A theory of financial services competition, compliance and regulation

Abstract

Purpose This paper aims to derive the conditions under which a financial services firm will want to hire a compliance services company and show how much money they should spend. Design/methodology/approach This paper uses a mathematical model to show the intuition behind many of the compliance decisions that cost financial services firms billions every year. Findings This paper finds that hiring compliance firms may save banks and brokerages money. However, their advice may lead to an embarrass de riches – whereby the lower compliance costs and higher profit advantages they confer may lead to more regulation. Regulators may furthermore tighten regulation – with the expectation that financial service firms will adapt somehow. This paper presents a fresh perspective on the Menon hypothesis, deriving conditions under which financial regulations help the competitiveness of an international financial centre. Research limitations/implications The paper represents one of the first and only models of compliance spending by financial services firms. Practical implications This paper provides five potential policy responses for dealing with ever ratcheting financial regulations. Originality/value The paper hopefully launches literature on the compliance service industry – and the buy-or-do decision to engage in financial services compliance. This paper finds that efficient compliance can hurt firms, by encouraging regulation. This paper shows how firms can forestall the extra regulation that comes with easier internet and computerised monitoring.