What is ‘Nudge Theory’ – and why should we care as bankers?
Being completely rational all the time is unnatural to most human beings. It is completely natural to be irrational most of the time, however. Therefore, it’s much more effective to see a customer’s behaviour in their natural, irrational setting and ‘nudge’ or steer them towards a particular attitude.
Banks and financial institutions should start thinking about adapting their processes, products and services to their customer’s natural way of thinking. One approach that some are considering involves ‘debiasing strategies’ based on Nudge Theory. Some banks are now starting to accept that a more effective approach to getting the desired behaviour from their customers is to use their cognitive biases to help them achieve their financial goals even if they appear counter-intuitive to the ordinary observer.
For example, a bank may decide to use social default bias to nudge its customers because they are susceptible to social influences. For instance, customer-focused projects could have design features with a heavy social element. Customers are likely to copy social behaviour if it is presented by the bank as the status quo.
Banks also know that a majority of their customers characteristically want and expect low-cost engagement and minimal maintenance when it comes to their savings and investments. If a bank wants to keep customers engaged in their finances, then nudging them is a novel approach. When it comes to biases like cognitive cost/sunk cost effect, any effort to reduce procedural steps, pages, processes, required actions etc. will be effective because they all contribute to reducing the cognitive costs for keeping customers more engaged. Creating activities, games, offering incentives etc. to encourage engagement tends to increase the cognitive costs and in fact has the opposite effect and lowers customer engagement because of the increased cognitive load.
Advisers are slowly incorporating some of the findings of the leading behavioural economists in order to nudge their customers depending on the outcome they are seeking. Sanctions and rewards can be used jointly and severally depending on what outcome is sought. According to a vast number of financial surveys, the majority of British bank customers are by nature risk averse and not prepared to leave their comfort zones. When it comes to savings and investments, these customers are more likely to associate risk with losses than potential gains.
Based on Daniel Kahneman and Amos Tversky’s ground-breaking work, Prospect Theory, customers will be risk-averse if they are faced with choices that lead to gains, but will be risk-seeking if they are faced with choices leading to losses. Banks can now use Nudge Theory to obtain the ‘right behaviour’; if the desired effect is to make customers risk averse (e.g. insurance), offer them choices with gains. If the desired effect is to make customers risk seekers (e.g. investments), offer them choices with losses. This may seem counter-intuitive but a lot of research supports it.
Jim Coke is a Researcher in the Human Centred Design team at Lloyds Banking Group. He is currently completing a PhD at King’s College London in the field of behavioural economics, risk and uncertainty in China.