LONDON (Reuters) - The Financial Conduct Authority (FCA) announced sweeping changes in financial regulation on Wednesday, telling banks they can no longer blame customers when products go wrong and promising to study how consumers behave to make sure they can make the right decisions.
The FCA is one of two new agencies launched this month to replace the Financial Services Authority and rewrite the rules for a financial industry brought low by the 2008 crisis and years of costly misbehaviour.
The FCA's main focus is on protecting consumers who have been ripped off in recent years by the selling of inappropriate products in a series of scandals that led to settlements costing banks billions of pounds.
Banks will no longer be permitted to claim the "caveat emptor" or "buyer beware" defence when selling complex products to customers with little knowledge of finance, the FCA's managing director Martin Wheatley will say in a speech later on Wednesday.
It signals a shift from the principle that has long underpinned UK financial regulation, under which the risk of an investment decision usually falls on the buyer.
"There are questions that many investors simply will not ask because they are humans, not automatons," Wheatley will say in his first speech as CEO, excerpts of which were made available in advance. "There is a question of how a regulator navigates the balance of power between consumer and provider."
Wheatley will announce plans to draw on the emerging field of behavioural economics for the first time by a British regulator, to encourage better consumer decisions and stop sharp practice at banks, according to the excerpts.
Unlike traditional economics, which assumes people will tend to behave rationally, behavioural economics looks at how social and emotional factors lead people to make decisions. It uses insights from psychology to explore the reasons for mistakes, like failing to cut losses when an investment goes wrong or not understanding what compound interest is.
"We want the regulatory system to use behavioural economics to ascertain whether people are being put off switching products through inertia, inattention or even the simple fear of regret from making the wrong decision," Wheatley will say.
The FCA is part of Britain's new supervisory system, launched to draw a line under both the financial crisis and two decades of scandals over the mis-selling of products, from pensions to payment protection insurance.
A separate body will supervise whether banks are sound, splitting the duties of the former FSA which used to be responsible both for overseeing banks' financial positions and for monitoring misbehaviour in the financial sector.
The banks' 14 billion pound compensation bill for mis-selling loan insurance is high enough for regulators to force them to hold more capital to keep the financial system stable.
Etay Katz, a financial services lawyer at Allen & Overy, said the speech marks a shift in responsibility for banks delivering a product to mass markets.
"The broader concern is that this will not only be applied just to retail but also to wholesale as well so you can't assume a big investor like local authorities have the expertise that can be relied on," Katz said.
Parliamentarians are pushing the FCA to get banks to offer a suite of easily understood, simple savings products to encourage more people to save for their retirement and rely less on pensions from cash-strapped governments.
The watchdog published two papers on behavioural economics, looking at how consumers choose and use products, and encouraging customers to claim redress.
(Reporting by Huw Jones)