The Financial Conduct Authority (FCA) has published two occasional papers on behavioural economics to explore how people make financial decisions.
The FCA says behavioural economics can help the regulator understand the mistakes consumers make, how firms respond to these mistakes, how this affects competition, and what interventions the FCA might consider.
The occasional papers Applying behavioural economics at the Financial Conduct Authority and Encouraging consumers to claim redress: evidence from a field trial can be found on the FCA website.
The first paper focusses on how consumers choose and use financial products, and how behavioural biases can lead to firms competing in ways that are not in the interests of consumers. The second explores how best to encourage consumers to respond to customer contact letters. The papers are the first in the FCA’s occasional paper series.
Martin Wheatley, FCA chief executive, spoke yesterday at the London School of Economics in his first speech since the FCA came into operation on 1 April 2013.
He summarised the challenges facing the financial services industry: “One of the most significant challenges for modern financial regulators and financial services alike is to recognise that we operate within a very human environment. A fallible world – not just of ratios and complex models but also responses, sometimes flawed, that behavioural economics helps us understand.
“Regulators have a choice as to how they handle these kind of challenges. There is a question of how a regulator navigates the balance of power between consumer and provider.”
Touching on the concept of caveat emptor, or ‘buyer beware’, Wheatley noted that suggesting consumers are ultimately responsible for making poor decisions has its limitations.
He said: “‘Buyer beware’ becomes hard to defend when unsophisticated customers are buying seriously complicated financial products, where the risk of failure is far more dangerous than a decision in the supermarket to buy three bananas instead of one.
“There are questions that many investors simply will not ask because they are humans, not automatons.”
He added: “I want the FCA to bring a more human face to the regulation of financial services; a more pragmatic approach to regulation. Not only to defend against sharp practice but also to encourage better decision making among consumers.
“The best financial service companies, the most consumer-focussed, go to considerable pains to make sure their customers are steered towards the best products and the most suitable. We should applaud these firms and learn from them.”The FCA wants to make sure customers are far more easily able to compare product prices and to assess their value. We want the regulatory system to use behavioural economics to ascertain whether people are being put off switching products through inertia, inattention or even the simple fear of regret from making a wrong decision.
“We should not pretend this is a straightforward discipline. There is no mechanical routine to follow when we apply behavioural economics to regulation. It will require us to change the way we identify risks, diagnose problems and troubleshoot.
“It’s also worth pointing out that behavioural economics is not enough, on its own, to guarantee good regulation or strong financial products. It is a part only of the new FCA’s identity.”
