Chapter 1: Why Governments Regulate Financial Services

Why Governments Regulate Financial Services

Governments regulate financial services to prevent failures of the free market system.
These failures could damage the stability of the overall financial system and cause financial loss to consumers.
The Central Bank of Ireland is the main regulator of financial services firms established in the State.
The objectives are:
- A stable financial system
- Consumer protection
This is reflected in the Mission Statement:
- ‘We serve the public interest by maintaining monetary and financial stability while ensuring that the financial system operates in the best interests of consumers and the wider economy.’
And in statutory objectives:
- The stability of the financial system
- The proper and effective regulation of financial service providers and markets, while ensuring that consumers of financial services are protected.

Different Types of Regulation

There are four main types of regulation of financial services firms:
- Structural
- Systemic
- Prudential
- Conduct of Business

Structural Regulation

Structural regulation covers the initial authorisation process to become a financial services firm.
The purpose is to ensure that only those of sufficient financial standing, integrity, competence, and experience can set up as financial services firms.
Under the EU Single Market financial system, structural regulation is the responsibility of the firm’s home Member State, i.e., the State where the firm is legally established.
Once authorised in one EU Member State, banks, insurance companies, insurance intermediaries, and investment funds are usually free to conduct equivalent business in other EU Member States, either on a cross-border basis (called ‘freedom of services’) or by setting up a branch in that other State or States (called ‘freedom of establishment’).
Example:
- A bank is set up in the Republic of Ireland.
- The Central Bank of Ireland authorised it.
- This bank can accept deposits from investors in another EU Member State either on a cross-border basis (e.g., through the internet) or by setting up a branch in that other EU Member State.
This freedom to conduct financial services in other EU Member States is usually referred to as ‘passporting’.

Systemic Regulation

Systemic regulation seeks to ensure that risks to the overall financial services system are minimised.
A major failure in the financial services system could lead to a breakdown in public confidence in the financial system, leading to a sudden withdrawal of funds, and/or the collapse of a major financial institution, such as a bank or an insurance company.
In a classic scenario, it might begin with a run on an individual troubled bank.
- Depositors all attempt to withdraw their funds in panic at the same time.
- This is likely to undermine public confidence in other banks, possibly producing a domino effect throughout the system, domestically and perhaps beyond, as there is a ‘flight to quality’, with everyone seeking to move their funds to stronger banks, Governments and other low-risk assets, at home and abroad.
Financial regulators therefore try to create early warning systems and information networks in the hope that swift and early remedial action might limit systemic risk to the whole financial services system.

Prudential Regulation

Prudential regulation aims to establish that financial services firms comply with a set of rules designed to ensure their continuing solvency, liquidity, and ability to meet their financial obligations to their customers.
The rules cover prudential and financial stability, internal control arrangements, and corporate governance.
For example, the Central Bank of Ireland requires:
- Some financial services firms (e.g., banks, insurance companies, and investment firms) to maintain certain minimum levels of capital and free reserves, and
- All financial services firms to make regular financial returns to the Central Bank.
Under the EU Single Market financial system, ongoing prudential regulation of financial services firms operating cross borders is the responsibility of the regulatory authorities of the firm’s Home Member State.
Example:
- ABC Life is a German life assurance company and operates in the Irish State through a Branch established here.
- ABC Life’s solvency (including its Branch in Ireland) is regulated by the regulatory authorities of its Home State, i.e. BaFin in Germany.
However, under the EU’s Single Supervisory Mechanism (SSM), the European Central Bank (ECB) is the competent authority for banking supervision throughout the EU.
The ECB is, therefore, the competent authority for the supervision of banks in Ireland.
Certain banks, referred to as Significant Institutions, are supervised directly by the ECB for prudential purposes.
- These banks currently include Bank of Ireland and AIB.
In the case of other, less-significant, banks, the Central Bank of Ireland supervises them directly for prudential purposes, while the ECB supervises them indirectly.
- In these cases, the ECB, which has ultimate responsibility for the functioning of the SSM, may issue guidelines to ensure consistent supervision or even take over the direct supervision for prudential purposes of an institution if it considers it necessary.

Conduct of Business Rules

Conduct of Business regulation aims to establish that there is protection for consumers dealing with financial services firms by specifying certain procedures, disclosure of information, and competency requirements which must be followed by firms when dealing with consumers.
The Central Bank has issued a Consumer Protection Code which applies to certain financial services firms when dealing with consumers in the State for certain types of financial services.
Under the EU Single Market financial system, conduct of business rules applying to dealings with consumers resident in an EU Member State are generally set by that Member State, i.e., referred to as the ‘host’ Member State.
As already indicated, the EU Member State where the provider is established and authorised is referred to as its ‘home’ Member State.
Prudential regulation is the responsibility of a firm’s ‘home’ Member State.
Conduct of business rules in a Member State are the responsibility of that ‘host’ State.
Example:
- ABC Life is a German life assurance company and operates in the Irish State through a branch.
- ABC Life’s solvency (including its branch in Ireland) is regulated by the regulatory authorities of its home State, i.e. BaFin in Germany.
- Its home Member State is therefore Germany.
- However, in its dealings with Irish consumers, it must comply with the Central Bank of Ireland’s Consumer Protection Code and other relevant local regulatory requirements.
- In its dealings with consumers in this State, Ireland is the host Member State.
The local conduct of business and marketing rules which a financial services firm must comply with when dealing with consumers in that State are sometimes referred to as the ‘common-good requirements’.
Consumers are also protected by a variety of other measures, e.g., the Investor Compensation Act scheme, as well as the provision by the Competition and Consumer Protection Commission of independent information and surveys etc., to consumers on financial services charges and returns.

The Central Bank of Ireland

The Central Bank of Ireland is the main regulator of the provision of financial services in the State.

Main Functions

The main functions of the Central Bank of Ireland are:
- To regulate financial services firms operating in the State.
  - These include:
    - Credit institutions, also known as banks.
    - Insurance companies, both life and general, and including reinsurance companies.
    - Insurance, investment, mortgage credit and mortgage intermediaries, sometimes referred to as ‘retail’ intermediaries.
    - Debt management firms.
    - Credit unions (through the Registrar of Credit Unions, who is part of the Central Bank).
    - Retail credit firms and home reversion firms.
    - Credit servicing firms.
    - MiFID investment firms.
    - Unit trusts and other collective investment schemes, including UCITS and non-UCITS funds, such as Alternative Investment Funds, and certain service providers to such collective investment schemes.
- Holding an inquiry into whether a regulated financial services firm, or persons concerned in its management, have not complied with financial services legislation.
- Monitoring the provision of financial services to consumers of those services to the extent that the Bank considers appropriate, for the purpose of protecting the public interest and the interests of consumers.
- Promoting and protecting the interests and welfare of consumers in relation to the prohibition of unfair, misleading or aggressive commercial practices by regulated financial services firms.
  - This particular function, in relation to regulated financial services providers, is shared with the Competition and Consumer Protection Commission.
The Central Bank is required by law to perform its functions and exercise its powers in a way that is consistent with:
- The orderly and proper functioning of financial markets,
- The prudential supervision of providers of financial services, and
- The public interest and the interest of consumers.

Funding

The Central Bank imposes an annual levy on regulated financial services firms operating in the State, in order to pay for part of the cost of providing such regulation.
The objective of the levy is to raise, directly from the financial service providers it regulates, an increasing percentage each year of the budget attributed to the Central Bank’s supervisory activities, with the objective of having 100% industry funding by 2024.
The following target rates of recovery of the cost of regulation apply for 2023 (collected in 2024):
- Credit Institutions are required to fund 100% cent of their supervisory costs.
- Insurance undertakings and investment firms are required to fund 100% cent of their supervisory costs.
- Investment funds are required to fund 100% cent of their supervisory costs.
- Retail intermediaries and debt management firms are required to fund 100% of their supervisory costs.
The method of calculation of the levy varies depending on the industry classification of a financial services provider.
There are 12 categories (A-N):
- Category A: Credit Institutions;
- Category B: Insurance undertakings;
- Category C: Intermediaries and Debt Management Firms;
- Category D: Investment Firms;
- Category E: Investment Funds and Investment Fund Service Providers;
- Category F: Credit Unions;
- Category G: High-Cost Credit Providers (formerly Moneylenders);
- Category H: Approved Professional Bodies;
- Category J: Bureau de Change;
- Category L: Default assessment;
- Category M: Retail Credit Firms, Home Reversion Firms, and Credit Servicing Firms;
- Category N: Payment Institutions and E-Money Institutions.
Where a firm falls into more than one category, it must pay a levy for each category it falls into.
- For example, a credit union which is also an insurance intermediary must pay the Category F AND the Category C levies.
Some of the categories above are further divided into sub categories, to which different levies apply.
In most cases, the levy payable is related to a firm’s size, importance and risk profile or its ‘Impact Category’.
‘Impact Category’ is derived from the Central Bank’s assessment of the potential impact of the failure of the provider on financial stability and consumers.
For example, for life insurance undertakings with an Irish head office, the levy for 2023 varies according to Impact Category as follows:

Impact Category	Levy
Ultra-high	€4,393,100
High	€1,993,369
Medium high	€455,784
Medium low	€90,608
Low	€28,147

Enforcement

When a financial services firm fails to comply with relevant legislation and codes of conduct issued by the Central Bank, this is referred to as a ‘prescribed contravention’.
- For example, if a firm failed to comply with any provision of the Central Bank’s Consumer Protection Code, this would be a ‘prescribed contravention’.
With regard to a possible contravention by a firm, there is a two-stage process:
- 1. The Central Bank conducts an inquiry into whether or not a prescribed contravention is occurring or has occurred, OR
  * The firm acknowledges to the Central Bank that a prescribed contravention has occurred, or is still occurring, and has consented to the Central Bank dispensing with an inquiry and agrees to the imposition of a sanction.
- 2. Where a prescribed contravention is found to have occurred, either by inquiry or where the firm admits that the contravention has occurred, the Central Bank can then impose one or more sanctions on the firm.
The possible range of sanctions which can be imposed by the Central Bank where a prescribed contravention is found to have occurred include:
- A caution or reprimand;
- A direction to refund any charge or sum paid for the provision of a financial service by the firm;
- A fine to be paid to the Central Bank of up to the greater of €10 million and 10% of annual turnover, in the case of a corporate body or an unincorporated body, or €1 million, where the firm is a natural person; however, the fine cannot exceed such an amount as would cause a regulated financial services provider to cease business or cause an individual to be adjudicated bankrupt;
- A direction to cease committing the contravention; and/or
- An order to pay part or all of the costs of the Central Bank’s inquiry and investigation;
- Suspension or revocation of authorisation.
A person involved in the ‘management’ of a firm can also be subjected to inquiry and sanction by the Central Bank where, following an inquiry or where the person agrees, the person is found to have participated in the commission of a prescribed contravention by the firm.
The possible range of sanctions in this case include disqualification from being concerned in the management of a regulated financial services provider for a specified period and a fine of up to €1 million.
Following the introduction of the Individual accountability framework in 2023, the Central Bank can now take enforcement action under the Administrative Sanctions Procedures directly against individuals for breaches of their obligations rather than only for their participation in breaches committed by a firm.
A finding by the Central Bank following an inquiry that a firm or member of management is committing or has committed a prescribed contravention and/or the level of sanction to be imposed by the Central Bank, can be appealed by the firm or individual involved to the Irish Financial Services Appeals Tribunal.
The Irish Financial Services Appeals Tribunal is an independent tribunal to which entities regulated by the Central Bank can appeal certain decisions (referred to in legislation as ‘appealable decisions’) made by the Central Bank, e.g., imposition of a sanction for non- compliance, refusal to grant authorisation, etc.
The regulated entity or the Central Bank may appeal a decision of the Irish Financial Services Appeals Tribunal to the High Court.

Redress for Consumers

Where the Central Bank is satisfied that there have been widespread or regular ‘defaults’ by a financial services firm, and that consequently customers of the firm have suffered, are suffering or will suffer financial loss or damage, the Central Bank may give the firm a direction requiring it to make appropriate redress to the customers involved.
The ‘defaults’ by the firm covered by this power are:
- Charging a customer an amount which the firm is not entitled to charge,
- Providing a customer with a financial service which the customer has not agreed to receive,
- Providing a customer with a financial service which was not suitable for the customer at the time when it was provided,
- Providing a customer with inaccurate information which influences the customer in making a decision about any financial service,
- A failure of any system or controls of the firm, or
- A prescribed contravention.
The redress which the Central Bank can direct the firm to make to the customers involved includes the actual or anticipated loss plus interest.
Example #1:
- The Central Bank is satisfied that DEF Bank has been systematically overcharging (through a computer systems error) its current account holders by levying a monthly charge on the accounts, which it was not entitled to charge under the agreed terms and conditions of the accounts.
- The Central Bank could direct DEF Bank to make an appropriate refund to all such account holders, with interest.
Where the substance of a customer complaint has been dealt with by the Central Bank issuing a direction to the firm involved, that complaint cannot then be dealt with by the Financial Services and Pensions Ombudsman.
Example #2:
- Joe is a current account holder of DEF Bank above, who was overcharged.
- He has been refunded by direction given by the Central Bank to DEF Bank.
- The Financial Services and Pensions Ombudsman cannot investigate a complaint from Joe about the same overcharging on his current account, as the complaint is deemed to have been dealt with by the direction issued by the Central Bank.

Registrar of Credit Unions

The Registrar of Credit Unions deals with the registration, regulation, and supervision of Credit Unions.
The Registrar of Credit Unions is part of the Central Bank and acts as the ‘delegate’ of the Central Bank in ‘managing the performance and exercise of the functions and powers of the Central Bank under the Credit Union Act, 1997’.

Competition and Consumer Protection Commission

The Competition and Consumer Protection Commission (CCPC) is an independent body which has a dual mandate to enforce competition and consumer protection law in the supply of goods and services to consumers, including financial services.
Some of its functions in relation to the provision of financial services to consumers are shared with the Central Bank.

Commercial Practices

The Consumer Protection Act, 2007 makes illegal a wide range of unfair, misleading, and aggressive commercial practices.
A ‘commercial practice’ is defined for this purpose as:
- “… any conduct (whether an act or omission), course of conduct or representation by the trader in relation to a consumer transaction, including any such conduct or representation made or engaged in before, during or after the consumer transaction.”
The CCPC shares with the Central Bank the function of regulating unfair, misleading, or aggressive commercial practices by financial services firms.

Promoting the Interests of Consumers of Financial Services

Under the Competition and Consumer Protection Act 2014, the CCPC is required to promote the interests of consumers of financial services by:
- Promoting public awareness and conducting public information campaigns for the purpose of educating and providing information to the public in relation to consumer protection and welfare,
- Providing information in relation to financial services, including information in relation to the costs to consumers, and the risks and benefits associated with the provision of those services, and
- Promoting the development of financial education and capability.
To this end, the CCPC may:
- Undertake studies, analyses, and surveys with respect to the provision of relevant financial services to consumers,
- Collect and compile information for that purpose, and
- Publish the results of any such studies, analyses, or surveys.
The CCPC shares these functions with the Central Bank.
The main way the CCPC provides information to consumers about financial services is through its website, where it compares various financial products, e.g., deposits, and also provides various calculators such as a mortgage and loan calculator.

Regulating Credit Intermediaries

The CCPC authorises and regulates credit intermediaries, i.e., persons who arrange personal unsecured loans for consumers.
Therefore, credit intermediaries are not regulated by the Central Bank.
Examples of credit intermediaries would include garages and retailers who arrange loans, leasing, and hire purchase for consumers.
Most current authorised credit intermediaries are garages.
In addition to the power to grant or refuse an authorisation to act as a credit intermediary, the CCPC also has powers under the Consumer Credit Act, 1995 in relation to matters connected to the provision of consumer credit:
- Advertising and offering of finance; annual percentage rate (APR) must be shown;
- Restrictions on inertia selling;
- Sending circulars offering credit to minors;
- Provision of a cooling-off period;
- Duty to disclose information relating to the financial standing of the consumer, where the consumer is refused finance.

Levies

The CCPC imposes levies on certain financial services firms to fund the provision of information to consumers in relation to financial services, including information in relation to costs, the risks and benefits associated with those services and promoting the development of financial education and capability.
The levy is based on information relating to the business level of the firms, obtained from official sources or from the firms themselves.
The levy is applied to financial institutions such as banks and insurance companies, but not to insurance or investment intermediaries.