Why Regulate Financial Services?
CHRIS FORD AND JOHN KAY
One of the first things that strikes someone with a background in utilities regulation is the sheer extent of financial services regulation. Any one who wishes to offer investment advice must be authorised under the Financial Services Act 1986 (FSA); any one who takes deposits requires approval from the Bank of England -- apart, of course, from building societies who are regulated by their own Commission; insurance companies are regulated both by the DTI and under the FSA. As a result, whereas the typical utility regulator deals with few firms -- OFWAT regulates 31 and OFGAS and OFTEL are largely concerned with one alone -- the Personal Investment Authority has some 5,000 members ranging from sole traders to some of Britain's largest companies.
There is an equally marked contrast in the regulators' attitudes towards the entry of new firms. In general, utilities regulators actively seek to promote increased competition. Regulation is intended to control the prices a dominant company charges -- both to consumers and to other firms. This should allow such firms access to a network at reasonable cost. Whatever one's views about the success of the utility regulators, it is clearly a very different task from that adopted by financial services regulators.
Here the emphasis is less on promoting competition and restricting prices; more on controlling entry and behaviour. Firms must be 'fit and proper'; satisfy capital adequacy standards; and provide 'best advice'. Far from focusing attention on those firms that might be in a position to abuse market power, the costs of financial services regulation appear to fall disproportionately on smaller firms.
The objectives and origins of financial services regulation are not the same as those of utility regulators. We describe these differences further below. But the differences in regulatory approach and philosophy go far beyond those that these distinct objectives and origins would imply. The basic differences are that financial services regulation is principally aimed at process, and utility regulation at outcome. Utility regulators have a view of the structure of the industry they seek to bring about, and measure their