Costbenefit analyses of financial regulation

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Costbenefit analyses of financial regulation

• DTI conference on the evaluation of regulation
• Dr Luis Correia da Silva, Managing Director
• Reinder van Dijk, Managing Consultant
• November 24th 2006

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Overview

• CBAs/impact assessments of financial regulation
• post-implementation review
• framework for measuring benefits
• Oxera study for FSA
• what to measure?
• how to measure?
• illustration of framework

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CBAs of financial regulation

• emphasis has been on quantifying the costs of
  regulation
• FSA CBAs of new rules
• Deloitte cost of regulation study
• now more focus on assessing benefits
• Oxera/FSA framework for assessing benefits
• assessment of benefits of regulation of retail
  financial services
• post-implementation reviews
• depolarisation
• new regime for soft commission and bundled
  brokerage arrangements

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Post-implementation review

Post-implementation trajectory

Market development



Baseline

Time





Today







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Conceptual framework
Potential market outcomes regulation
Market outcomes no regulation
Types of benefit that could be realised
Types of regulatory intervention
Types of risk/ market failure
Types of potential benefit
Actual outcomes post- intervention
Types of cost that could be imposed
What to measure
How to measure
Actual measurement of benefits
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Two parts of the measurement exercise

• what to measure?
• improvements in market outcomes that result from
  regulation
• how to measure?
• direct measurement of changes in market outcomes
• indirect measurement using proxy metrics
• focus on mechanisms through which regulation
  delivers better market outcomes
• different empirical methodologies

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Types of detrimental market outcome for consumers
Sub-optimal choice
Reduced choice
Market failures
Higher costsfrom operational risks
Risks
Higher costsfrom financial risks
Higher costsfrom systemic risks
Misaligned incentives
Higher pricesfrom market power
Higher costsfrom transaction inefficiencies
Financial exclusion
An efficient market may deliver outcomes that are
considered unfair from a public policy point of
view
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Direct measurement of consumer benefits
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Direct measurement empirical techniques

• before-and-after comparisons
• event-study methodology
• market models used by competition/industrial
  economists
• econometric techniques to test for structural
  breaks
• quantifying total detriment before regulation
• upper bound of benefits
• surveys to gather subjective evidence
• including stated-preference/willingness-to-pay
  surveys
• benchmarking
• including international comparisons

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Direct measurement limitations

• ex ante evaluations
• data requirements
• control for other influences on market outcomes
• measurability of relevant metrics of market
  outcome
• quantification of reductions in market prices or
  lower transaction costs is possible
• but how to measure
• improvements in consumer purchase decisions?
• reductions in risk of systemic failure?

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Indirect measurement of benefits Example
suitability letter
Improved market outcomes?
Through change in consumer behaviour?
Through change in firm behaviour?
Consumers make better purchases (quality,
quantity)
Consumers better understand what they need and
adjust purchases (switch product/ provider or
change quantity)
Firms provide better advice or sell better
products (eg, audit trail improves incentives)
Consumers use suitability letter in
disputes Letter facilitates dispute resolution
Consumers incur lower transaction costs
Consumers buy same product more cheaply
(price)
Firms reduce prices because they incur lower
supervision and dispute-resolution costs
FSA/Ombudsman/FSCS Suitability letter has
evidential value in supervision, enforcement and
redress process
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Summary

• What to measure
• identify the market outcome dimensions that the
  regulation may be improving

• Direct measurement
• evaluate feasibility of methods and techniques
  for measuring changes in market outcomes

• Identification of mechanisms by which regulation
  delivers an improvement in market outcome
• analyse the causality links between regulation
  and outcome

• Indirect measurement using proxy metrics
• identify proxy metrics (metrics that reflect
  improvements in mechanisms) and apply methods and
  techniques for measuring changes in proxies

• Validation of links
• test that proxies can be used to infer a change
  in the final market outcome

• Completeness check
• analyse other (unintended) impacts on market
  outcomes and repeat exercise if required

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Concluding remarks

• benefits measurement is complex
• direct and indirect approaches
• market outcomes
• mechanisms through which regulation delivers
  improvements in outcomes
• systematic measurement of market impacts
• important for policy formulation
• further research required on consumer behaviour
• experimental economics

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www.oxera.com

• Contact
• Reinder van Dijk
• 44 (0) 1865 253 069
• reinder_at_oxera.com