Can Reforms of Financial Regulation Encourage Economic Growth?

The UK government is proposing regulatory reforms of the financial services sector as part of its agenda for boosting economic growth. The main focus is on encouraging domestic investment by pension funds and relaxing household access to credit. The chances of success are highly uncertain.

A central component of the new UK government’s economic agenda involves reforms of domestic financial regulation to encourage growth. The proposed changes are part of a broader financial services growth and competitiveness strategy to revive the country’s financial services sector, a component of the new industrial strategy. They also reflect a wider move by the government to encourage regulators to liberalise rulebooks in order to deliver growth.

Unlike in other sectors, in financial services, deregulation to deliver growth was started by the previous government through its Edinburgh reforms. Under these measures, the industry regulator – the Financial Conduct Authority (FCA) – has already been assigned a ‘secondary objective’ to its primary one of ensuring that financial markets work well: namely, facilitating the international competitiveness and growth of the economy.

In this article, we examine the two main pillars of financial services reform within this strategy: increasing domestic business investment through reform of rules relating to how pension funds and consumer savings are invested; and increasing consumer demand through relaxing the supply of credit to households.

Encouraging pension fund investment in the UK
A first element of reform of UK pension funds is the creation of larger pension schemes, which can take advantage of economies of scale. In a series of measures including a forthcoming pensions schemes bill to be put to parliament, the government is seeking to create what are referred to as pension ‘megafunds’ – for example, by pooling local government pension schemes (of which there are currently 86 in the UK) into fewer, larger funds.

The new megafunds will be required to specify a target for the pool’s investment in their local economy, working in partnership with local and mayoral combined authorities to identify the best opportunities for supporting local growth. The government hopes that this could increase local investment in the UK by £20 billion, and total UK investment by £80 billion.

A second element of this reform is to encourage households to put more of their savings at risk by buying investments, such as equities listed in the FTSE100 index. Many individuals with investible financial assets choose to hold them mostly or wholly in cash.

The FCA estimates that 11.8 million consumers in the UK have £10,000 or more of investible assets, yet hold the majority or all of these assets in cash. Survey evidence suggests that of these, 44% (5.2 million) have some appetite to take investment risks (Financial Lives Survey, 2023).

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Courtesy of John Gathergood and Sarah Hall, Economics Observatory