This blog post is inspired by one of the Top 10 books every FinTech professional should read– “Dollars and Sense” by Daniel Ariely and Jeff Kreisler.
Understanding the rationale behind financial decision-making has long been a challenge. Money touches every part of our modern consumer life, from family budgets to national politics, from shopping lists to saving accounts. And there is more and more to think about every day, as the financial world becomes more advanced. The truth is, making bad money decisions is the hallmark of humanity.
Given the challenge people and businesses have when thinking about money in rational ways, what can banks do to improve the way people decide? What if the focus were moved from trying to change consumer habits, to designing products that fit the way people already behave? This might eventually lead to a change in behavior in itself, in a nuanced way. For it to happen, bankers need to look into behavioral economics, which relies on psychology to understand the motivations behind people’s financial decisions. Brands such as Amazon and Netflix invest millions into understanding the psychology of their consumers’ shopping habits in order to drive purchases. Could banks do that too?
In the following post, I’ll be looking at 3 aspects of behavioral economics and analyzing how different financial institutions’ products and policies would look if they took behavioral economics into account when designing experiences.
Personal Financial Management offered by banks has evolved greatly since its birth in the early Eighties.Our categorization of money affects how we treat it and how we use it. We sort our money into different mental accounts, with different rules, depending upon how we get it, how we spend it, and how it makes us feel. For example, people are more likely to spend their salaries on “responsible” things like paying bills, because they deem it “serious money”, but if they get an Amazon voucher, they will probably be more inclined to buy things they normally wouldn’t. Those accounts have different spending rules emotionally.
Nowadays, almost all banks offer categorization, advanced analytics on spending habits, and essentially do all the hard money-management work for their customers.
In the future, it will all be even more intuitive; you will simply provide data to your bank, and its unseen PFM, working hard in the background, will automate your bills, make recommendations based on your personal information, circumstances and solve headaches. Most importantly, it will close more gaps between our conscious understanding of how money works and how we should rationally think about using it.
Clearly there is a gap between money that we spend on daily essentials, or ‘responsible purchases’ and money that we don’t really need or that we spend on ‘luxury’ items. Banks can help us in controlling the emotional side of money management. How? By giving us a detailed breakdown of our fixed expenses, and helping us to make more informed decisions about our disposable income. People tend to have similar expenses each month, so by banks showing us what the best course of action is for our money, they can help us plan ahead and spend less on the unnecessary.
THE PAIN OF PAYING
This is the idea that we experience some form of mental or physical pain when we pay for things; shopping might provoke feelings of happiness, but studies have shown that when it comes to paying, the areas of the brain involved in processing physical pain are triggered.
“In the modern world of online banking, using credit cards, e-wallets, automatic bill-payment is the equivalent of putting on little “financial helmets” to reduce the pain of paying. Like bad doctors, we treat the symptom, not the underlying disease (the paying).” – Jeff Kreisler
If we can’t feel it, it can’t hurt, right?
Let’s say a customer books a vacation. After registering the transaction, banks can proactively offer the customer competitive foreign exchange rates.Banks have the potential to decrease the pain of paying in daily lives, something that logically has greater benefits for them than the customer, though they would do well to place greater emphasis on enhancing the “pleasure” that comes from saving. It’s a fact that in the future almost all the friction will be eliminated from payment systems. That’s why to truly help their customers, banks need to focus on their customers’ long-term financial health or saving rates.
The truth of the matter is that people feel pain when making payments that are not accounted for in our mental budget. How can banks help us to avoid that feeling? By stepping in to solve both last minute financial problems (so that unexpected issues don’t impact on our finances), and think ahead about the long term, so that the future is under control.
Short term example: I had to go to the dentist unexpectedly, and had to pay more than expected for treatment. As soon as that transaction is charged, my bank account goes into the red, but immediately my bank offers me a line of credit to pay it off in 6 months. I pay €X for that credit line, but it amounts to less than the fee that they would charge me after 1 day of being ‘illegally’ overdrawn.
Long term example: I want to start saving for my vacation, and my bank offers me the option of setting up a savings goal (the bank knows that I typically spend more money each summer than throughout the rest of the year). They help me calculate how much I can safely save each month, and if I accept, the money will be transferred directly to my savings ‘pot’.
Anchoring occurs when we are drawn to a conclusion by something that should not have any relevance to our decision. For example, if we are used to buying a soda for one dollar, this influences how we determine the value of a given product or service from that point on. It’s about trusting ourselves, because once an anchor enters our consciousness and becomes something we accept, we instinctively believe that it must be relevant, informed, and well reasoned.
According to the financialbrand, as in any relationship, it is imperative that a strong foundation of trust is established before moving the relationship forward. In banking, this equates to providing the necessary information required to best use the service opened before trying to sell another product or service.What if a bank becomes our trusted advisor? What if customers turn to their bank for guidance in times of doubt and uncertainty? Sound too unrealistic?
The less we know about something, the more we depend on anchors. Open Banking will widen the access to existing products, like credit, debt and financial advice and bring new products to market at the click of a button. Digital comparison tools will enable much easier assessment of complex product pricing, especially as banks are required to provide their data in a more standardized way.
To become any kind of advisor, you need to gain the trust of the end user first. And to get that trust, transparency is key (I only trust people that are clearly open with me). Open Banking could feasibly help banks to rebuild a trusting relationship.
This is just a peek behind the curtain – a small fraction of the inner working of the financial brain. If banks and Fintechs put their minds to it, we can individually and collectively improve the decision-making process. The next step for banks is to turn this awareness (or learn even more) into an actionable plan, into change and tangible next steps.
Special thanks to Miriam Ballesteros for sharing the book and to Jeff Kreisler for sharing his insights with me!