Who regulates the regulator?

By Philip Sinel

How did we get to a position where, for more than a decade, banks got away with aggressively selling ‘ineffective and inefficient’ products? The answer lies in utterly inefficient regulation that, ultimately, throws up huge questions about the way in which the UK’s financial system is governed.

 

It’s hard to argue against the notion that the mis-selling of Payment Protection Insurance (PPI) will go down as one of the most notorious banking scandals in recent years, surprising no-one who owns a mobile phone and has, therefore, been hounded by claims companies. What is surprising, however, is not that the scandal happened in the first place, but that it took so long for the regulator to stamp out PPI once and for all.

Even as the total paid out by UK banks reaches £36bn, and the deadline for submitting claims passes, we still dwell under the ever-growing shadow of the banking sector’s bête noire. The sector has braced itself for additional claims, with Lloyds setting aside a whopping £1.8bn extra funds for such an eventuality, a move mirrored by RBS, CYBG and the Co-Op.

The obvious question, then, is how did we get to a position where, for more than a decade, banks got away with aggressively selling ‘ineffective and inefficient’ products? The answer lies in utterly inefficient regulation that, ultimately, throws up huge questions about the way in which the UK’s financial system is governed. To put it another way: who regulates the regulator?

On the face of it, PPI was innocent enough. Sold as insurance to high street customers taking out loans, the idea behind PPI was that if the customers lost their jobs then their insurers would pick up the balance of the outstanding loan. Ultimately, however, PPI was an inherently flawed product, and one that should have set alarm bells ringing for all but the most negligent of regulators.

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PPI was not benchmarked in any way, which meant that consumers were left totally devoid of any comparable and were required to buy the PPI given out by the bank selling the loan.

For a start, PPI was chiefly sold to self-employed customers who, by definition, could never make a claim as they could not lose their “job”. Secondly, PPI operated as a kind of financial closed shop, or an aggressive cross-sell where without PPI (which is where the banks made the big bucks) no loan could be taken out. What is more, PPI was not benchmarked in any way, which meant that consumers were left totally devoid of any comparable and were required to buy the PPI given out by the bank selling the loan. At the same time, PPI was often underwritten by the banks themselves, so they were getting both sides of the transaction – it was the financial gift that kept on giving, though not to the consumer.

Worse still, anybody trying to claim had to jump through all sorts of hoops. It was questionable whether anybody ever got any money back, with obfuscation delays and red tape thrown up at every opportunity – and that was just for those who were entitled to claim.

None of this should have come as a surprise to a diligent regulator, not least the issues consumers faced with getting money back: the Guardian reported in 2004 that just 15% of claimants actually received any money, almost a full year before the late Financial Service Authority started taking any action, which even then was too little, too late. By 2005, the Daily Telegraph and Citizens Advice had also covered the news, and the FSA finally issued its first report on PPI, noting poor selling practices and lack of compliance controls.

Rather than act swiftly or decisively, the regulator dithered. Despite being alert to problems from at least 2004, it didn’t levy the first fines until 2007, and even then, the focus was on smaller operations.

And that should have been it for PPI: the regulator now aware of a growing chorus of criticism of a product that people had been “duped” into buying, in the words of Peter Vickery-Smith, head of consumer advice service Which? Incredibly, it was not.

Rather than act swiftly or decisively, the regulator dithered. Despite being alert to problems from at least 2004, it didn’t levy the first fines until 2007, and even then, the focus was on smaller operations. For example, Alliance & Leicester was fined £7m in 2008 against a PPI income of £135m. In fact, it wasn’t until 2009 that single premium PPI – one of the most egregious mutations of the product – was banned. The real scandal, then, lies as much in regulatory inertia as it does with the banks flogging a knowingly-flawed product.

To make matters worse, it didn’t need to be this way. How difficult would it have been for the regulator to ban the sale of the product that could never be drawn upon – insurance for the self-employed? To make sure the products were affordable and fit for purpose? To insist on full disclosure to customers, not only of the true costs, but also to disclose that a person did not have to have PPI in order to obtain a loan?

Above all, why did it not prohibit banks from selling their own products where they are self-insuring?

Was the end of PPI caused by regulator? No, it was not; it was caused by those love-them-or-hate-them ambulance chasing claims companies. In other words, the private sector and market forces who finally provided redress – less their cut, of course. The numbers are staggering. Lloyds has been receiving 70,000 PPI claims per week since they started their redress scheme and even this is a drop in the ocean – 64m policies were sold between 1990 and 2010, “but in many cases exclusions meant that customers could never claim.”

That a loose cartel of claims companies ultimately ended one of the most significant banking scandals in recent years, in place of a manifestly deficient regulator, should be a serious cause for concern. How will the FCA react when the next mis-selling scandal inevitably rears its head? I sense, we will almost certainly see history repeat itself.

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About the Author

Philip Sinel is a Jersey Advocate and litigation lawyer. He is the Senior Partner at Sinels. His areas of practice include Commercial Litigation, Professional negligence, Fraud, Trust Law, Banking and Financial Services and Private clients.