While prudential regulation focuses on the safety and soundness of banks, conduct regulation is designed to protect customers, maintain market integrity, and ensure fair competition. It addresses the behavior of banks, their employees, and associated financial institutions to prevent mis-selling, fraud, and unfair practices.
This post explains the purpose, principles, legal frameworks, and real-world implications of conduct regulation.
1. What Is Conduct Regulation?
Conduct regulation refers to the rules, standards, and supervisory practices that govern how banks and financial institutions interact with customers and the market.
Its main goal is to promote ethical behavior and transparency, ensuring that banks:
Unlike prudential regulation, which protects the bank itself, conduct regulation primarily protects consumers, investors, and market participants.
2. Why Conduct Regulation Matters
Banks have unique power and responsibility:
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They control customer funds, often in large amounts.
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They advise and influence clients’ financial decisions.
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They participate in securities markets, affecting valuations and investments.
Without conduct regulation:
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Customers could face mis-selling of products (e.g., unsuitable loans or investment products)
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Market integrity could be undermined by insider trading or price manipulation
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Competition could be distorted by unfair practices
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Public trust in the financial system would erode
3. Core Objectives of Conduct Regulation
1. Fair Treatment of Customers
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Ensure transparency in fees, interest rates, and product terms
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Prevent misrepresentation or omission of risks
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Guarantee customer rights to information, complaints handling, and redress
2. Market Integrity
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Prevent market abuse (insider trading, price manipulation, fraud)
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Promote transparency and accurate pricing
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Ensure fair competition between banks and financial institutions
3. Consumer Protection
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Protect vulnerable customers from predatory lending
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Ensure suitability of products for individual risk profiles
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Enforce disclosure and reporting standards for investment advice
4. Prevention of Conflicts of Interest
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Banks must separate advisory roles from proprietary trading where required
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Ensure recommendations are in the best interest of clients, not just for profit
5. Enhancing Trust
4. Key Areas of Conduct Regulation
a. Sales and Marketing Practices
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Advertising must be accurate and clear
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Terms and conditions must be transparent and accessible
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Promotions must not mislead or exaggerate potential benefits
b. Suitability and Appropriateness
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Banks must assess clients’ knowledge, risk appetite, and financial situation
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Especially critical for investment products and complex financial instruments
c. Disclosure and Transparency
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Clear information on fees, charges, interest rates, and risks
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Obligatory disclosure of conflicts of interest and related-party transactions
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Transparent terms for credit, mortgages, insurance, and investment products
d. Anti-Money Laundering (AML) and Combating Financing of Terrorism (CFT)
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Banks must verify client identities (KYC)
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Monitor for suspicious transactions
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Report to authorities as required by law
e. Remuneration and Incentives
f. Complaint Handling and Redress
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Mechanisms for timely, fair, and accessible dispute resolution
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Obligation to compensate customers for losses due to mis-selling or malpractice
5. Legal and Regulatory Frameworks
Conduct regulation exists across national and international jurisdictions, often overlapping with prudential rules:
Europe
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MiFID II (Markets in Financial Instruments Directive II): Investor protection, transparency, and suitability
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Consumer Credit Directive: Fair lending practices
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EBA Guidelines: Conduct of business standards
United Kingdom
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Financial Conduct Authority (FCA): Primary authority for conduct regulation
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Treating Customers Fairly (TCF): Principle-based framework
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Senior Managers and Certification Regime (SMCR): Personal accountability
United States
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Dodd-Frank Act: Consumer protection, transparency, and accountability
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Consumer Financial Protection Bureau (CFPB): Supervises conduct for financial products and services
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Securities Exchange Act: Insider trading, market manipulation
Asia
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Monetary Authority of Singapore (MAS) – Fair dealing, disclosure, and risk management
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Hong Kong SFC and HKMA – Market integrity and consumer protection
6. Conduct Regulation in Practice
a. Suitability Assessments
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Banks must evaluate customer needs, risk tolerance, and financial capacity
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Example: Recommending a high-risk investment product to a conservative retiree is prohibited
b. Disclosure Documents
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Prospectuses, Key Information Documents (KIDs), and loan agreements must be clear, truthful, and non-misleading
c. Complaint Management
d. Market Conduct Monitoring
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Detect and prevent insider trading, market abuse, or collusive behavior
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Surveillance systems and reporting obligations are standard practice
7. Differences from Prudential Regulation
| Feature | Prudential Regulation | Conduct Regulation |
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| Objective | Bank safety, stability | Fairness, transparency, ethics |
| Focus | Capital, liquidity, risk | Customer treatment, market integrity |
| Beneficiaries | Bank, depositors, system | Customers, investors, public |
| Authority | Central banks, prudential supervisors | Conduct regulators, consumer protection agencies |
| Tools | Capital ratios, stress tests | Disclosure rules, suitability tests, monitoring |
8. Challenges in Conduct Regulation
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Rapid technological change: Digital banking and FinTech require updated rules.
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Cross-border transactions: Different jurisdictions may have conflicting conduct rules.
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Complex financial products: Difficulty in ensuring full transparency and understanding for consumers.
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Behavioral risks: Employees or institutions may still engage in unethical practices despite regulation.
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Enforcement: Regulators need resources to detect, investigate, and punish misconduct.
9. Real-World Example
The payment protection insurance (PPI) scandal in the UK:
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Banks mis-sold insurance products to millions of customers who did not need them
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FCA intervened, forcing compensation exceeding £40 billion
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Illustrates the importance of conduct regulation in protecting consumers and maintaining trust
10. Conclusion
Conduct regulation is essential for a fair and trustworthy financial system:
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It protects customers and investors from fraud and mis-selling
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Ensures market integrity and transparency
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Promotes ethical banking culture
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Complements prudential regulation by focusing on behavior, not just solvency
For businesses, entrepreneurs, and finance professionals, understanding conduct regulation is critical to legal compliance, risk management, and maintaining reputation in an increasingly regulated and competitive market.
