The Financial Conduct Authority (FCA) last week published an ‘occasional’ paper describing how behavioural economics can help it understand and solve problems in retail financial markets more effectively.

Behavioural economics uses insights from psychology to explain why people behave the way they do.

The crux of the thinking is that people do not always make choices in a rational and calculated way. In fact, most human decision-making uses thought processes that are intuitive and automatic rather than deliberative and controlled.

The FCA wants to help consumers overcome these behavioural problems when it comes to finance. So what new perspectives on interventions do behavioural economics offer the FCA?

Sponsored

Giving brokers the winning edge

Sponsored by Rely

Dual approach

In its regulation, the FCA is looking to implement two complementary approaches to identifying behavioural risks.

One is looking for specific indicators of likely consumer mistakes. The other is checking for a mismatch between a product’s declared function and consumers’ actual use.

Drilling down into the paper reveals four ways in which the FCA believes it could solve consumers’ behavioural problems.

The first is to provide information. This would mean the FCA requiring firms to provide information in a specific way or banning specific marketing materials or practices, such as the proposed ban on the marketing – or selling – of unregulated collective investment schemes (UCIS) to retail investors.

Many advisers already give clients a range of potential investment, pension or life cover scenarios to choose from as part of their processes, but take note – this is an area the FCA is looking into.

Third involves controlling product distribution, by requiring products to be promoted or sold only through particular channels or only to certain types of clients (see above on UCIS).

Next is to change the ‘choice environment’. This would mean adjusting how choices are presented to consumers.

This article continues…

Continued from previous page…

Finally is the control of products. This would mean the banning of specific product features or whole products that appear designed to exploit consumers, or by requiring products to contain specific features.

Out of these four measures the FCA seems to want to favour the first and second. It calls these ‘nudges’, small prompts that, if designed well, have low costs and can lead to better decisions by consumers – if they are effective in preventing mistakes – without restricting choice.

The FCA is also keen to use behavioural economics to understand how consumers make decisions in order to improve the effectiveness of traditional remedies, such as disclosure.

However, the FCA admits that consumer psychology is nuanced, and specific interventions can succeed or fail based on small details. It therefore wants to test interventions in practice before implementing them.

Pragmatic

FCA chief executive Martin Wheatley (pictured) said in a speech to coincide with the release of the paper that he wants to use behavioural economics to bring a human face to regulation.

“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,” he said.

However, he recognised that this is an area of fledgling expertise and that behavioural economics would not solve every problem – nor should it try to.

“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.”

Clearly behavioural economics is not enough on its own to guarantee good regulation or strong financial products.

But it will form part of the new FCA’s identity, so it may be a good idea to read up on it now so you can get ahead of the game.

>> Find out more
For more information on this subject click here