Customer decisions are not completely rational or optimal. External and internal factors influence the final choice a customer makes, this holds true for financial decisions too.
Understanding what influences customer decisions and choices can provide banks with the tools to create customer journeys and experiences that encourage better financial management and improve the financial health of their customers.
Financial health looks at the state of one’s financial situation, taking into account things like how much savings a person has, or whether or not they are set-up well for retirement. Being financially healthy allows people to lead enjoyable lives and to avoid stresses associated with poor financial management. From a bank’s perspective, financially healthy customers positively impact the bank’s bottom line. A 2015 Gallup survey found that customers who believe their banks are looking out for their financial well-being, purchase more products from that bank than from a bank that does not.
So how can banks use behavioural science techniques to improve the financial health of their customer base?
Behavioural science is the study of human behaviour. It involves understanding why people behave in a certain way and what drives their decision-making processes. When applied to banking, it attempts to understand and explain why people make certain financial choices. When a bank is able to analyse and understand the previous behaviours of customers, it helps them to predict what future behaviours will look like and encourage customers to either change or maintain that behaviour before a decision is made.
There are many behavioural science theories that have been put forward by leading researchers in the field of behavioural science, like Thaler, Sustein and Ariely that banks can study in order to better understand their customers and their decision-making processes.
Loss aversion theory proposes that the pain of loss is much greater than the pleasure of a gain. People are more willing to take a risk that avoids loss than one that would make a gain. Loss aversion can prevent people from making financial choices that could potentially lead to a loss. For example, people may choose not to invest their money out of fear of losing it, even though it could bring them greater gains.
In order to encourage people to invest, banks need to consider their aversion to losing money and present investment opportunities in simpler, less risky ways. Micro- investing is a good way to get to get people who are risk-averse to start investing. Micro-investing providers like Raiz Invest, add rounded-up, small-change amounts to an investment fund. It is a pain-free way for people to begin investing without the fear of loss.
The concept of mental accounting suggests that people think of value in relative rather than absolute terms. This means that people consider more than just the value of a product or service but consider the value derived from the transaction. For example, people treat money differently depending on where it came from and what it will be used for.
Studies have shown that people are happy to spend more on credit card than they are in cash and they will treat recent gains as more disposable than long-term gains. Adding disproportionate value to funds can cause people to overspend because their perception of the value of money is skewed. Banks can support their customers by offering multiple accounts and an aggregated view of their financial situation, so that all money can be monitored in the same place, preventing incorrect metal accounting.
This principle assumes that present rewards are weighted more heavily than future ones. People want immediate gratification and struggle to see the future implications.
For example, individuals find it difficult to save for retirement because they find it hard to see the long-term benefits and their predictions of the future are usually incorrect. It is hard for people to envision what the future will look like which means they are less inclined to plan and save for it.
Social norms assume that decisions are made by people who are molded by their social environments and that there are social constructs that influence the way people behave.
What this means is that people will adapt their behaviours so that they fit within the rules of a group of people. Comparing one person’s behaviour to another’s can help change behaviours.
For example, banks can apply this theory by showing customers how much the average person within a similar demographic group has in savings, this type of feedback can encourage individuals to start actively saving if they are not at the same level as the average.
Choice overload proposes that people struggle to make decisions when there are too many choices available. Over choice is associated with choice deferral – avoiding making a decision at all.
By simplifying the choices presented to customers, banks can make the decision process simpler and encourage customers to sign up to programmes and products that will improve their financial health.
Behavioural science has many applications. For banks, understanding human decision making and its consequences for finance can lead to the improved success of financial health programmes which can instigate positive behaviour change amongst customers. Actively helping customers to improve their financial health drives customer engagement which will in turn increases profitability.
The Moneythor engine uses behavioural science techniques to provide personalised, contextual and actionable recommendations, insights and nudges that help customers to manage their personal finances. Get in touch to find out more