In Defence of Bankers: Buy now, pay later!
- Jim Coke
The moral conundrum
With recent campaigns on financial wellness, the message that comes across is that bankers need to do more to engage responsibly with users. One aspect of the changing financial ecosystem, which bankers are often asked to emulate, is the hyper-personalisation that fintechs and savings apps offer to their users. It would appear that they [fintechs] are bending their clients’ ears and, consequently, their money.
A separate charge that seems pervasive is that bankers will use unethical practices to keep their clients in further debt rather than help them manage their finances well. The argument, in a nutshell, is that it’s in the banker’s best interest to do so; debt is more profitable. I cannot speak for every lending practice, but as a banker, I will defend what we do (I am not referring to keeping people in debt). Specifically, I will focus on the practice of ‘Buy Now Pay Later’ (BNPL) finance and show that rather than a beguiling attempt to profit from charging higher interests rates and potentially putting a customer into a debt spiral, it is rooted in the Choice Architecture Axiom and ultimately in a client’s best interest.
Choice Architecture Axiom
Bankers serve a plethora of clients’ needs and wants by servicing various risk profiles and propensities, ensuring that they have ample choice. In fact, I will argue that as a responsible banker, I must always maintain the Choice Architecture Axiom (I borrow this from Level Financial Technology’s Nudge Strategy). Level insists that when using nudges to cause a change in financial behaviour, they do not eliminate or reduce available choices. Level’s nudge management strategy is not designed to manipulate the financial decisions consumers make. Instead, it always begins with the Choice Architecture Axiom and asks if the nudge (or any intervention on their part) attempts to reduce or eliminate available choices. If that is the case, then it does not form part of Level’s nudge management strategy.
Similarly, as a banker, I must ask myself, do my products or services reduce or eliminate available choices for customers with different risk appetites? If the answer is in the affirmative, then I am not serving my client’s interests. My defence is that banking should always promote the Choice Architecture Axiom because it ultimatelyserves clients’ interests. How do I justify the sometimes unintended consequences such as overspending, debt etc.? For that, I turn to two complementary behavioural economic concepts; hyperbolic discounting and Simon’s Satisficing Theory.
Hyperbolic discounting
When customers face two similar rewards or values that arrive one after the other, they tend to prefer the reward or value that comes sooner. The discounting of the second reward or value is often in line with how long it takes to arrive. In simpler terms, people desire an immediate reward rather than a higher-value, delayed reward.
But this desire does not follow a normal curve but a hyperbola. Once a certain amount of time passes, the desire for an immediate reward fades, and we are happy to wait for the delayed higher-value reward. How much time must pass before we think this way? Well, that depends on what it is we are talking about, and our will power. However, what is certain is that experiments have shown that we all seem to apply this kind of discounting over time, some of us more than others. Bankers have a duty to their clients, which includes understanding how they prioritise wants in the short to long term. The assumption, often misconstrued, is that consumers use discounting in the same way it is taught in business schools. It is the same misconstrued assumption that was held more than 50 years ago that economic agents are rational thinkers using optimised strategies.
Behavioural economists have now corrected that assumption and bankers should also acknowledge that consumers use a different mental discounting process. Our customers use hyperbolic discounting and do not ascribe to the same time-value-of-money calculations. Buy Now Pay Later financing is a valuable product that meets customers’ needs who rely on their mental discounting for meeting financial demands on their limited resources. How does this relate to Simon’s Satisficing Theory, and what exactly is it in the first place?
Satisficing
Herbet Simon (1957) began the descent of the economic agent away from rationality. His Bounded Rationality theory stated that people make decisions that are not entirely rational and based on optimised strategies. These decisions are ‘bounded’ because of the limitations of the mind and constraints in time. What happens is that we arrive at choices that are just sufficient and satisfy the need at hand. Simon stated that people don’t use rationality but ‘Satisficing’ to make decisions - we choose what is sufficient and satisfies. The flip side to this is that we shorten the decision-making process, optimise our available time and invariably become more efficient. In the real world, customers use satisficing because of constraints thatbankers are not privy to or cannot reasonably contemplate given the infinite permutations of variables.
As bankers, we believe that we are not able to determine how customers should optimise their choices. However, as long as there is ‘capacity’ (both in the legal and factual sense), and with financial advice, those choices should be respected and serviced. Due to the vast array of possible outcomes and the sheer inability to achieve optimal maximisation, people will choose the most satisfying option which will suffice when it comes to their finances. What seems to be evident from recent studies is that regardless of the source of money, consumers will create shortcuts because of the sheer volume of information that needs to be computed. Consumers do not have the time to evaluate all possible outcomes and make decisions without carrying out a cost-benefit analysis.
People instinctively choose the 'option that is good enough' but not necessarily the best option. No two customers will be alike. Bankers should not expect customers to make financial decisions by following an a priori approach relying on logical, statistical and theoretical models. Customers rarely make decisions about money that way; that is what the empirical evidence is telling us. Actual behaviour follows Simon’s Satisficing Theory and for each individual, satisficing will vary according to their expertise or knowledge, their environment and the characteristics of the financial need. Buy Now Pay Later financing is a solution for some customers’ preferences that are just sufficient and satisfy the need at hand, whatever that may be.
In Defence of Bankers
Bankers must start to look at behavioural finance in the same way fintechs and savings apps do for their users. But we must go a step further. We must personalise our services and product offerings by understanding our customers’ psychology and defending our practices. We must stop being defensive about how we provide for customer’s wants and needs. Instead, we should start by going back to basics. We should boldly proclaim that we provide opportunities to customers who have both short-run and long-run preferences (hyperbolic discounting functions) and those who want to save time in their decision-making and avoid problematic perfectionism (Satisficing Theory). Buy Now Pay Later financing meets both needs.
Author
Dr. Jim Coke is a member of the Chartered Banker Institute and the Chief Behavioural Officer at Level Financial Technology Limited (www.getlevel.co.uk). The views and opinions expressed in this article are those of the author. They do notnecessarily reflect the official policy or position of any other agency, organisation, employer or company. Assumptions made in the analysis are not reflective of the position of any entity other than the author.