Despite years of regulatory reform, there is a long way to go before we can say UK financial markets work well enough to meet the needs of UK households, the real economy and wider society. The scale of the task can be seen in the Financial Inclusion Centre’s Policy and Risk Outlook which identified nearly 30 priority policy issues and risks that must be tackled to make markets work – see Financial Inclusion Centre policy and risk outlook 2016 final.
To be fair, in 2016 we saw some progress in certain areas which we hope can be built upon. But what can we expect in 2017?
For example, consumers now have a legal right of access to a basic bank account as a result of EU legislation. Moreover, banks introduced fee-free basic bank accounts last year. But there is still work to be done on access to banking services. Banks need to do more to ensure that customers are transferred to the new model basic bank accounts, while regulators must be more transparent on which banks are complying properly with the legal right of access provisions.
At a more fundamental level, we still need to have a frank and open debate about what we expect from banking. Consumer advocates seem to want banks to maintain an extensive branch network, introduce innovative fintech services, and retain the free-if-in-credit current account model. All the while, banks are having to deal with huge legacy redress cases and expensive, creaking IT systems, low financial returns and compete with more agile, newer rivals. Something has to give. We hope 2017 sees that frank and open debate.
The introduction of automatic enrolment (AE) and NEST in pensions has been one of the few genuine public policy successes of recent years. But, much more needs to be done to ensure people are saving enough for retirement. Critically, we need major policy reform to help the millions of people in insecure employment (such as the self-employed and zero-hours contracts workers) save for retirement. Moreover, the pensions ‘freedom and choice’ reforms threaten to reverse progress, exposing consumers to much greater market, longevity, and misselling risks and pushing up the cost of saving for retirement. Consumers will need good value, safer, default retirement options from trustworthy providers.
We have seen encouraging developments in the credit union sector with some innovative credit unions launching more flexible, accessible financial products. But, the community lending sector remains marginal and renewed efforts are needed to scale up the capacity of the sector if it is to meet consumers’ needs for fair, accessible and affordable credit. Moreover, following its success in the payday lending market, the Financial Conduct Authority (FCA) needs to clamp down on unfair overdraft charges and practices in other ‘sub-prime’ sectors such as rent-to-own, and the reselling of consumer debts.
We have made little progress on building household financial resilience and long term financial security. There is a significant problem with legacy credit card debt and we are seeing noticeable increases in household debt again. Moreover, the household savings ratio has fallen to worrying levels. Clearly, much needs to be done in 2017 to prevent a further deterioration in household finances and to start building financial resilience.
It would churlish to deny that standards of behaviour in retail financial services have improved, driven primarily by tougher conduct of business regulation applied by the FCA. These gains will have to be defended against the deregulation agenda which will gain momentum from Brexit in 2017 (see below).
Similarly, the Bank of England and Prudential Regulation Authority (PRA) have done much to introduce regulation to promote financial stability and improve the prudential regulation of our major financial institutions. Of course, we will not actually know if these reforms are sufficient until faced with another 2007-08 style financial crisis. Let’s hope it doesn’t come to this. But, new risks have emerged driven by investors ‘searching for yield’ in the era of low interest rates (itself a response to the financial crisis). These risks have not been evaluated properly and, as a result, have not been mitigated.
The FCA is also consulting on its ‘mission’. The response to this will guide the FCA’s philosophy and approach over the coming years. This is a big moment for consumer advocates particularly those who represent the interests of vulnerable consumers as the FCA is considering whether it should prioritise vulnerable consumers. But, there are obvious risks, too. The whole debate about the balance of responsibilities between regulators, firms and consumers for protecting consumers has been re-opened. There is a clear risk that the balance will shift back to consumers – again Brexit could provide the extra impetus for deregulation.
While standards of conduct have improved, this has yet to translate into improved consumer confidence and trust. Low levels of consumer confidence and trust remain a serious problem for government, regulators, consumers and, of course, the industry itself. Low levels of confidence undermines consumers’ willingness to engage with financial services which means they are less likely to provide for a pension, save for the future, protect their incomes and contents and so on. The industry has to work harder to persuade consumers to buy financial products which pushes up the cost of distributing products and services. Competition is undermined as consumers are unwilling to shop around and differentiate between good and bad brands, seeing them all as bad as each other. We hope 2017 will see renewed efforts to improve consumer confidence and trust in this critical sector. Maintaining effective regulation will be a pre-requisite.
But, it is not all down to regulation. Our ‘theory of change’ for improving markets is based on the holy trinity of good regulation, good competition, and good corporate governance and business ethics. We hope 2017 will see more effective competition coming into the market. The more far sighted leaders in the financial sector understand what’s at stake if confidence is not restored and maintained, and we hope they will continue their efforts to to improve standards of corporate governance and business ethics.
Overall, it looks like 2017 will be a big year on the consumer protection and conduct of business fronts. Hard won gains are under threat.
But, at least there are gains to be protected on consumer protection and conduct of business fronts. We have seen little progress on the major structural problems which beset the UK financial sector – particularly the sector’s inefficiency, poor economic and social utility and tackling the externalities created by financial market activities.
Households are expected to use financial products and services to build financial resilience and long term financial security. But, much of the industry has not adapted to the new economic and financial reality forged by low returns, technological change, more realistic regulation, changing labour markets, and squeezed household finances. The industry is becoming less relevant for growing numbers of economically vulnerable households. It is difficult to see how we can avoid greater levels of financial exclusion in the longer term unless we develop alternative, more efficient, flexible business models, products and services.
In this new economic and financial reality, the industry will struggle to deliver fair value products for middle-income households, too. In an era of low returns, the priorities for providers and intermediaries such as financial advisers will be to drive down costs, promote long term thinking, and improve the way risk and reward is communicated to consumers.
Financial services isn’t just a pure consumer issue. The financial sector already plays a role in meeting public policy needs such as housing, retirement incomes, long term care, and social security replacement. This role is expected to increase over the years as policymakers attempt to transfer risk and responsibility for meeting these needs to citizens. But, the financial services industry is struggling to provide the flexible, good value, trusted products and services people need.
The housing crisis has been well documented. In parts of the UK, people face a real shortage of decent, affordable homes, and sky-high rents. In comparison to financial consumers, renters have very little consumer protection from exploitative or abusive market practices. The housing crisis can be partly explained by financial market behaviours. Huge amounts of credit were created in the financial markets and then pumped into housing market which, in the absence of sufficient supply, simply had the effect of pushing up prices beyond the reach of many.
But, the financial sector is now shaping up to try to take advantage of the very housing market failure it helped create. Large institutional investors such as pension funds, insurance companies and hedge funds are lobbying for the opportunity to build homes for rent. At a time when the returns on safe assets such as gilts (government bonds) are low, investing in homes for rent is an attractive proposition. But, while this might be good news for institutional investors, it would be bad news for renters and for taxpayers. Renters will end up paying more on rent than if the state had used its financial clout to borrow cheaply to invest in building homes. Taxpayers will suffer too if higher rents result in higher amounts of housing benefit being paid to support private renters.
Sitting behind retail financial services are the huge wholesale and institutional financial markets and financial infrastructures. These markets and infrastructures are of national economic interest. Despite their importance, wholesale and institutional financial markets receive comparatively little scrutiny from civil society. The economic and social utility of financial markets needs to be challenged. Nor do we have the mechanisms in place to deal with the externality costs created by financial markets.
We have only begun to understand the conduct failures in these critically important markets. Inefficiencies and market failure (such as resource misallocation and poor investment performance which undermines retirement incomes) in these sectors have a greater impact on the economic welfare of households and the real economy than failures in retail financial services.
The range and scale of market failure in the asset management sector still has the power to shock as the evidence in the FCA’s interim report shows. The regulator’s report has deservedly attracted many plaudits from civil society groups. The FCA has proposed some interesting, and potentially effective, remedies to tackle the market failure identified in the report. The scale of market failure means that conventional remedies such as greater transparency and information disclosure (which competition regulators tend to favour) will not work.
Far reaching interventions are needed to tackle the embedded conflicts of interests and structural flaws in the sector. But the asset managers will fight tooth and nail to prevent structural interventions no doubt arguing that serious reform is not advisable given the potential impact of Brexit on the sector. Consumer and civil society groups scored great successes in cleaning up the banking and insurance sectors (think PPI, with-profits, mortgage endowments). They will now need to turn their attention to the asset management sector and maintain pressure on the regulator in 2017 if the necessary reform is to happen.
Behaviour and activities in financial markets continue to create systemic risks and threaten economic resilience. Financial markets have been criticised for misallocating resources on a grand scale, channeling resources to speculative, short term investment opportunities and economically unproductive activities rather than to the most economically productive and socially useful activities. Financial markets can exacerbate regional, intra and inter-generational economic inequality.
Market failure doesn’t just harm consumers, it can harm the interests of firms – for example, high charges on investment funds extract value from consumers’ savings and reduce the amount of investment capital that reaches firms. Market short-termism affects the ability of firms to invest for the long term.
The UK has a very well developed system of regulation for promoting financial stability, prudential regulation, and supervising conduct in financial markets (albeit hitherto mainly focused on retail financial services). But, serious problems and gaps in the regulatory system remain.
The approach to competition followed by UK regulators is flawed. It remains based on demand side interventions in the hope that influencing consumer behaviour will in turn improve corporate behaviour – despite the evidence of history that this has very limited effect. 2017 would be a good time to rethink competition policy in financial services.
More fundamentally, we do not have the institutional regulatory framework to develop and implement policies to improve the economic and social utility of financial markets or deal with the externalities created. We hope 2017 sees consumer and civil society groups turn their attentions to these critical financial markets.
That is the state of play now. Financial markets and services are not working well for society. On top of this, we now have Brexit to contend with. The shock of Brexit happened in 2016. But, to use a well-worn cliche, the devil will be in the detail and it is 2017 when we will to start to get a sense of the implications for EU-derived legislation. It all depends on which form of Brexit the UK adopts (or to be precise is forced to adopt by the EU). This could range from ‘Brexit-lite’ to ‘hard-Brexit’.
Hard-Brexit could be potentially very damaging to UK financial consumers and households through the loss of valuable consumer protection measures and the creation of new financial stability risks. Moreover, Brexit risks causing ‘policy blight’ in the Government and regulatory agencies. Senior decision makers will be focusing on Brexit and there may be less time and resource dedicated to dealing with the ongoing market and public policy crises described here.
Perhaps there is a silver lining? Perhaps Brexit provides an opportunity for a fundamental rethink of the role of the UK financial sector and how it is regulated so that it serves the interests of society – a chance to take back control of financial markets?
But, we’re not holding out much hope on this. Brexit provides the ideal opportunity for financial sector lobbyists to push hard for deregulation. The chances are that any ‘taking back of control’ will involve an already powerful financial sector having greater control over its own destiny outside the purview of the EU (which has a more social justice, interventionist approach to making markets work).
Understanding what is at stake and hard-wiring consumer rights and financial regulation into UK law pre-Brexit must be a priority for consumer and civil society groups in 2017.
So, it looks like 2017 is shaping up to be another busy year for campaigners in financial services – with Brexit on the horizon, perhaps the most critical year in a long time. As a small, non-profit organisation we have limited resources so would welcome the opportunity to work with other civil society organisations, regulators and progressive firms in the industry to make markets work better.