The direct and compliance costs of financial regulation

This paper attempts to estimate both the direct and indirect costs of regulation for major sectors of the UK financial services industry. We also compare UK direct costs with those for the US and France and this provides a benchmark for assessing the effect of regulation on the competitive position of the UK financial services industry. We believe that this is the first attempt to compare regulatory costs in the UK with those of its major competitors. For indirect costs, in the absence of an international benchmark we compare our results with the predictions made at the time of the introduction of the Financial Services Act, by Lomax (Lomax, D., 1987. London Markets After the Financial Services Act, Butterworths, London) and Goodhart (Goodhart, C., 1988. The costs of regulation. In: Seldon, A. (Ed.), Financial Regulation or Over-regulation. Institute of Economic Affairs, London, p. 31). They estimated that indirect costs would be £4 for every £1 of direct costs and that annual aggregate costs would be £100 million. Our results suggest that, so far as direct costs are concerned, the costs of regulation for the securities and derivatives trading and broking sector are substantially lower for the UK than for the US and France. In contrast, for the investment management and unit trust industry UK costs are significantly higher than those for the other two countries. For the life insurance industry, UK costs are similar to those in France but markedly lower than those for the US. We also find for the securities industry around £4.1 of indirect costs per £1 of direct costs. For the investment management industry the corresponding figure is £3.2. However there is substantial variation across firms and, although our sample is too small to be definitive, the ratio appears to be related to firm size. Although these results are broadly in line with the predictions of Lomax and Goodhart it should be borne in mind that both numerator and denominator are substantially higher in real terms than those used by Lomax and Goodhart.