Improving financial services regulators" cost-benefit analyses

The banking and finance sector is a prime example of a ?meta-sector?. It is instrumental in supporting activity in other sectors such as hospitality or manufacturing through services including lending and payments processing. As a result, those industries? successes are banking and finance's successes and their risks are lenders? risks to bear too. Equally, it is well known that many of the risks inherent to banking and finance can, if not carefully managed, spill over into other sectors. This interdependency means that the regulation of banking and finance has far-reaching implications beyond just the sector itself.

This makes it all the more crucial that financial services regulators carefully consider the potential costs and benefits of their interventions before any formal or informal rule-making.

Avantage Reply worked with UK Finance to review the practices in relation to regulators? cost-benefit analyses (CBAs) and developed a set of recommendations for consideration by HM Treasury as part of its financial services future regulatory framework review. In doing so, we reviewed a broad range of practices across financial services and non-financial services regulators, both in the UK and outside.

This research, supplemented by discussions with the industry, led to our making the following key recommendations in the resulting policy paper:

1. Financial services regulators should conduct CBAs for all interventions, not just formal rule-making, because not mandating CBAs can lead to an incomplete assessment of their impact. Exceptions should only be made for significant extenuating circumstances, and not merely on grounds of impracticality.

2: CBAs should be based on cumulative assessments. Financial services markets are complex and operate within a multi-agency regulatory landscape. The underlying complexities of these markets cannot be fully assessed through static or standalone CBAs that focus on the immediate impacts of single policy proposals by a single regulator.

3: CBAs should not be focused solely on one potential option or policy approach but should instead analyse a full spectrum of options, from ?do nothing? to formal rulemaking. Within this analysis, options to adopt non-regulatory solutions or to improve supervision and better enforce current rules and guidance should be considered.

4: Like all forward-looking assessments, CBAs are typically based on a number of assumptions and are subject to limitations. Therefore, it is important for CBAs to undertake an appropriate sensitivity analysis of options to assess the range of benefits and costs under different scenarios.

5: Where proposed interventions would mandate or promote the provision of new products or services, CBAs would be improved by undertaking market assessments that demonstrate there is enough interest in supplying and consuming them. This could prevent regulators from considering policy options that are ineffective because of inadequate market acceptance.

6: When undertaking CBAs, regulators should consider whether rules with the same policy objective exist in other jurisdictions (e.g. the EU and the US) to promote consistency with other financial centres. This is significant for financial services firms operating across geographies and to avoid regulatory arbitrage.

7: We believe that CBAs conducted by regulators should be subject to appropriate independent scrutiny. There is a range of potential approaches to independently scrutinise CBAs, from internal reviews to external scrutiny by an independent body.

All these recommendations do not operate in a vacuum but interact with and reinforce each other. We believe that if the future regulatory-framework were to adopt these measures, financial services regulators? CBAs, and therefore the effectiveness of their interventions, would be significantly enhanced.

For more details, please refer to our full publication or reach out to and