Can Policy Improve Our Financial Decision-Making?

Evidence Points to Need for Tougher Financial Regulation

Ireland needs tougher regulations to protect consumers when they deal with banks and other financial companies, according to new ESRI research. Reviewing more than 80 studies of how people make financial decisions, the research reveals systematic biases in financial reasoning that can result in consumers paying too much for financial products and taking on too much risk. Most consumers lack the knowledge needed to choose the better deals from among the many mortgages, credit cards and other financial products on offer. The international research shows that even those consumers with better financial understanding are prone to reasoning that can lead them to take on too much debt or to pay too much in fees to banks and other providers of financial services.   The evidence from a range of countries suggests that companies can exploit people's difficulties in understanding financial products. Education, information campaigns and efforts to simplify descriptions of products make at best only modest improvements to consumers' decision-making. Although poor financial decisions by banks and other businesses were the main cause of the financial crisis, both globally and in Ireland, many consumers also made financial decisions that contributed to the crisis and that, in many cases, to personal outcomes they would come to regret. ESRI report author, Dr. Pete Lunn, said: “In the wake of the financial crisis many countries have recognised the need to strengthen protection for consumers of financial services and have begun to introduce new rules. The evidence shows that we need tougher regulation of the financial sector – to have rules that force companies to act more in the consumers' interest.” A revised Consumer Protection Code came into force in Ireland on 1 January 2012. Some of its provisions, such as stricter rules on balanced advertising and pressurised selling, should help consumers. But the international evidence implies that getting companies to act in consumers' interests will require stronger enforcement than in the past. This could include tougher inspection, bigger punishments and the publicising of violations. If that fails to work, financial products could be made subject to licence.

Note to Editors: 1. Can Policy Improve Our Financial Decision-Making?", by Pete Lunn (ESRI) is the 8th paper in a special series of ESRI studies that survey available evidence to address issues related to Ireland's ongoing economic crisis. It will be published online on the ESRI website at 00:01 a.m. Wednesday 29th February. A copy of this paper is available under embargo on request. 2. A total of 12 studies are being undertaken as part of this “Renewal” project, which is supported by FBD Trust. 3. This paper will be presented at a Conference "Financial Stability After the Crisis", to be held at the ESRI on Wednesday 29th February 2012, which will also feature papers on macro-prudential policy and on loan-to-value limits.