reason given for financial regulation. But consumers in financial markets are probably less subject to fraud, misrepresentation, discrimination and information asymmetry than consumers of other products.
Concern about ‘negative externalities’ (costs born by others) is another argument for regulation. However, on examination it is clear there are few genuine externalities.
Regulations on externality grounds is justified only for financial institutions which hold government-insured deposits; for insurance companies which provide government-mandated non-contracting third party insurance ) for instance, for cars); and for companies which underwrite long-term life insurance and annuities.
Financial regulation incurs costs, borne by consumers and taxpayers, which probably exceed the benefits they receive. There are substantial unintended costs (such as reduced diversification of financial institutions and the absence of less costly and more innovative products because of restrictions on entry to financial markets).
An ‘optimal’ regulatory system’ for banks would involve substantial capital requirements, periodic reporting of assets, liabilities and capital and a ‘structured early intervention’ system for the authorities.
For government-mandated third party liability insurance, life insurance and annuities, insurance companies should be subject to capital requirements similar to those for banks.
If governments wish to protect consumers of financial products the best procedure is to establish an Ombudsman to which consumers who feel they have been mistreated can go.
The proposed regulatory system ‘â€¿would be almost costless to taxpayers, the regulated companies and consumers of their products and services.’ Compared with existing regimes, it has the great advantage of not restricting entry to financial markets nor the introduction of new products.
1998, Hobart Papers 135, ISBN 0 255 36415 6, 130pp, PB