What is sunk cost fallacy?

Sunk cost fallacy is a cognitive bias that occurs when people continue investing in a project or decision even if it’s no longer viable or profitable. Why? Simply because they’ve already invested time, effort, and money into it and so abandoning the project or decision now, can feel like a waste of the already invested resources (Arkes & Blumer, 1985).

Imagine you bought a ticket for a movie, but halfway through, you realise that it’s terrible. You have two options: leave and do something else or stay and watch the movie until the end. By staying, you may be wasting more of your valuable resource, time. If you leave, you may feel like you are losing the time and money invested so far. This conflict relates to sunk cost fallacy and the same principle applies to financial decisions.

Why does it happen?

Sunk cost fallacy occurs because people naturally tend to avoid losses, even if it means continuing to invest in something that is no longer profitable. Additionally, people often attach emotional value to things they’ve invested in, making it harder for them to let go. This bias can lead to irrational financial decisions and keep people from achieving their financial goals.

Let’s say you bought shares of a company that have been consistently declining in value. Despite the downward trend, you continue to hold onto the shares because you have already invested a large sum of money and don’t want a loss. This way of thinking might cause you to overlook better chances to invest, which could eventually result in even more losses.

Another example could be continuing to pay for a subscription service that you no longer use or need, simply because you have already paid for it in advance and don’t want to “waste” the money you’ve already spent.

In what ways can banks use sunk cost fallacy to empower individuals to manage their money more effectively?

Financial institutions can help their customers beat the sunk cost fallacy by offering helpful financial guidance and tools. These tools can help them make rational decisions based on the present and future, rather than past investments. For example, banks can offer budgeting and savings tools that enable customers to track their expenses and create financial goals. This approach encourages customers to focus more on their future financial objectives rather than just what they’ve already put in (Tversky & Kahneman, 1991).

Moreover, banks can offer individualised financial tips and support to assist customers in recognising when they’re caught in the sunk cost fallacy and how to break free from it. This way, customers can make wiser money choices that match up with their larger financial plans.

Conclusion

Getting past the sunk cost fallacy can be a challenge, especially in money matters. But, by understanding what this bias is all about and how it works, financial institutions can lend a hand in guiding customers toward wiser financial choices that align with their long-term goals. With the right financial knowledge and tools, customers can shake off the sunk cost fallacy and work toward a more secure financial future.

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Do you find yourself ignoring advice and recommendations even when they might be in your best interest? You might be experiencing autonomy bias. This cognitive bias makes us place too much value on our own opinions and preferences, leading us to ignore outside information that could help us make better decisions. In banking, autonomy bias is the tendency of individuals to overestimate their ability to control their own financial future and decisions, leading them to disregard potential external factors that could impact their financial well-being. This bias can cause people to take on more financial risk than they can handle and can lead to poor financial planning and decision-making.

Why does it happen?

Autonomy bias is the natural result of our want for independence in our rational decision making. We all want to feel in charge of our decisions and want to believe they are uninfluenced by others – it is human nature. Thus, when presented with choices we may become resistant to choices suggested by others, believing them to be an attempt at controlling us and our decisions. Financial decisions can be particularly challenging, as they often involve complex information and trade-offs. Autonomy bias can cause us to stick to our own limited understanding, even when it’s not in our best financial interest (Johnson & al., 2012).

Imagine a person who has a savings goal of $10,000 for the year. They set up a recurring transfer from their salary into a savings account and plan to leave the money untouched until the end of the year. However, unexpected expenses come up and they dip into the savings account throughout the year, spending more than they had planned.

Here, the person’s autonomy bias may have influenced their behaviour. They set up the recurring transfer and made a plan to save, but when unexpected expenses arose, they didn’t adjust their plan to fit the new circumstances. Instead, they continued to spend from the savings account as if nothing had changed.

In what ways can financial institutions utilise autonomy bias to facilitate improved personal financial management?

Financial institutions can harness this effect by reframing services as tools for empowerment. For example, instead of simply suggesting a savings account with a high interest rate, a bank could provide money management tools including a savings calculator that lets customers set their own goals and see how different savings options would affect their progress.

Or, instead of prescribing a specific investment portfolio, a bank could provide an investment platform that allows customers to build their own customised portfolio based on their goals, interests and priorities. By using interactive and personalised tools that present different choices equally, customers can feel as if they are more in charge of their own finances.

Conclusion

Autonomy bias in banking can be a double-edged sword when it comes to personal financial management. On one hand, it can cause us to ignore valuable advice and make suboptimal financial decisions. On the other hand, by harnessing the effect of autonomy bias, banks can empower customers to make more informed and personalised financial decisions (Thaler & Sunstein, 2008).

By giving customers the tools and information, they need to explore their options and make decisions that align with their values, banks can help their customers achieve their financial goals while feeling confident and in control. So, next time you’re making a financial decision, remember that autonomy is important, but so is seeking outside advice and exploring all your options.

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Our choices are driven by the information that is communicated to us and things that we see. As a result, we have a tendency to fixate on information that is distinctive while ignoring anything that doesn’t particularly stand out.

Why does it happen?

The word salience is defined as “the quality of being particularly important or easy to notice”. When we’re considering, building or designing a product, it is key to acknowledge that the information presented first and most prominently has the ability to affect our decision making process. Our inclination to focus on information that is unique or different leads us to the salience bias. Salience bias, however, is not limited to attention grabbing information. It can also affect our financial wellbeing and our purchasing decisions. For example, when we see a 2-for-1 deal, it is easy to be distracting by the savings rather than focus on whether or not we might need the extra item.

How can financial institutions harness the effect of salience bias to enable better personal financial management?

Positioning saving as the default option in digital banking apps

On the whole, we understand that people are more likely than not to go with the first easiest option that is presented to them. When users are presented with a saving as the default option, financial institutions are harnessing the effect of salience to encourage users to save. Since it is more effort for consumers to opt-out from the pre-programmed default, positioning saving as the default may encourage the formation of good financial habits for users in general.

Ongoing financial wellbeing programmes

When implementing a financial wellbeing program, ensuring that users see the right information at the right time is crucial. Banks can harness the effect of salience by ensuring the right content is shown at the right time to prompt users to act accordingly. Should a user be saving as soon as they get paid? Send a push notification. Are their credit card bills due? An in- app reminder might do the trick. Salient reminders can be used as an approach to nudge users into developing better financial habits in the long run.

Conclusion

It is crucial for banks to acknowledge salience bias and that it has the potential to impact users negatively if they simply focus on the most emotive and leading details at hand. However, it can also be effectively embedded into digital banking applications to support the development of better financial habits for users by ensuring that the right messaging and nudges are being communicated at the right time. Helping consumers interact with the right information at the right time is not only encouraging for users on their financial wellbeing journey, it will also help banks build a more engaging relationship with users in the long run.

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What is the Certainty Effect?

The certainty effect is an observation stemming from a behavioural model called Prospect Theory by Kahneman and Tversky that describes the inclination we have to feel inordinately confident about outcomes that are certain (i.e. 0% and 100%), compared to outcomes that are less certain (i.e. a probability like 40% or 50%) but most definitely viable. Gains and losses are valued differently, and we are more likely to make decisions based on perceived gains instead of probable losses.

A probable loss also has a greater emotional impact than an equal amount of gain, so if choices are presented in a manner of both offering the same result, it is more likely that we pick the choice offering perceived gains.

How can the Certainty Effect be applied to financial services?

Clear and concise communication

Certainty in decision making is highly valued by users, and therefore it is a great way to develop trusting relationships with consumers. For example, in a financial wellbeing challenge, providing consumers with timely updates of their progress and providing positive reinforcement as they approach their goal can develop a sense of comfort and control over their journey, helping them persevere through to completion.

Reframe uncertain messaging and offers

When it comes to communicating offers and campaigns, uncertainty can cause consumers to second guess if they want to commit to something. For example, instead of offering three apples for the price of two, offer one free apple with two purchased. The certainty is greater with a zero-priced third apple, and consumers do not need to calculate whether or not the savings on the third is proportional, making the positive impact obvious immediately.

Certainty effect in reverse

Conversely, for some consumers, uncertainty can actually prompt engagement and be used as a motivational tool. Uncertain rewards such as lucky dips and prize draws can be used to target this group of customers and maintain engagement throughout longer term challenges. Either way, a consumers relationship with risk vs certainty needs to be considered when scaffolding financial wellbeing challenges over extended periods of time and can be personalised to the individual’s preference.

Consumers would choose clarity over chance, even if this directs them towards less profitable financial decisions. By understanding the influence the certainty effect has on customers, financial institutions are positioned to support better decisioning by the framing of choices and options to help customers succeed in their financial wellbeing journey.

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What is confirmation bias?

Confirmation bias describes the tendency to favour, focus on and give credence to information that fits in with our existing hypotheses. We are often attentive and attuned towards information that upholds our beliefs, while perhaps also unconsciously undervaluing information that disproves and challenges them.

For example, the way a question is phrased and asked can often result in responses that are consistent with a hypothesis or viewpoint. If you were to Google “Is Pepsi better than Coca-Cola?,” the responses will surface sites that lists why Pepsi is better. However, if the question was reversed, the query will surface sites that provides reasoning for why Coca-Cola is superior. In this case, the use of affirmative language results in collecting evidence which backs up your original hypothesis – from a source which most likely supports your original hypothesis.

Confirmation bias is often displayed during the process of discovery or when information is recalled selectively causing it to be interpreted in a one sided manner. Time and again, studies have shown how people choose to focus on responses that supported their own hypotheses and remain resistant to conflicting evidence. Often this can result in positive feedback cycles; after having our positions challenged we tend to feel an even greater commitment to our original beliefs!

How can banks and financial institutions help customers navigate and avoid confirmation bias?

Personal Financial Management (PFM) solutions

Providing customers with interactive PFM tools like foresights to display what upcoming expenses they are expecting for the month is a great way to encourage them to understand what they are purchasing on a regular basis and prompt them to make more intentional financial decisions. PFM tools can also help by sending prompts to customers to help them recognise their proclivity towards expenses that might be encouraged or informed by their confirmation bias, thus giving them time to stop and reconsider the way the react to the circumstances.

Gamification of digital banking services

The gamification of digital banking services can be a fun way to introduce information to users, enabling them to have a deeper understanding of their finances. Embedded quizzes, surveys or questionnaires can help deliver information in a positive manner, framing information in such a way that encourages users to deliberate their decision making process. This way, the information served acts as a nudge rather than a direction, thus allowing decisions to be challenged in a gamified manner.

Financial wellbeing programmes

We know that our cognitive biases can distract us from making sound financial decisions. Therefore, giving users a clear overview of their finances is the first step in helping them realise and acknowledge their cognitive biases. Serving financial literacy content directly to users is the next step as it provides users with valuable insights and information that they might not have access to elsewhere. Beyond that, long term financial wellbeing programmes can be impactful by consistently analysing a user’s financial overview with the goal of offering them a better idea of the longer term impacts of their financial decisions.

Conclusion

As consumers, the first step to reducing the impact of confirmation bias is to recognise it and understand the types of decisions it is most likely to impact. When making financial transactions, is important to acknowledge the impact confirmation bias has on our ability to evaluate information and the decisions it can influence. Remember – decisions are not fully considered if we are only relying on information that already supports our assumptions. Financial services can help consumers understand their confirmation bias by drawing attention to past biased decisions in the aim of empowering consumers to make better financial decisions in the long term.

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What is the Framing Effect?

The framing effect is a cognitive bias which describes how identical scenarios, when portrayed in different ways can result in vastly different choices and decisions being made. Human behaviours and responses to the same situation can be influenced significantly by the context in which the inherent ideas are framed – through questions asked, choice in use of language and presentation of information.

For example, a consumer is looking to buy some diet cola over in the supermarket. One was marketed as “80 percent sugar free” and the other says it contains “20 percent sugar.” The framing of nutritional information resulted in the former being chosen, because it appears to be the healthier option despite the fact that there is the same amount of sugar in both drinks. The higher value highlighted in the first diet cola was associated with it being the better option. This is but one example of how identical information can be perceived as less or more enticing depending on what attributes are accentuated, and there are plenty of those when it comes to our finances.

Why does it happen?

Our brains attempt to simplify decision making processes by using cognitive shortcuts to quickly establish outcomes in our daily lives. Decisions associated to the framing effect are based upon the way information is introduced to us, rather than the information itself. As such those decisions may be ill-informed – lesser options can be portrayed positively and can make them seem more favourable than they actually are.

When it comes to framing, Tversky et al (PDF) puts forward that “outcomes are commonly perceived as positive or negative in relation to a reference outcome that is judged neutral.” The framing effect is not just about how information is portrayed, it is also based on benchmarking and outward reference points. Alternative reference points can consequently also affect whether an outcome is determined to be advantageous or disadvantageous.

Additionally, people are generally loss averse and want to steer clear the negative emotions being evoked as a result of losses as much as possible. Framing an outcome around a loss has been shown to have more impactful and longer lasting effects than the same outcome presented as a gain.

How can banks address the framing effect and help their customers avoid this cognitive bias?

Quizzes, surveys and questionnaires

In order to help consumers understand their financial situations better, quizzes, surveys and questionnaires can be employed within digital banking apps. This method of self-discovery can help users realise not just what their financial goals are, but more importantly what their risk appetites are financially, thus helping them gain clarity of what financial decisions they can afford to make, regardless of how the framing effect can make them feel about potential purchases and investments.

Personal Financial Management (PFM) solutions

With the deployment of PFM solutions for banks, rich, interactive and educative perspectives on their finances can be given to consumers to enhance the framing of their financial data. PFM features can surface options in a manner that highlights positives (or downsides) of the financial decisions being made, thus allowing users to fully understand the impact of the past and future decisions they are making. Positive language and the appropriate tone of voice can also be used to frame information and help encourage users to save for the future.

Framing saving as a default choice in digital banking services

A key aspect of consumer behaviour indicates that consumers are more likely to stick with the easiest option that has been presented to them. By presenting users with a default choice of saving or setting up smart automated transfers into their savings accounts, financial institutions are framing savings as a key aspect, thus making it less likely that consumers will opt-out from the automatic default framework of saving.

Conclusion

As consumers, the framing effect has the potential to impact both positively or negatively. In order to avoid it, it is key to remember the most important thing to focus on is the message rather than the method of delivery. As financial institutions, it is possible to use the framing effect as a means to nudge customers into making better financial decisions. Effectively framing the right messaging can help users act in a way that will benefit their financial wellbeing in the long run.

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What is the Cashless Effect?

The Cashless Effect is a cognitive bias that characterises an inclination to be more willing to part with our money when there is no actual physical transaction taking place. Essentially, we are more likely to spend more money when we are not spending physical cash, as it more abstract and therefore less psychologically painful to part with.

The “pain of paying” is a typical negative emotion to go through when paying with physical currency. However, tapping or swiping a card and the absence of tangible cash takes the edge off quite easily. Digital payments create a form of disassociation from the negative arousal we tend to feel from parting with cash, and as it becomes a primary way which we make transactions, it becomes easier to overspend and make higher risk purchases that we typically would.

What can financial institutions do to help consumers be aware of the Cashless Effect?

Monthly notifications for auto-debit payments and subscriptions

In addition to cashless transactions at the point of sale or e-commerce store, it is also common for consumers to set up auto-debit for recurring payments and subscriptions today. Auto-debiting as a default is a shortcut that enables consumers to very easily forget that they are in fact paying for services or subscriptions that they perhaps no longer require. Regular notifications for new, upcoming or soon-to-renew auto-debit payments can be a useful way to help users track their spending, understand what they are paying for and gives them the opportunity to cancel if they no longer require the subscription.

Money management tools

As cashless payments become the norm, it is important that banks provide users with timely spend tracking features allowing them to understand their finances better and help with ensuring that they don’t overspend. From setting up budgets, financial forecasting capabilities that analyses spending habits, visuals that provide users with an understanding of their regular payments’ schedules, to automated settings that divest a predetermined amount for savings regularly, banks can provide users with actionable and personalised money management tools to continually review their finances, hence providing some control over the Cashless Effect, despite the instrument’s many undeniable benefits in terms of convenience.

Increasing friction for big expenses

Cashless payments remove effort and friction from the purchasing process, thus further eliminating the pain of paying. Payment methods like Apple Pay, Google Pay and Amazon 1-click have revolutionised the payment process, doing away with even the use of cards while checking out.

By increasing friction for users who want to pay with cashless methods especially for online purchases and big expenses, consumers can be compelled to take a moment to consider the amount they are paying for the items they want to buy, thus giving them the chance to reconsider their purchases.

Furthermore, if a buyer is overstretching their budget, this moment of pause gives them the opportunity to confirm that they indeed want to go through with the payment despite the negative arousal they might feel.

In addition to their inherent security benefits, friction points in digital banking are created through means such as the requirement of one-time passwords (OTP) sent to users via text or needing to launch digital banking apps to verify payments. It can also be a requirement to pay with an alternate method for larger payments. While these methods might seem cumbersome to users on a day-to-day basis (again, notwithstanding their security benefits), it brings back a form of acknowledgement to payments, thus inciting a more tangible feeling of parting with money which hopefully enables more informed decision making.

Conclusion

Cashless payments are a wonderful convenience for consumers and are here to stay. Having said that, financial institutions should help consumers stay on top of their finances and be informed about their financial situation regularly to curb the overspending side effect which this seamless payment method may generate. The Cashless Effect should be considered by financial institutions when building out financial wellbeing programs and personal financial management (PFM) tools as well, to ensure a more cohesive approach being taken by all stakeholders involved in order to offset the consequences it may pose to users in the long run.

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It is common for customers who are loyal to a brand, product or company to frequently and erroneously assume that they have superior odds of winning a prize even though they’re told that the winners will be picked at random. This belief is a cognitive bias that practioners have called the lucky loyalty effect.

Why does this happen?

There is a direct correlation between the amount a consumer invests in a brand and the entitlement they feel towards the chances of them winning a reward being offered by said brands, even when the outcome is known to be random.

However, it is important to note that this bias is not solely based on the financial investment a customer makes in a brand. By choosing to support one brand continuously over another, consumers are deciding to also invest their time and emotions into the brands they choose to champion. These are all factors that make loyal customers assume they should be prioritised over anyone else.

How can financial institutions leverage the lucky loyalty effect?

Strategy is key

The lucky loyalty effect is a powerful tool banks can use to persuade loyal customers into engaging with their financial institution. Having said that, it is crucial to also acknowledge that this cognitive bias is based on entitlement and perceptions customers have of reaping the benefits of their long-term commitment with the bank. These perceptions are not cerebral, and without a cohesive strategy on how the lucky loyalty bias can be implemented, it might end up backfiring.

Embed gamification in your offerings

The digital banking landscape offers many options for customers, and financial institutions should constantly find new and fun ways to delight customers, keep them engaged and prevent them from looking elsewhere. Gamified experiences such as the chance to win a surprise cashback or a lucky draw every time an expenditure milestone is met can be a great way to periodically excite long term customers and give them a chance to win something. Creating multiple touchpoints enhances the customer journey especially for consumers who experience the lucky loyalty bias, potentially causing them to be more likely to take part in quests or lucky draws where they feel they have a higher chance of winning.

Gamification techniques applied to banking are also a great way to further encourage customers to use the bank’s services during a promotional period. Once again, customers who experience this bias are more likely to have higher levels of participation and engagement as they are more confident of their chances of winning.

Employ a loyalty program

The lucky loyalty effect might work adversely and end up creating an unrealistic expectation by customers to always be rewarded. Research shows that loyal consumers tend to feel higher levels of “deservingness” as they are used to being rewarded for their loyalty in the past, thus expecting a continuity in rewards for future patronage as well.

A well-constructed loyalty program would ensure that the expectations of these consumers are met, as the desired effect of such an offering is to reward and categorise loyal customers by setting them apart from the “regular” customers – providing them with specific perks that are not available to everyone else. Members feel special and rewarded simply for being a part of a such a program without needing to win anything!

Loyalty programs in banking can also be enhanced by embedding gamification techniques or personalised offers and promotions that are relevant to customers. It helps maximise the interactions consumers can have with their banks, further building upon the brand-customer relationship and heightening their loyalty to a brand and its products.

Conclusion

Customers that have invested more in a bank (who have multiple product offerings) are more likely to participate in promotional activities as they would perceive themselves to have a higher chance of winning.

The lucky loyalty effect should be considered in the development of marketing and promotional strategy to achieve higher levels of customer advocacy, motivate long term commitment from customers and create opportunities for cross-selling.

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Whether we are acting as students, employees or consumers, our efforts towards completing a goal accelerate drastically the closer we are to achieving it. As human beings, there is a tendency for us to be more motivated by how much remains to complete a goal, rather than how far we have come. There is a correlation to the commitment we have invested in an opportunity, which is why consistency and commitment are strong motivators in the completion of any task. 

The goal gradient effect was originally proposed by pioneer behavioural psychologist Clark Hull in 1934. He conducted an experiment on rats to test his theory, and found that they ran progressively faster as they approached the food at the end point. This theory indicates a classic finding from behaviourism: animals put in more effort as they near a reward. Building on this theory, behavioural scientists began to generate new propositions about human psychology in relation to rewards, and the implications on consumer behaviour in general. 

Studies have also shown that the goal gradient effect has a direct impact on our social psyche and motivation. For example, people are more likely to contribute as charitable campaigns approach their goals. Late stage efforts allow donors to feel a greater degree of perceived impact, a heightened level of satisfaction with their generosity and fulfilment from having personal influence in solving a social problem. 

How can financial institutions use the Goal Gradient Effect to help consumers develop better financial habits?

Remove barriers to entry and incentivise customers

Marketing specialist Guy Kawasaki once quipped that “the hardest part about getting started, is getting started”. For a range of reasons, consumers find themselves hesitating when it comes to developing better habits, financial or otherwise. Targeted use of incentives is a great way to get customers “out of the starting blocks” and on the way to achieving their goals. Once consumers are on the path towards their goal, the likelihood of them achieving success increases considerably. The goal gradient can be used in this situation, whether through loyalty programmes or in making investment funds attractive to customers, to incentivise the initial uptake.

Visuals as a motivating factor 

Envisioning progress towards a goal induces an increment in the speed of completion. PFM solutions including saving goals allow customers to watch the rate at which they are saving, thus heightening their desire to finish. Additionally, reminders and nudges when a customer has reached a milestone have the potential to motivate them further. 

While the ratio of benefit to the remaining cost increases as we approach a goal, levels of effort are also expected to decline once a goal has been achieved. How do we then ensure sustainability and longevity in the newly formed financial habit of saving? In this case, a suggestion or ideas for the next big thing to save for might help consumers keep up with their newly formed good habits, and ideally also help them achieve financial wellbeing in the long run.

Reframing goals and making them achievable

The motivation to achieve a goal is directly related to its size. For example, a customer wants to save $400 a month. Instead of telling them to set aside $100 a week, an option is to break it down to $14.30 a day. Not only does the figure appear more achievable, the customer will also be able to compare that amount to the price of a movie ticket, a fast food meal and the choice of a taxi versus public transport. Suddenly, the idea of saving $400 a month seems all the less daunting. Moving the goalpost forward not only increases motivation, it also helps with a daily sense of accomplishment and gives the customer an instant physiological reward.

Conclusion

Consider the Goal Gradient Effect when implementing new loyalty programmes, building personal financial management solutions centered around savings and financial wellbeing programmes. Remove barriers to entry and incentivise users to begin with whilst ensuring they can see how far they’ve come. Breaking down goals helps them appear achievable and gives consumers a regular sense of accomplishment to help them stay motivated. It is easy to focus on what is left to achieve but getting there is made easier when you can appreciate how far you have already come. 

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Moneythor’s behavioural science series, a four-part collection of blogs, is based on interviews held with Klaus Wertenbroch, a renowned expert in behavioural economics and consumer-decision-making. In this series we will be delving into the topic of behavioural science in financial services, it’s benefits and pitfalls, the impact it can have on the financial wellbeing of customers and the role it will play in the future of banking.
 

Part 4 – What Role will Behavioural Science Play in the Future of Banking?

The future of behavioural science, like most other things, is digital as banks continue to transform the channels they use to communicate with customers and the experiences they deliver online. According to Wertenbroch, “most financial experiences – just like most other commercial and even many personal interactions – will be increasingly digital. The COVID-19 pandemic is accelerating this trend even more. Insights from behavioural science will thus be applied via online tools.”

When considering the role behavioural science will play in the future of banking, Wertenbroch notes “[The] impact it will have on customer experiences will depend on how financial service providers want to use behavioural insights. On the one hand, they could use these to take advantage of consumers’ vulnerabilities that arise from the systematic, ‘hardwired’ deviations from rationality, which behavioural scientists have identified and documented over the last 50 years. Needless to say, such business practices would be ethically questionable.”

Potential ethical pitfalls from the commercial application of behavioural science principles have prompted regulators to intervene in how these principles are used in banking. Wertenbroch points out that “Regulators have increasingly been cracking down on using behavioural insights to consumers’ detriment. For example, the United States Credit Card Act of 2009 requires banks to calculate how long it will take customers to pay off their debt if they make only minimum monthly payments. These suggested minimum payments anchor customers on making payments that are low enough to keep them in debt longer and thus generate higher interest income for the bank. Such anchoring and reference effects have been well researched by behavioural scientists.”

When asked if there is a need for behavioural science techniques to be regulated, Wertenbroch says “That’s a very important question. Broadly, my answer is no unless there is potential for abuse. For one, as behavioural science techniques are increasingly applied to shape customers’ digital experiences, customers’ privacy needs to be protected, but privacy regulation is not specific to behavioural science techniques in financial services. Applying insights from behavioural science could also allow banks to exploit customers’ cognitive vulnerabilities (e.g., present bias in consumer spending in response to excessive credit limits and low minimum monthly credit card payments).
Regulation may be needed to curb such abuses that harm consumers, which traditional economic and legal analysis finds difficult to acknowledge, given its prevailing rationality assumptions.”

Regarding the question of regulation, Wertenbroch adds “Beyond these, regulation does not generally seem warranted, even though critics may still question the ethics of nudging. Nudging is meant to improve individual and societal well-being, for example, by prompting consumers to make better financial decisions, without infringing on people’s freedom of choice. That’s a utilitarian objective, which not everyone shares. Opponents allege that nudging amounts to manipulation because it targets automatic cognitive processes outside of individuals’ awareness and control, so-called ‘system-1′ processes. It is less important to these critics that nudging is for consumers’ own good than that nudging prompts people to make choices that they might otherwise not make, presumably interfering with consumers’ autonomy to make decisions free from external influence.”

In response to the criticism of nudging Wertenbroch remarks “In my view, it is hard to argue that nudging significantly undermines autonomy. That is because autonomous decision-making always relies on both automatic and controlled cognitive processes. Moreover, at least in cases where consumers choose to self-impose constraints via some form of pre-commitment (e.g., frequently paying with limited cash instead of using their credit cards), they themselves reveal through their behaviour that they understand that they need help. In those cases, consensual nudging should be ethically uncontroversial. In sum, it is difficult to justify a need to regulate behavioural science techniques in general beyond curbing abuses of consumers’ private data and psychological biases.”

While the debate about ethics in behavioural science will no doubt continue in the future, it is important to remember the positive impact that it can have on customer wellbeing.

“As the examples show, financial service providers can use behavioural insights to help improve their customers’ wellbeing. That should be a win-win in that customers will interact with their service providers more extensively when they see the benefits they get from these interactions and this will also strengthen the service providers’ brands. Providing information to help customers minimize anchoring and framing effects, helping them save more for the future, or reducing friction points are straightforward behavioural science measures that can improve not only digital customer experiences but customers’ lives.”

Part 1 – When Banking and Behavioural Science Collide

Part 2 – The Benefits and Pitfalls of Behavioural Science in Banking

Part 3 – How can Behavioural Science Improve Financial Wellbeing amongst customers?

About Klaus Wertenbroch

Klaus Wertenbroch is a Professor of Marketing and Novartis Chaired Professor of Management and the Environment at INSEAD, one of the world’s leading and largest graduate business schools. Wertenbroch is an expert in behavioural economics and consumer-decision-making.

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