There is a 'new term' in town: 'Behavioural
economics'. Actually it's really just a fancy term for concepts that have been
in play for the best part of 30 years, but recent developments in neuroscience
have added to the field. What is being discovered may affect everyone who has
ever purchased a financial product (i.e. everyone reading this) and all
organisations that have ever sold them.
'What was I thinking?'
You probably think that you make
rational financial decisions most of the time, right? That may well be the
case, but many of us don't. Anyone who has ever wondered 'what was I thinking
when I bought those shares?' or similar, will know what I am talking about.
We like to think we make decisions
objectively and after sufficient deliberation but studies from psychology and
neuroscience consistently show that many of our decisions are driven by our
in-built biases or 'cognitive biases'. These are developed early in our lives
and usually persist, so we often tend to respond intuitively or emotionally
rather than rationally and deliberately.
This can lead to poor judgement in
many walks of life and most of the time it need not have serious consequences -
we are all humans and we make mistakes. However, when it can result in
financial collapse like it did for many during the Global Financial Crisis it
becomes necessary to get the decision right, and to look into the reasons why
that may not be possible.
Behavioural Economics
This is where behavioural economics
comes in. The interest in why even sophisticated people choose an inferior
product - even when a more suitable product is available - has intrigued many
economists, financial institutions, and behavioural psychologists alike.
Since the groundbreaking work of Nobel
Prize-winning psychologist Daniel Kahneman in the 1980s the theories have been
floating around; but with additional findings from neuroscience about how we think and behave, plus
the influence of the Global Financial Crisis, interest has started rise.
More and more work has gone into answering
two main questions:
1. Why do so many consumers make 'sub-optimal' decisions when
selecting financial products?
2. Why do they choose poor products over products that are
better suited to their needs?
Behavioural economics sets out to
quantify financial decision-making and take a more 'scientific' approach to it.
The tendency in the past was to just 'assume' that people make decisions armed
with all the right information.
The GFC showed that this didn't
necessarily apply - and the fallout affected countless millions of people. So
the regulators in the UK, Europe, the US and Australia have all become
interested.
The Financial Conduct Authority
(FCA) in the UK says 'Behavioural economics takes us beyond intuition and helps
us be precise in detecting, understanding, and remedying problems that arise
from consumer mistakes.'
How does it affect financial
organisations?
Many financial institutions have
come under the spotlight for their marketing strategies in recent years.
Fingers point at attempts to exploit customer decision-making by appealing to
their biases, knowingly leading them to less effective choices than
alternatives or competing products.
Because of interest from financial
market regulators about these practices, it is only a matter of time before
financial products and services come under the hammer from regulators again, in
an effort to protect customers. Financial products are often complex, but they
can be presented as deliberately confusing or misleading, and the regulators
will be targeting this. Financial institutions will need to examine how their
range of products and services are presented to their customers to make
features more transparent.
The main area of dispute here is
where the line will be drawn between effective marketing and 'unethical'
manipulation of decision-making.
As with any regulatory change, this
is an opportunity for financial institutions to differentiate themselves in the
market by leading the way and preparing for the changes that the rise of
behavioural economics will bring about.
The team at NeuroPower is at the forefront
of introducing new approaches to organisational development through the
findings of neuroscience. We apply them to all types of businesses, developing high
performing teams and enhancing leadership.
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