A Behavioral Approach to Consumer Protection & Financial Disclosure

Consumer Protection & Financial Disclosure Regime By Hazik Mohamed

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Outline Regulatory Objectives of Consumer Protection & Principles of Disclosure Rational Choice Theory and Bounded Rationality

1. 2.

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Why are There More Behavioural Problems in Financial Services? Some Typical Behavioural Biases Steps in Behavioural Analysis

Improving the Financial Disclosure Regime

3.

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Plain Language Drafting & Simplifying Consumer Credit Disclosure Minimum Payment Warnings & Countdown Reminders for Penalty Fees Comparative Layering & Product-Attribute Disclosure Regulate Current Pricing Strategies

Integrated Analysis of Market-wide Issues 5. Summary & Recommendation 4.

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Objectives 

The regulatory objectives are to promote effective competition in the interest of consumers of financial services : Strategic Objective

Operational Objectives General Functions

Regulators Ensure Markets Function Well

Market Integrity

Competition Duty

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Consumer Protection

Promoting Effective Competition

Choose the most pro-competitive measure provided that is compatible with the regulatory duties as a whole.

Principles of Disclosure Comprehensible and Simple II. Most Important Information Presented Prominently III. Product Warning IV. Comparability V. Based on How People Use Disclosure and Make Decisions I.

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Learning From Behavioural Economics Bounded rationality Accessing information

Bounded self interest

Narrow choice sets

Assessing information

Anchors and heuristics

Acting on information

Habits and status quo

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Bounded self control

Impulsive behaviour and procrastination Sacrifice and punishment

Rational Choice Theory and Bounded Rationality 

Consumer behavior have been dominated by the Rational Choice Theory : –

‘Rational Agent’ model • •

–

‘Mental Frames’ model • •

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relies on reason-based, analytical and rational decision-making overwhelmingly promoted in business and policy schools intuitive understanding of the decisions that people make unrealistic assumptions — from unlimited memory to pure self-interest

Bounded Rationality is the idea that when individuals make decisions (regardless of their intelligence), their rationality is limited by : – – –

the information they have, the cognitive limitations of their minds, the time available to make the decision. Slide - 6

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Why More Behavioral Problems in Financial Services People find it easier to think about things they know well 2. Financial products are inherently abstract - (people find them complicated) 3. Inherently involve risk and uncertainty - (which we can find difficult) 4. Often have to make trade-offs between present and future, which can be tricky e.g. exercising self-control and delay gratification 5. Can be emotional e.g. psychoanalytical studies show deep emotions such as anxiety, fear, regret and shame when it comes to financial losses. 6. Learning can be difficult, not only for infrequent decisions, e.g. on mortgages, pensions and annuities, but also for charging structures, e.g. overdrafts. 1.

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10 Common Behavioural Biases and Effects in Finance Beliefs (Mental Frame) Shaped by our experiences, upbringing and perspectives

Heuristics (Mental Short-cuts) Quick rules of thumb serve as short-cuts to decision-making

Overconfidence e.g. excessive belief in ability to pick winners

Framing and Limited Attention e.g. overestimating value of financial product because of the way it is packaged/presented

Over-extrapolation e.g. extrapolating small sample (or limited time period) performance to future returns

Mental Accounting e.g. investment decisions made by asset instead of whole portfolio

Projection Bias e.g. maxing out a credit card based on credit approved without considering payment difficulties

Across-the-board Rule of Thumb e.g. decisions made across all funds instead of allocation or case-bycase basis Social Norms e.g. accepting advice because financial advisor is likeable or attractive

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Preferences Influenced by emotions, environment and psychological experiences Anchoring or Referencing e.g. add-on insurance product is cheap compared to base product Loss Aversion e.g. holding on to a losing stock longer than necessary but selling off a winning stock quickly Present Bias e.g. spending lavishly for immediate gratification

Steps in Behavioural Analysis Step 1 : Identify and Prioritising Issues

 How to spot consumer risks caused by biases?  How can these risks be prioritised?

Step 2 : Understanding Root Causes of Problems

 If consumers are biased, what do they really want and need?  How to analyse firm-specific issues?  How to analyse market-wide issues?

Step 3 : Designing Effective Interventions

 What interventions are available to protect consumers?  How to intervene?  How to assess impact of interventions?

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Improving the Financial Disclosure Regime 1.

Plain Language Drafting U.S. start-up Bagcheck included ‘plain English highlights’ alongside more detailed legally drafted terms and conditions :

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Improving the Financial Disclosure Regime 2.

Simplifying Consumer Credit Disclosure ANZ ‘s attempt for less volume of disclosure but better customer comprehension :

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Improving the Financial Disclosure Regime 3.

Minimum Payments Warnings U.K. research has found that credit card bills with a minimum monthly payment have an anchoring effect on customers and that removing a minimum payment could increase average repayments, halving the interest paid by cardholders (Stewart, 2010).

4.

Countdown Reminders for Penalty Fees Cadena and Schoar (2011) found that monthly text messages reminders reduced 20% in interest payments and 7% reduction in late payment charges. In terms of savings, Karlan et al. (2010) found that a general reminder increased savings by 6% and a goal-specific reminder ballooned savings by 16%.

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Improving the Financial Disclosure Regime 5.

Comparative Layering High impact, short form disclosure at the outset, which covers only the most important points and allows customers to easily compare different products. Then, more detailed disclosure is made available on request (click through).

6.

Product-Attribute vs Product-Use Disclosure The use of credit cards, for example, depends on :

i. ii.

iii.

product attributes such as the reward points and profit rate, the consumer's inter-temporal consumption preferences, and external forces affecting the consumer's desire to borrow or need to borrow such as present and expected available income and conditions affecting the demand for funds, e.g., illness, travel or divorce. Slide - 13

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Regulate Current Pricing Strategies 

Evaluate rules concerning calculation methods, permissibility of certain price components, the level or the depiction of prices (Wruuck, 2013).

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Continually ensure greater transparency to promote consumer protection and boost market efficiency, as transparency is one of the prerequisites for functioning (price) competition.

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Boost financial services transparency namely through : i. ii. iii.

Accessibility, Comprehensibility Comparability of price information.

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Designing Effective Interventions Scale of Intervention Level Least

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Most Interventionist

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Provide more Information. Compel firms to provide information in a specific way or prohibit specific marketing materials or practices. Change the Choice Environment. Adjust how choices are presented to consumers. Control Product Distribution. Require products to be promoted or sold only through particular channels or only to certain types of clients. Control Products. Ban specific product features or whole products that appear designed to exploit, or require products to contain specific features.

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When Most Interventionist Action is Required Financial products like those that brought about 2008 financial ruin in the U.S. should be banned.

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– –

affordable housing goals imposed on Fannie Mae and Freddie Mac in 1992 were the major contributors to the deterioration in underwriting standards (1992 - 2008) growth of an unprecedented ten-year housing bubble and stimulated the growth of a private securitization market for subprime loans.

Financial experts, economists and policy makers are also subject to biases, mental shortcuts (heuristics), social and cultural influences.  Mechanisms be in place to check and correct for those biases and influences 

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decisions of policy makers and regulators have large effects on other people’s lives.

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Integrated Analysis of Market-wide Issues 

Behavioral biases often interact with competition weaknesses and other problems in markets, such as classic information asymmetry, regulatory failures, macroeconomic factors, etc. Dynamic process of firms and consumers adjusting their strategy and behaviours

Asymmetric information, externalities, misaligned incentives

Behavioural biases of consumers and firms

MARKET

Regulator analyses how features interact to generate outcomes

Facts of life; e.g. macroeconomic factors

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Regulatory failures : undesirable effects from previous interventions

Competition Failures

OECD Regulatory Policy and Behavioural Economics 

Good regulatory design and regulatory delivery improve environments for good decision-making. Simplification

Regulatory Design

Defaults and Ease

Regulatory Salience and Attention

Policy

Regulatory Delivery & Expected Outcomes

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Debiasing and Decision Quality

Summary 

The contributions of behavioral insights are mostly subtle and simple, in a common-sense way – –

policies that work with inherent human weaknesses tend to achieve better outcomes regulation is not merely a constraint on behaviour but also an enabler and a facilitator to achieve positive outcomes

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Most people like to make quick decisions (financial or otherwise) but fail to see that these quick decisions can be laden with biases and mistakes

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Providing information (products, schemes, policy) that are clear, relevant and simple to understand helps to minimize mistakes, improve good decision-making, protect consumers and make markets efficient Slide - 19

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Recommendation 

Imperative for regulators to explore behaviorally-informed policies that help people adopt desirable behaviors to improve their conditions – –

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adapt regulatory delivery to natural fallible tendencies (default preferences) in order to achieve intended results. less resistance and higher adoption rates

Integrating insights from both behavioral economics and more traditional analysis of competition and market failures has much scope for helping regulators choose the right interventions.

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