Red Tape. A lot of government focus in recent years has been on cutting red tape. Sounds good. Sounds intuitive. But despite being overseen by two regulators, ASIC and APRA, and being steeped in regulation, the financial services industry is rife with problems. The Banking Royal Commission has a long way to go, and it is far from clear what types of reform is needed. Less regulation however, is not a likely outcome.
When less regulation works
In the face of ineffective regulators, banks have been de facto self-regulated. As well as common sense, both new and old history tells us that this is not a good idea. Adam Smith, father of free market economics, devoted a whole chapter in The Wealth of Nations to advocating for regulation of the banking sector – although this applied more specifically to risky lending practices.
“Though the principles of the banking trade may appear somewhat abstruse, the practice is capable of being reduced to strict rules. To depart upon any occasion from those rules, in consequence of some flattering speculation of extraordinary gain, is almost always extremely dangerous, and frequently fatal to the banking company which attempts it.”
In more recent history in 2000, at the direction of former MP Joe Hockey, a Treasury Taskforce on Industry Self Regulation tried to identify some of the main industry characteristics that promoted effective self-regulation.
The taskforce determined that industries conducive to self-regulation tend to have the following characteristics:
- Active industry associations where participants contribute resources, consult stakeholders and monitor outcomes
- Strong competition where participants strive to offer compelling products or othersider is losing market share
- Interest in establishing strong relationships with the wider community, not only immediate customers
- Mature industries where rogue participants are more likely to have already been detected and weeded out
Arguably this criteria could apply to a number of heavily regulated industries, banking and other sectors. However, guiding these principles the taskforce also provides the guidance that:
“Self-regulation is most effective where there are clearly defined problems and low risk of serious or widespread harm to consumers. In other words, the consequences of self-regulation failing to resolve a specific problem would not seriously harm consumers. Where there are strong public interest concerns, such as major health and safety issues, and the specific problems are of high risk and/or high frequency then other forms of regulation may be more appropriate.”
Defining a problem clearly before addressing it applies just as easily to direct regulation and pretty much any problem. However, this is often easier said than done.
Spectrum of regulatory responses
When trying to answer what type of regulation should be used in different scenarios, the relatively new phenomenon of the sharing economy provides fruitful fodder.
A government-commissioned Deloitte Access Economics study in 2015 detailed a spectrum of options ranging from none, light touch, self, quasi, co, and explicit regulation.“While explicit regulation can rectify a number of imbalances such as inefficient resource allocation or monopolistic behaviour, it still has a cost.”
While acknowledging that less regulation meant sharing economy businesses had a competitive advantage over traditional business, the report cautioned against using heavy-handed regulation and stifling innovation. In favour of light touch regulation, it noted that sharing economy platforms tended to follow ‘self-imposed rules’ and had stronger ‘reputational mechanisms’ (like two-way customer feedback, ratings) than mature business.
So while explicit regulation can rectify a number of imbalances such as inefficient resource allocation or monopolistic behaviour, it still has a cost. As the UK’s Environment Secretary Michael Grove spruiked in a recent speech, by leaving the EU, Britain would be freed from a myriad of EU regulation constraining innovation. For example, under one widely ridiculed regulation, until 2008 bananas sold in the EU were not allowed to be too bendy.
Where to from here for banking regulation?
The Government recently announced the introduction of a new consumer data right, which aims to make it easier for customers to share their data with third parties like competitors and comparison websites. The idea is that this will promote greater competition and ultimately better products and services. Banking is the first cab off the rank, with energy and telecoms likely to follow in future.
This new measure may mark a change in regulatory strategy – rather than trying to solve problems purely through directly regulating behaviour (which grows increasingly difficult and inefficient to police as circumstances become more complex and widely used), the legislation may tackle problems in the financial sector in other ways, through rectifying information asymmetries and so end users can more effectively monitor their relationship with their providers.
It’s made even more effective by specifically trying to promote access to comparators – the bane of the existence of telecom and utility retailers. These business can do some heavy lifting for consumers, spending the time and developing well-oiled processes going over more technical details to allow consumers to get the best deals – for a nominal fee of course. In conjunction with Adam Smith’s ‘direct rules’, this could be provide some powerful results.
Incidentally, this is also a good political strategy to address some battleground political issues, putting more control in the hands of frustrated customers.
The Royal Commission has a long time to go, followed by another long period of reflection and reform. It’s too soon to tell where the reforms will land. But in the meantime, more data access should start injecting more transparency and clarity into the landscape, hopefully driving positive change in a new way.