Nudging consumers and regulators
By Alberto Mingardi
About one year ago, the British Financial Conduct Authority (FCA) — which also regulates consumer credit — published an Occasional Paper aimed at explaining how it is going to take advantage of the insights of behavioral economics. For one thing, the paper wasn’t ambiguous at all. Its starting point was the notion that “people often make errors when choosing and using financial products, and can suffer considerable losses as a result,” which thus justifies regulation as “market forces left to themselves will often not work to reduce these mistakes.”
We’re bound to make mistakes, that may be due to present biases, overconfidence, over-extrapolation (i.e., extrapolating from a few years of investment return to the future) or the inherent imperfections of our preferences. So, the FCA argues, regulators should intervene by forcing firms to provide information, “adjust how choices are presented to consumers,” “require products to be promoted or sold only through particular channels or only to certain types of clients” and, eventually, “control products”: i.e., ban some specific products or products’ features.
The underlying idea is that consumers make mistakes “persistently and predictably” – and thus regulators can find a fix, to allow them to understand what is truly their interest.
Today a new paper has been released, by the newly established Regulatory Conduct Authority (RCA). The RCA shall implement the same basic insights of behavioral economics, to the very field of regulation.
Yes, consumers can act over present biases, overconfidence, over-extrapolation etc. But so can regulators. They are affected by present biases (eg., they may introduce a new regulation for immediate gratification, including headlines on the press and TV interviews); by reference dependence and loss aversion (they may believe an additional obligation added to an existing regulation does not entail costs, because the existing provision is very extensive); by regret and other emotions (over-regulation can be pursued for the sake of obtain the peace of the mind). Regulators are often over-confident (they entertain extravagant notions of their own ability to identify mistakes made by businesses and consumers), over-extrapolation (they may extrapolate from just a few years of their own regulatory experience to the future) and projection biases (they might impose a price reduction without considering revenue difficulties that may rise in the future).
The RCA has, not differently than the FCA, selected a few strategies to lessen the impact of regulators’ biases: force regulators to provide information; adjust how choices are presented to regulators; “require policies to be promoted only through particular channels or only to certain types of licensees.” The RCA knows that “Regulatory psychology is nuanced, however, and specific interventions can succeed or fail based on small details.”
According to Sir Ian Byatt, former Director General of Water Supply , “This RCA Paper should be on the desk of every regulator.”
To err is human, but regulators aren’t a bit less human than consumers. Consumers’ humanity can endanger them, so can regulators’. It is time to act!
P.S. One the two papers mentioned above was purposefully released on April 1st.