Monday, March 17, 2014

Applying Behavioural Economics at the Financial Conduct Authority

The role of behavioural economics in regulation is a key new area in policy. This FCA document "Applying behavioural economics at the Financial Conduct Authority" has been discussed in our classes over the last six months. It reviews the case for integrating behavioural economics insights into regulation, in particular financial regulation.

It is a very useful document outlining the basic behavioural biases, the potential role they might play in consumer decision making, how they may influence firm behaviour, potential tests for behavioural market failure and potential policy remedies.

Some of this is early stage. There are clearly not yet streamlined tests for behavioural market failures. However, a number of policies have already been influenced by these ideas. The case studies from the Office of Trading on gym contracts (page 49) and Ofcom (page 49 also) on autoextension of telecommunications contracts are worth looking at and show how these ideas area being translated across different regulators.

It seems very clear that behavioural biases operate across many markets that are confusing for consumers. What is less clear is the role of the regulators. Should they attempt to steer markets without overly interfering or adopt harder lines in cases where consumers are clearly confused?

An excellent example is provided in the document in the area of consumer redress (see page 45). The FCA conducted a trial testing the efficacy of letter reminders to increase the number of consumers claiming redress for being missold a product. Of 200,000 customers who had been overcharged 21 pounds on average only 1.6 per cent responded to basic reminders. This is multiplied by a factor of 6.5 when a number of behavioural aspects of the letters are altered.

It is interesting that such techniques can influence behaviour but it is hardly satisfactory that 90 per cent of consumers still fail to seek redress. The success of pension autoenrolment policies suggests it is possible to have deep influence on individual and market behaviour through changing defaults. However, many of the solutions to the effects being exploited in consumer markets involve much less direct effects like reminders and other type of indirect nudges. It is a big question as to whether more direct policies such as banning certain practices are desirable.

Useful Readings:

Mark Armstrong and John Vickers "Consumer protection and contingent charges". A later version of this is available in the Journal of Economic Literature.

The Office of Fair Trading investigation into fees for fitness clubs an interesting example of where a regulator specifically took action on a practice said to be exploiting consumer biases.

Huffman and Heidtke "Behavioral Exploitation Antitrust in Consumer Subprime Mortgage Lending"

Useful presentation by Maurice Stucke "Behavioral Exploitation and Its Implications on Competition and Consumer Protection Policies".

Stucke "Behavioural Antitrust and Monopolisation".

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