The House of Lords last week returned the Financial Services Bill to the House of Commons after completion of the third reading, writes Sarah Parkes. If passed, the Bill would replace the Financial Services Authority with the ‘twin peaks’ regulation of the Financial Conduct Authority (FCA) and the Prudential Regulation Authority. A Financial Policy Committee will be created within the Bank of England to monitor and respond to systemic risks.

• Sarah Parkes, is a pupil at 36 Bedford Row.

The statutory objectives of the FCA will be to secure consumer protection and promote integrity and competition within the financial system. Laudable as these aims may be, it is difficult at this stage to assess the likely efficacy of the Bill in delivering them. The detail is to be left to the bodies themselves. That said, there are differences in opinion about the very architecture of the new regulatory system.

Nowhere have these been more pronounced than on the subject of competition. Lamenting its current state within the sector, Lord Sassoon, an architect of the Bill, recently remarked: ‘One of the mysteries or tragedies of the banking system is how few new entrants there have been over many decades.’ To combat this, the Bill empowers the FCA to refer cases directly to the Competition Commission.

However, Sir Donald Cruickshank, a former chair of the London Stock Exchange, has criticised the Bill as an inadequate mechanism to tackle the strange hold of the big four high street banks. ‘Sir Humphrey lives!’ he said. ‘There are three qualifying phrases before competition is even mentioned.’ Appearing before the cross-party parliamentary commission on banking standards, he argued instead for a specific competition authority for the financial sector, with the power to implement its own rulings.

The drafters of the Bill were right to avoid this kind of reliance on competition as a panacea for the financial sector. Important as it may be, competition needs to be tempered by the potentially conflicting interests of integrity and consumer protection. The Bill retains the principle that consumers should take responsibility for their decisions, but is more paternalistic than the Financial Services and Markets Act 2000.

Competition and innovation can provide effective checks on financial providers. But the unhappy marriage of poor financial literacy and aggressive selling of complex products had quite the opposite effect in the years leading up to the crisis. A recent Which? survey concluded that the pressure amongst sales staff at five major high street banks was worse than ever. 46% reported that they knew colleagues who had mis-sold products in order to meet targets; 81% said that the pressure to meet sales targets had stayed the same or increased since the major mis-selling scandals before the crisis.

Considering the reactive approach of the FSA to mis-selling, Adair Turner remarked, ‘This periodic process of large scale customer detriment and then customer compensation is not an acceptable or sensible model for the future.’ To this end, the FCA’s mandate is a far more pro-active one, encouraging intervention before consumers suffer harm.

An article in Compliance Officer Bulletin earlier this year pointed to research suggesting that consumers struggled to understand products generated in an innovative environment. The interest-only mortgages that helped to fuel the pre-crisis property bubble are a prime example of this. When consumers lack the skills and interest to shop around, it produces a stifling effect on competition: ‘the unfettered pursuit of innovation and its resulting complexity are more likely to make consumers just give up and take whatever is offered.’

In 2009, the OECD reported that financial illiteracy played a major role in aggravating the effects of the crisis (Financial Literacy and Consumer Protection: Overlooked Aspects of the Crisis, OECD, 2009). Although the Money Advice Service was established in 2010 to address this deficiency, it was only six months ago that Parliament first considered a Private Member’s Bill to include financial literacy on the national curriculum. It will not receive its second reading until next year.

The Financial Services Bill contains a number of improvements in top-down regulation of the financial sector. However, the role of consumers themselves in policing the market should not be underestimated. The provision of education to strengthen their role in this regard should be prioritised as highly as the competition objective: there is no point having choices unless they are informed.