Economic Rationale for Financial Regulation
People and firms depend on the financial market to conduct even the most basic tasks. Businesses acquire loans from financial institutions for expansion, and the average consumer needs to constantly withdraw funds from their accounts to pay for goods and services. The global economy relies on the sturdiness of the financial system hence the need for its regulation. Financial regulations are the directives and legal guidelines that dictate the conduct of financial corporations (Prasanna et al., 2019). Bank runs are due to either a lack of regulatory entities or their inefficiency. Furthermore, the existence of information gaps between the various players in the financial market hence the need for a third party to safeguard the consumer’s welfare (Prasanna et al., 2019). The economic rationale for financial policing lies in the sensitivity of the financial system, boosting customer credence, amending market defects, and reducing surveillance costs,
Sensitivity of the Financial System
The effects emanating from the collapse of a banking institution creep into the entire financial system. If a bank runs bankrupt, the customers of other banks may fear losing their money and withdraw their savings. As a result, the banks will have no excess reserves to give out loans to potential investors, causing an economic slowdown (Prasanna et al., 2019). Additionally, when a financial institution collapses, the common man is the one that suffers, as most of these firms are registered companies with separate legal entities (Trapanese, 2021). The public spends a substantial amount of funds to rescue a failing financial company and the tax burden may spread to generations to come. People do not deserve to carry weights that they are too heavy to bear hence the need for regulation. Monetary laws ensure the soundness of these institutions by monitoring their cash flow continuously (Prasanna et al., 2019). Monitoring of financial corporations’ activities and injections prevents insolvency, which may cause bank runs and affect the economy negatively.
Amending Market Defects
Consequently, financial markets operate under either monopolistic competition or oligopolistic market structures. There exists an information imbalance under these structures, giving one party an advantage over the other (Trapanese, 2021). The perfect competition allows producers to produce their goods and services without external interference. Subsequently, the price in the market reflects the real cost of production hence pareto efficiency. However, due to the sensitive nature of the commodities produced by the financial companies, having the government in the financial market is unavoidable. There is no perfect information in financial markets as the customer has less information than the institution and the complexities associated with some financial instruments make it difficult for a client to evaluate their quality correctly. Additionally, if the customers decide to appoint the financial institution to act on their behalf, the company may seek its interest rather than the good of the party it represents (Prasanna et al., 2019). Legislation backs consumers and forces financial institutions to act in a manner that benefits the principal. Regulatory authorities force public financial institutions to make their records public, providing the public with information on their financial position, which approximates the quality of their financial instruments.
Reducing Surveillance Cost
In addition to amending market defects, the financial regulatory authorities proctor the activities and behavior of financial institutions due to the nature of their service. Like any other company, the consumers, owners, and valuation entities would be forced to surveil the actions of financial institutions to ensure they serve their interests (Prasanna et al., 2019). If each party were to monitor these firms on their own, they would incur high costs, free riding, and hurdles to accessing the financial information of these companies. Statutory bodies ensure that consumers and other parties avoid paying copious amounts for similar services, lowering the information costs (Prasanna et al., 2019). They are also more proficient, enjoy economies of scale from surveilling many firms and have the power to force financial institutions to alter behavior in case of whistleblowing (Prasanna et al., 2019). Financial regulation reduces the free-riding problem and the surveillance cost.
Boosting Consumer Credence
Moreover, another economic reason for financial regulation is to enhance consumer credence in the financial market. A customer can hardly determine the caliber of a financial asset when buying it as time reveals its trends and actual market value (Prasanna et al., 2019). As such, a risk-averse buyer will refrain from acquiring financial instruments due to the information gaps regarding profitable and non-profitable assets. The inefficiency will push the risk-avoidant customer away from the financial market, leading to its crush (Prasanna et al., 2019). For instance, in 1994 and 1995, there was a significant decrease in sales of life assurance and retirement benefit schemes due to successive impropriety and precarious vending activities (Prasanna et al., 2019). Financial governance provides customers with autonomous confidence in the conditions of a contractual agreement, the security of its instrument, and the standard of counsel, increasing the level of investments and accumulation of funds in the financial markets.
Effectiveness of the Regulatory Structure of the UK Financial Sector
The regulatory structure of the United Kingdom (UK) financial sector is quite effective in governing the UK financial system. The basis of the UK financial, and legislative make-up is the Financial Services and Market Act 2000 (FSMA) (James & Quaglia, 2019). However, the UK left the European Union in early 2020, leading to the adoption and restructuring of some of the financial services laws. Evaluating the effectiveness of the UK regulatory structure helps to show its competency. Each of the legislative agencies has been effective in streamlining the UK’s financial system. The figure below shows a diagrammatic representation of the UK’s regulatory framework.
FCA and PRA
The Financial Conduct Authority (FCA) oversees the actions of financial corporations, while the Prudential Regulatory Authority (PRA) auspices the economic administration and legislation of bank and non-bank corporations. The FCA and PRA have shown their willingness warrants consumer protection by forcing financial institutions to work in their client’s favor (James & Quaglia, 2020). Recently, the FCA took the insurance companies to court for refusing to pay businesses adversely affected by the COVID-19 pandemic (Trapanese, 2021). The court ruled in favor of the FCA, and numerous businesses were compensated and are on their way to recovery from their decline. However, they have been complaints of the agencies acting in favor of the big financial institutions and failing to protect the consumers’ interests. The government is working to develop structures that will increase transparency to foster customer welfare.
The BoE
The BoE oversees the financial market, especially the banking institution. The entity effectively makes monetary policy policies and enforces them through the banking institutions. The discount rate set by the Monetary Policy Committee for the BoE to give loans to banks in the UK is 1.25%, which is very low, fostering liquidity of banks and the availability of excess reserves for lending to the public (Trapanese, 2021). The BoE is also keen to make certain that its currency remains stable to avoid capital flight. Currently, the sterling pound is the most robust and rates 12.8% of day-to-day foreign economic activity (James & Quaglia, 2020). The BoE is effective in fostering confidence in the sterling pound and its financial markets.
The PSR and CMA
In addition to that, the PSR oversees accredited payment companies to ensure the safety of the consumers. The PSR holds webinars with the public to ensure their involvement in creating robust payment systems that best suit their needs (James & Quaglia, 2020). The PSR faces lags in decision-making as public feedback is time-consuming, reducing its efficiency. The CMA guarantees competitiveness in the financial sector (James & Quaglia, 2019). However, the CMA is yet to establish a truly competitive financial market as the large institutions influence key aspects of the industry due to their large capital base, leaving the small companies with no option but to go along.
The rationale for Current Organization of Financial Regulation in the UK
The UK is still finding its footing in the financial sector following its exit from the EU. Before Brexit, the UK used the regulation of the EU within its borders. However, since it declared its autonomy, the country had to examine the suitability of those regulations in the changing times. Britain had to consider a range of factors, such as the ability of the existing firms to adapt and the economic ties it has with the EU, before revolutionizing its financial sector (James & Quaglia, 2019). The UK has taken on some of the EU’s financial regulations. The rationale for the present structuring of financial control in the UK aims at streamlining operations, reducing bureaucracy, and embracing alterations in the financial markets.
Streamlining Operations between UK and EU
The UK aims to make financial operations between itself and the EU as seamless as possible. The country has adopted some of the EU’s legislation directly and has taken some into the Britain law (James & Quaglia, 2019). Some financial firms conduct activities in the UK and EU countries and changing all the policies will interrupt their business activities and negatively impact the economy. The UK has taken on Acts such as those for the capital requirement, market infrastructure, and payment services (Ahir & James, 2021). Furthermore, the UK can compel changes progressively to the adopted legislation, allowing time for the business to absorb the changes.
Reducing Bureaucracy in Regulation
Too much regulation signifies an increase in costs to consumers. Some potential investors may be scared away from setting up financial institutions due to heavy paperwork and legal approval (James & Quaglia, 2019). For instance, the UK has done away with the passport requirement. Passporting requires that a firm from outside the EU that wants to conduct its operations within its jurisdiction register before commencing its activities (James & Quaglia, 2019). These companies can now operate within the UK without registering as a company there. The current regulatory structure encourages lucid stipulation of directives founded on desired results to evade extreme red tape.
Embracing Alterations
In the same light, new financial instruments are creeping into the financial market, necessitating a broader regulatory framework. The onset of bitcoins and other cryptocurrencies requires new policies to be composed for consumer protection (Trapanese, 2021). The world is slowly moving towards using tokens for transactions. Automation in the financial sector is quickly gaining popularity and is essential for the survival of the firms within that industry (Ahir & James, 2021). The UK regulation structure encourages invention and creativity to keep its sector ahead in global competition.
Impact of Brexit on UK Financial Regulation
Brexit has notably affected the UK financial regulation. Britain has had to alter some of the laws from the EU to gain a competitive edge in the global sphere. (James & Quaglia, 2019). However, the departure has made the UK independent, and it may not be able to enjoy some of the benefits that may accrue from the EU’s favorable legislation. As such, some firms consider some of the UK laws unfavorable, especially when they make losses. Brexit has increased innovation in the UK financial regulation and has led to laws that expand its system (Ahir & James, 2021). Britain envisions a financial legislation structure that is sustainable and more transparent.
Expansion
Brexit has enabled the UK to formulate policies that foster extraterritorial financial services. Recently, the UK proposed Equivalence, which permits firms certified by comparable authorities to operate in the UK or EU without further approval. The contract allows the member countries to review the firm’s operations and gives them the potency to revoke it within 30 days (Pennesi, 2022). The EU is yet to concede to the Equivalence, making it difficult for companies in the UK to conduct operations in the EU. As a result, numerous firms have shifted to the EU to establish their businesses for ease. All is not lost, as the UK stands a chance of recovering through the Overseas Persons Exclusion, which saves foreign firms the unnecessary strain of getting a license to operate within the UK (Ahir & James, 2021). Concessions with the Swiss and Japan for open borders between these states will ease cross-border trade (Ahir & James, 2021). The legislative framework for international financial trading will increase the country’s revenues.
Innovation
In addition to the regulation that enables expansion, Brexit encouraged the UK to enhance innovation in its financial system. Several financial firms around the globe have lost resources and their clientele’s confidence due to cyber-attacks necessitating the need for a more security. However, mechanization requires heavy funding due to its heavy infrastructure. The UK has proposals in place to draw funding for sole financial technology and elevate UK’s rank as an international tech hub (Ahir & James, 2021). Financial innovations also present risks to the regulation as they could also be a tool for fostering fraud in the legislation due to a lack of proper surveillance systems. The emergence of a comprehensible and congruous worldwide UK enterprise blueprint in connection with fintech and virtual issues will improve the current and forthcoming financial contracts, placing the UK ahead in the global scope. Digitization revamps fiscal mechanization and enhances customer service and the efficacy of the financial system.
Sustainability
Following Brexit, the UK has incorporated the sustainability report as a reporting requirement for financial institutions. One of the Millennium Development Goals is moving towards a greener society and the Brexit allowed the UK to be part of the mission fully. The goal of the UK regulation is to reduce the environmental impact of its financial system to null by 2050 (James & Quaglia, 2020). UK’s regulators require each firm to state in its records the impact of its activities on the environment for a comprehensive spectrum of the environmental liability they expect to encounter and the extent of their contribution to the contamination (Ahir & James, 2021). However, the regulation presents some difficulty as firms may opt to report lower environmental impact to save face and maintain a good corporate image. The regulatory agencies must develop a structure for examining the sustainability of these firms to ensure compliance. Positioning the UK’s financial institutions with a green trajectory will accrue concrete benefits for the ecosphere and community.
Transparency
Despite the popular discourse that the autonomy of the financial legislators improves its efficiency, the entities should answer to a higher authority to keep them in check. One of the reasons for having controls is that superintending responsibilities usually entail resolving eminent political matters, such as bailing out or closing financial institutions and extending to personal ownership rights (Jones & Knaack, 2019). Granting these regulators the utmost independence could be giving them too much power. Secondly, the regulators may also be subject to regulatory capture: a bias toward the firms they oversee due to information gaps, inadequate resources, and familiarity with the firms (Jones & Knaack, 2019). As a result, the agencies may end up protecting the industry rather than the consumers.
In a bid to enhance consumer protection in the UK after Brexit, Britain has put in place measures that necessitate the answerability of the regulatory agencies. The FCA, PRA, and BoE have a memorandum of understanding that requires them to consult with each other before executing their plans and giving feedback on their progress (Ahir & James, 2021). Some of these entities are also subject to audits to ensure that there is a proper use of resources and that they serve the interest of the party they represent (Ahir & James, 2021). The regulators have reparative accountability that requires them to rectify disservices by righting deficiencies in lawmaking (Jones & Knaack, 2019). The actions will increase the transparency and culpability of the financial regulators, solidifying consumer trust in the system.
Summary
Financial legislation is essential in any economy for a robust structure. The financial market is closely interconnected, and the misconduct of a single company adversely affects the performance of other institutions. Regulatory authorities monitor the operations of these firms to detect any issues beforehand to protect the market and foster consumer trust. The UK has different regulatory bodies that oversee different segments and activities of its financial institution. The FCA supervises the corporation’s behavior while the PRA their financial performance. The BoE focuses on the liquidity of the banking institutions and keeping the country’s currency stout through monetary policies. Brexit has increased innovation, sustainability, expansion, and transparency in the UK financial regulation.
References
Prasanna, G., Malcom, K. H. D., Antonio, S. S., & Isabel, S. (2019). Regulatory complexity and the quest for robust regulation. European Systemic Risk Board (ESRB), European System of Financial Supervision, Frankfurt a. M.
Ahir, A., & James, K. R. (2021). Rebooting UK financial regulation for a post-Brexit world – a conference summary. SSRN Electronic Journal.
James, S., & Quaglia, L. (2019). Why does the United Kingdom (UK) have inconsistent preferences on financial regulation? The case of banking and Capital Markets. Journal of Public Policy, 39(1), 177–200.
James, S., & Quaglia, L. (2020). Rule maker or rule-taker? Brexit, Finance and UK Regulatory Autonomy. International Political Science Review, 43(3), 390–403.
Jones, E., & Knaack, P. (2019). Global Financial Regulation: Shortcomings and reform options. Global Policy, 10(2), 193–206.
Pennesi, F. (2022). The equivalence regime: Financial regulation between EU and third countries. Equivalence in Financial Services, 75–91.
Trapanese, M. (2021). The economics of non-bank financial intermediation: Why do we need to fill the regulation gap? SSRN Electronic Journal, (625), 1–83.