FCA publishes occasional papers on behavioural economics exploring how people make financial decisions

The Financial Conduct Authority (FCA) has published two occasional papers on behavioural economics to explore how people make financial decisions.

The FCA is interested in behavioural economics as it 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 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.

The launch of today’s papers is a first crucial step towards ensuring that the promise and delivery of financial products are more closely linked.

Later today Martin Wheatley, FCA chief executive, will speak at the London School of Economics in his first speech since the FCA came into operation on 1 April 2013.

In his speech Martin will summarise 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’, Martin will note that suggesting consumers are ultimately responsible for making poor decisions has its limitations. He will say:

“‘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.”

Martin will also outline his vision for how behavioural economics will be used by the FCA, and how he hopes firms will act in future:

“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.

A better understanding of how customers make decisions will also improve competition, Martin will say:

“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.”

But Martin will also recognise 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.

“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.”

Notes for Editors

  1. The occasional papers Applying behavioural economics at the Financial Conduct Authority and Encouraging consumers to claim redress: evidence from a field trial.
  2. The full speech will be published on the FCA website later today.
  3. On the 1 April 2013 the Financial Conduct Authority (FCA) became responsible for the conduct supervision of all regulated financial firms and the prudential supervision of those not supervised by the Prudential Regulation Authority (PRA).
  4. The FCA has an overarching strategic objective of ensuring the relevant markets function well. To support this it has three operational objectives: to secure an appropriate degree of protection for consumers; to protect and enhance the integrity of the UK financial system; and to promote effective competition in the interests of consumers.
  5. Find out more information about the FCA, as well as how it is different to the PRA.