Cost-Benefit Analysis Framework: PSR Updated Approach

The cost-benefit analysis framework plays a pivotal role in regulatory decision-making, providing a structured methodology to evaluate whether a proposed intervention will lead to a net positive impact. As used by the Payment Systems Regulator (PSR), this framework is essential for ensuring that regulatory actions are grounded in robust economic evidence and designed to deliver effective, outcome-focused policies. On 18 September 2024, the PSR published consultation paper CP24/12, which introduces a draft statement of policy on its cost-benefit analysis framework, aligning with the additional accountability measures introduced by the Financial Services and Markets Act 2023.

Source

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CP24/12: Draft statement of policy on our cost benefit analysis framework

Payment Systems Regulator

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PSR draft cost benefit analysis framework

Payment Systems Regulator

Cost-Benefit Analysis Framework

The Financial Services and Markets Act 2023 brought new regulatory obligations for the PSR, emphasizing greater transparency and accountability in its decision-making processes. One of the most significant changes is the requirement for the PSR to publish a formal statement on how it conducts cost-benefit analyses (CBAs). This formalized approach ensures a consistent and structured application of the cost-benefit analysis framework, making it a central tool in all regulatory interventions.

The draft statement underlines the PSR's commitment to integrating CBAs early in the policy development process. Rather than using cost-benefit analysis merely as a justification tool post-policy formulation, the PSR incorporates it as a critical part of policy design and decision-making. This process includes establishing the costs and benefits through both qualitative and quantitative data, assessing uncertainties, and evaluating the proportionality of each regulatory action.

In February 2024, the PSR first introduced a draft cost-benefit analysis framework, which outlined how CBAs would influence the development and execution of policies. This initial draft established the methodology, focusing on identifying economic impacts, gathering data, and involving stakeholders in early stages to improve decision-making accuracy. The release of CP24/12 in September 2024 represents a more refined approach, shaped by stakeholder feedback and aimed at creating a transparent and dynamic policy-making environment.

The Role of the Cost-Benefit Analysis Framework in Regulatory Action

A cost-benefit analysis framework is a systematic process that enables the PSR to assess whether a proposed regulatory intervention will deliver a positive net impact. It provides a balanced view by evaluating both quantitative and qualitative data, helping the PSR make informed decisions that align regulatory objectives with economic efficiency.

The PSR's methodology within the cost-benefit analysis framework starts with defining the problem the regulation aims to solve. By using detailed causal chains, the PSR links the intervention to desired market outcomes, which allows for a clear analysis of the potential direct and indirect impacts. For instance, the PSR’s framework assesses not only the immediate compliance costs but also long-term benefits like increased market competition or improved consumer protection.

In terms of economic scope, the cost-benefit analysis framework assesses both one-time and ongoing costs, such as operational adjustments required by businesses to comply with new rules. The PSR also incorporates risk and sensitivity analyses, which allow for adjustments in regulatory approaches when significant uncertainties are identified. This ensures that interventions are adaptable and that the analysis remains relevant in dynamic market environments.

Key to the PSR’s approach is the recognition that the framework must consider not only direct financial impacts but also broader economic and social effects. The framework applies different levels of analysis based on the regulatory action's magnitude and potential consequences. For instance, the PSR may choose a simplified analysis for interventions with minimal impacts, while complex interventions may require more detailed quantitative models, including econometric techniques and Monte Carlo simulations to predict a range of possible outcomes. This comprehensive view allows the PSR to ensure that its regulatory interventions create sustainable benefits while avoiding unnecessary burdens on regulated entities.

The draft statement on the cost-benefit analysis framework also highlights the importance of proportionality in decision-making. The PSR assesses the cost of conducting a detailed CBA relative to the potential impact of the regulatory action. In situations where the potential costs and benefits are relatively small, the PSR may opt for qualitative evaluations rather than detailed quantitative assessments, ensuring the framework remains efficient without compromising decision-making quality.

Key Components of the Cost-Benefit Analysis Framework

The cost-benefit analysis framework proposed by the PSR is structured around several critical components:

• Identification of Impacts: The PSR starts by thoroughly identifying both direct and indirect impacts across a spectrum of stakeholders, including payment service providers, merchants, consumers, and the wider economy. This comprehensive approach ensures that all significant costs and benefits are captured, reducing the likelihood of unintended regulatory consequences. For instance, regulatory changes affecting payment systems could impose operational costs on service providers while providing time-saving benefits to consumers. These impacts may vary widely between different stakeholder groups, necessitating a highly detailed breakdown of how each party is affected. This differentiation allows for the precise targeting of regulatory benefits and ensures no group is disproportionately impacted.

• Qualitative and Quantitative Analysis: After identifying impacts, the PSR’s cost-benefit analysis framework employs a mix of qualitative and quantitative methods to assess the magnitude of each identified impact. This dual-method approach ensures the analysis remains robust. On the qualitative side, the framework may consider factors that are harder to quantify, such as consumer confidence or market competition. Quantitatively, the PSR strives to monetize as many impacts as possible, using rigorous economic modeling. For instance, if a regulation enhances the reliability of payment systems, the time savings for businesses and consumers can be monetized by assigning a value to the reduction in transaction delays. Econometric models may also be used to forecast the broader economic ripple effects, such as how improved payment efficiency might stimulate market growth.

• Balancing Costs and Benefits: Central to the cost-benefit analysis framework is the goal of ensuring that the benefits of any regulatory action outweigh its costs. This is achieved through a meticulous comparison of both quantifiable and non-quantifiable factors, including immediate financial impacts and more complex, long-term systemic effects. For example, a regulation might incur upfront compliance costs for payment processors, but the long-term benefits could include enhanced market stability, increased consumer trust, and improved innovation. These benefits might be difficult to quantify immediately but are critical for the holistic assessment of the regulation’s net value. The PSR uses sophisticated forecasting techniques to project these outcomes and weigh them against known costs.

• Stakeholder Engagement: A pivotal aspect of the PSR’s cost-benefit analysis framework is its reliance on stakeholder input to refine its analysis. The consultation paper CP24/12, which remains open for public comment until 3 November 2024, exemplifies this approach by encouraging those affected by regulatory proposals to offer feedback. Stakeholders, including businesses, consumers, and industry associations, are invited to scrutinize the assumptions, data, and methodologies employed in the CBA. This engagement allows for the fine-tuning of the framework based on real-world insights and experiences, enhancing both the accuracy and legitimacy of the regulatory process.

Legal and Regulatory Context of the CBA Framework

The cost-benefit analysis framework is firmly grounded in the legal requirements set out by the Financial Services and Markets Act 2023. This legislation mandates greater accountability and transparency in the PSR’s regulatory decision-making processes, requiring that all major interventions be justified through rigorous cost-benefit analysis. The framework ensures compliance with these legal obligations by integrating robust economic analysis into every stage of policy development. This not only demonstrates that regulatory actions are proportionate but also helps avoid overly burdensome or unnecessary regulations.

The cost-benefit analysis framework is also aligned with the Financial Services (Banking Reform) Act 2013, which further mandates that all significant regulatory interventions must be accompanied by a formal CBA. This alignment ensures that before the PSR enacts new regulations, it must demonstrate that the proposed action will deliver net benefits, particularly focusing on how it aligns with broader public interest goals. The publication of consultation paper CP24/12 reflects the PSR’s adherence to these legal frameworks, underscoring its commitment to transparent, evidence-based policy formulation.

Key Considerations

Several critical principles guide the PSR’s cost-benefit analysis framework, ensuring that it remains a robust and flexible tool for regulatory analysis:

• Proportionality: The PSR carefully calibrates the scale and depth of its analysis according to the potential impact of the regulatory action. In instances where the intervention has relatively low impacts, the PSR may opt for a streamlined, qualitative CBA. For more complex or high-impact interventions, the framework employs detailed quantitative models to provide a more thorough analysis. This proportionality ensures that resources are used efficiently while maintaining the integrity of the decision-making process.

• Risk and Uncertainty: Given the uncertainties inherent in regulatory interventions, the cost-benefit analysis framework incorporates sophisticated risk analysis techniques, including sensitivity analysis and scenario modeling. These tools allow the PSR to evaluate a range of possible outcomes, offering a clearer understanding of the risks associated with various regulatory actions. For instance, the use of Monte Carlo simulations within the cost-benefit framework enables the PSR to model multiple scenarios and their associated probabilities, ensuring decisions are made with a comprehensive view of potential risks and outcomes. This capability is crucial in fast-evolving sectors like payments, where technological advancements can quickly alter market conditions, making it essential for the cost-benefit framework to address uncertainty and adapt to new risks effectively.

• Transparency and Accountability: Transparency is a fundamental principle of the cost-benefit analysis framework. The PSR ensures that all stakeholders, including businesses, consumers, and policymakers, have access to the economic reasoning that underpins regulatory actions. By publishing detailed cost-benefit analyses (CBAs) alongside consultation documents such as CP24/12, the PSR provides stakeholders with the opportunity to review the assumptions, data, and models used in the regulatory decision-making process. This level of transparency fosters trust in the regulatory framework and promotes accountability, as stakeholders can critically assess and provide feedback on the economic justifications offered by the PSR.

• Iterative Process: The cost-benefit analysis framework is dynamic and evolves based on new data, stakeholder feedback, and shifting market conditions. The PSR conducts early-stage CBAs to offer preliminary estimates of the impacts, which are then refined as more data becomes available. This iterative nature of the cost-benefit framework ensures that regulatory decisions are continuously improved and adapted to the latest information. For example, initial cost estimates related to regulatory compliance might be adjusted based on real-world implementation feedback from businesses, allowing for more accurate and balanced decisions. This flexibility ensures that the cost-benefit framework remains relevant and aligned with market realities.

Proportionality and Flexibility in the Cost-Benefit Analysis Framework

The cost-benefit analysis framework used by the PSR is inherently flexible, allowing it to be tailored to the specific requirements of each regulatory intervention. The PSR recognizes that not every regulation demands a full, detailed CBA, particularly in cases where the potential impacts are minimal. In these instances, the cost-benefit framework allows for more qualitative analyses, ensuring that regulatory burdens are kept low while still providing a thorough examination of potential impacts. This adaptability ensures the cost-benefit framework is neither overly rigid nor resource-intensive, making it suitable for both large-scale interventions and smaller, more focused regulatory actions.

When determining the appropriate level of analysis, the PSR carefully considers several critical factors, including the magnitude of the intervention’s impact, the availability of reliable data, and the distributional effects on different stakeholder groups. By evaluating these factors within the cost-benefit framework, the PSR ensures that its regulatory actions are targeted, proportionate, and optimized to achieve their intended outcomes.