6 Cost of regulation
135. During our inquiry, it became apparent to us
that the cost of regulation remains a major concern for the financial
sector. Almost all witnesses told us that the cost of regulation
has risen in the last few years, and is expected to rise further
as the reform in the structure of regulation gets under way.[121]
136. There are broadly two types of cost of regulation
to the firm—direct and indirect. Direct costs are the fees
and levies paid by the industry, such as the fees to the FSA and
the levies for running the FOS and the Financial Services Compensation
Scheme (FSCS). These are relatively easy to calculate and readily
available, for example in the FSA annual report. The ABI told
us that the insurance industry paid £138m in fees and levies
in the year 2010/11.[122]
137. The indirect costs of regulation are much more
difficult to define and quantify. Indirect costs may include the
incremental costs of compliance, including the costs to firms
of activities required by regulators which would not have been
undertaken in the absence of regulation. All witnesses agreed
that indirect costs are considerable. For example, the ABI told
us that the average cost of running a compliance programme for
existing regulation is over £10m per annum for a firm. The
costs to firms appears to be increasing: Nomura has increased
its headcount on risk and compliance by 77% in the last 2 years.[123]
Such compliance programmes will, of course, engage with other
parts of the company, and place demands upon them. As a result,
the full cost may go well beyond the visible cost of running compliance
departments, consultancy and other fees.
138. Nearly all respondents pointed to a study published
in June 2006 by Deloitte on the cost of regulation, commissioned
by the FSA and the Financial Services Practitioner Panel. Many
believe that, although out of date, it is still the most relevant
piece of work carried out in the UK on this topic.[124]
139. As part of our inquiry into Competition and
Choice in Retail Banking, witnesses have also suggested that
the costs of regulation and of fulfilling regulatory requirements
may reduce competition. Ms Gadhia, Chief Executive, Virgin Money,
noted "that the regulatory capital regime, understandably
in some cases, clearly differentiates between the big incumbents
and the smaller providers, and for smaller providers, therefore,
there's a requirement to hold more equity".[125]
The scale of the difference is substantial:
If I look at the capital requirement for a mortgage,
as Virgin Money launches mortgages, we treat mortgages at the
35% risk-rating level to provide capital against that. When I
worked at RBS and was running a mortgage business there, because
of the scale of the business and the history of the customer,
the 35% is a much lower number—as low as 17% or less in
some cases.[126]
140. Given
the urgency of the Government's reform programme and the resources
and time needed to produce a further full study of the costs of
regulation, it will be impractical for the FSA to devote resources
to such a review at this stage. Once the new architecture has
been set up, we recommend that the PRA and the CPMA revisit the
whole issue of cost of regulation, in the light of the financial
crisis and the changes in regulatory structure.
141. Under FSMA,
the FSA is required to undertake a cost-benefit analysis of any
proposed regulatory changes. However, the full costs—always
ultimately borne by consumers—need to be shown. Cost-benefit
analysis must be improved within the PRA and the CPMA. New regulatory
requirements should only be introduced if a full cost-benefit
analysis has been conducted. The authorities also need to be certain
and demonstrate that the benefits are justified by any additional
costs to consumers that might be caused by restrictions to competition.
Transition cost
142. There will be transition costs in moving to
the new regime—the impact assessment in the Treasury's consultation
suggested they would amount to £50m spread over 3 years.
The document does not explain how the Treasury came up with this
figure of £50m, nor does it suggest whether it is the industry
or the taxpayers who will have to pay. We asked the Financial
Secretary to clarify who will pay for the transition cost:
Mr Umunna:
How much will the transition to the new system cost?
Mark Hoban: The estimate
put forward by the Bank and the FSA is for about £50 million.
Mr Umunna: Right. What
comfort can you give us that those costs are not going to be automatically
passed on to the consumers?
Mark Hoban: The costs
will be borne by the levy pay[er] in the first instance. So it's
the financial services businesses that currently fund the regulatory
arrangements that will pick up those costs.
Mr Umunna: How can you
be sure that they won't pass it on to the consumer?
Mark Hoban: Inevitably,
the costs of regulation are borne either by the consumer or by
the shareholders of these organisations. I'm not sure whether
you are suggesting that the taxpayer should pick up these costs.
Mr Umunna: No, what I'm
asking you is what comfort can you give that the industry won't
pass on the costs? That is what I was getting to.
Mark Hoban: I think if
we have competitive markets, where there is pressure on price,
the industry won't be able to pass on those costs to consumers.[127]
143. The City of London Corporation suggested that
the Government might have underestimated the transition costs,
given the complexity of the restructuring and the possible duplication
from the co-existence of the PRA and CPMA:
[...] the new structure does create the possibility
of duplication, not taken into account in the impact assessment
attached to the consultation paper. This includes the proposals
to separate out the FSA's existing authorisation, enforcement,
and rule-making functions between both the PRA and CPMA. There
is a clear need to examine more closely the level of benefit gained
against costs incurred. If the supervisory duplication within
the new structures materialises, there is a risk that the costs
of these proposals may exceed those set out in the assessment.
The estimate in the impact assessment of transitional costs of
£50 million spread over three years seems low in view of
the scale of the reorganisation required.[128]
144. We
are unconvinced by the Financial Secretary's explanation that
the £50m transition costs will be borne by the industry alone.
His contention that a competitive market means that the industry
will not be able to pass on the costs to consumers begs the question
as to the degree of competitiveness in the market. We urge the
Treasury to give more detail about the assumptions underlying
the £50m transition cost. It should also report regularly
over the transition period on the level of actual costs being
incurred.
From underlap to overlap—cost
of duplications?
145. The new regulatory structure has gone some way
to avoid the 'underlap' phenomenon in the previous Tripartite
regime, where no one single body was responsible for macro-prudential
regulation. There is likely to be overlap between the FPC and
PRA, especially on financial stability areas. Paul Tucker told
us:
You may be surprised that I say I hope to overlap,
but, as I've said before, I feel very strongly about one of the
problems in the previous system was that there was underlap [...]
We need to tolerate a little bit of overlap, while being careful
about efficient use of resources for the obvious reason[...][129]
The Treasury's consultation stated that there may
need to be overlapping powers and functions between the PRA and
CPMA. According to the consultation, whenever there is overlap,
arrangements will be put in place to ensure that the authorities
coordinate actions to minimise costs.[130]
146. Given the potential greater costs for the sector
under the new structure, Hector Sants believed that strong coordination
will be important between the PRA and CPMA at all levels, including
common interfaces for communicating with firms:
[...] We need to make sure as well, of course, that
firms don't feel we're building an inefficient process, [...]
because we need to have common interfaces for collecting data,
a common data stance and so on. So we'll need a set of structural
processes as well as hard-working communication at the senior
management level.[131]
147. We
appreciate the importance of avoiding the regulatory underlap
that we have seen under the Tripartite system. However, removing
the underlap should not result in an overlap of responsibilities
between the new bodies. Overlap, like underlap, can lead to confusion
and paralysis. Careful planning and consideration needs to be
given to the remits and boundary of responsibilities, especially
between the PRA and CPMA.
Wider issues
148. There is a danger that the urge to respond adequately
to the financial crisis will result in an assumption that more
regulation is required. We believe that one of the tasks of the
new bodies will be to analyse the existing regulatory structure
and identify those regulatory requirements which are truly effective,
and those which impose unnecessary costs. When we sought to gather
evidence on the cost of regulation we were repeatedly told that
those costs were unquantifiable because many regulatory requirements
simply mirrored what good companies would do anyway.[132]
We consider this lack of precision tells its own story.
The move to new regulatory arrangements should be accompanied
by better analysis of the cost of regulation, both one-off and
ongoing, for all kinds of financial firms, by sector and by size.
The aim should be to produce a better, more effective and more
cost efficient regulatory system.
121 See, for example, Q 120, 242, 299-302 Back
122
Ev 293 Back
123
Ev 311 Back
124
DeLoitte, The Cost of Regulation Study, 28 June 2006 Back
125
Competition and Choice in the Banking Sector, Uncorrected evidence
taken before the Committee on 18 January 2011, to be published
as HC 612, Q 636 Back
126
Competition and Choice in the Banking Sector, Uncorrected evidence
taken before the Committee on 18 January 2011to be published as
HC 612, Q 638 Back
127
Q 851-2 Back
128
Ev 242 Back
129
Q 800 Back
130
See QQ 128, 645-6 Back
131
Q 733 Back
132
Q 181, Ev 293, 301 Back
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