Retail financial services and the treatment of consumers: Key issues for the 2015 Parliament
From PPI to interest rate swap mis-selling, from irresponsible payday lending to excessive overdraft fees, and with packaged bank accounts the next predicted ‘scandal', a defining feature of the retail financial services sector has been its capacity to cause detriment to consumers.
The structure of the market and the nature of the products it sells have played a role in these problems; but so too have low levels of financial capability among consumers themselves.
The new freedoms available to those with pension savings will make it all the more important that consumers are capable of making well-informed choices in an increasingly complex financial world.
The scale of the problem
Many of the complaints about retail financial services end up with the Financial Ombudsman Service, which settles disputes in this sector that cannot be resolved by firms' own complaints procedures.
In 2013/14 the FOS had nearly 2.4 million enquiries, of which 20% turned into a formal dispute. Nor were these complaints, on the whole, vexatious: more than half were resolved in favour of the consumer.
Chart 1: Number of PPI cases
PPI cases have dominated the work of the Financial Ombudsman Service in recent years: Number of new cases, thousands, financial years 2005/06 to 2013/14
Chart 2: Non-PPI cases by area of complaint
Of the non-PPI cases, the majority relate to banking and credit services (current accounts, mortgages, credit cards etc.)
non-PPI cases by area of complaint, 2013/14 
The sums involved in providing consumers with redress can be colossal. The previous Government pledged £1.5 billion to compensate Equitable Life policyholders, and campaign groups want considerably more.
But even this is dwarfed by the £17.7bn in payment protection insurance (PPI) compensation paid out by November 2014.
What is it about financial services?
Consumer detriment occurs in other sectors too; but problems involving such large numbers of individuals and enormous sums of compensation are rare by comparison. What makes financial services in general, and banks in particular, so prone to scandal?
Part of the problem lies in the nature of the product and the difficulty consumers face in making informed choices, and changing their mind when things go wrong. A poorly chosen car can be sold; a poorly chosen toothbrush can be discarded in favour of a different brand.
However, if someone takes out a particular mortgage, business loan or pension and it turns out to be unsuitable, the deal cannot easily be undone. Indeed, the damage is often not apparent until years after the bargain is struck.
Another reason why the financial services sector has seen such problems at its retail face is that it is dominated by a few huge players which are seen by most consumers as being very similar, or more pejoratively as being ‘as bad as each other'.
Each of the ‘big five' banks have been implicated to varying degrees in mis-selling and misconduct. The formidable barriers to entry in retail banking mean that the scope for bad banks to be ‘punished' by new ‘challengers' is limited.
Putting it right
The principal sanction available to regulators in respect of misconduct by banks is fines. Since the financial crisis, these have got bigger. But there are limits and trade-offs: in particular, fines that are too large could damage the stability of an institution and thereby prove counterproductive.
An alternative to fining institutions is to identify individuals responsible for misconduct and fine them. Changes are being made to the regulation of banks to make it easier to see where individual accountability lies when problems occur.
It remains to be seen whether this will result in more individuals being sanctioned by the regulators, and if so, whether this will change the behaviour of others.
New entrants into the banking market have been encouraged. Several new banks are now on the high street with more applications to come. The operation of the payments system is also under official review to reduce this particular barrier to entry.
The Competition and Markets Authority is conducting an investigation into retail banking, which will report in April 2016. It remains to be seen how far these developments will weaken the dominance of the largest banks.
Caveat emptor
Is regulatory intervention the only response? Looking at recent scandals from the consumer's perspective – from the self-employed people who bought PPI policies that could never pay out, to the individuals taking out payday loans they had no prospect of repaying – there is evidence not only of mis-selling and sharp practice, but also of a lack of financial capability on the part of the public.
Various policies to improve financial capability and to end financial exclusion have been promoted by successive Governments. There is the new, free, impartial Money Advice Service established by the Financial Services Act 2010, which provides basic financial guidance.
The Retail Distribution Review set up under the now replaced Financial Services Authority has aimed to improve the structure and professionalism of independent financial advisers. Is this enough?
Financial capability has become still more important now that people aged 55 and over have greater freedom about when and how to draw their defined contribution pension savings. They have the choice not only to purchase Lamborghinis and world cruises, but also an array of potentially complex financial products, many of which may be unsuitable for their needs.
The options for newly-retired individuals with inappropriate pension arrangements are neither obvious nor pain-free.
Will we get this enormous transfer of responsibility wrong or right? Will regulation in the consumer credit market and retail banking improve consumer outcomes over the next five years? Or will the Financial Ombudsman Service still be the busiest office in town?