What can behavioural economics tell us about the loans market?

Human behaviour and decision making can be notoriously tricky to predict. After all, who predicted President Trump and Brexit?

However, in the financial sector, economists are using behavioural economics to help implement effective regulations and improve financial models for the benefit of customers.

In this post, we’ll look at what behavioural economics is and how it can help teach us about the loan market.

What is behavioural economics?

Behavioural economics studies the cognitive, social and emotional factors present when people make economic decisions.

Behavioural economists argue that people have biases and are not hyper-rational. This means that, once we understand these biases, we can model reality and gain insights. Now these economists are using this model in an attempt to change the way Britain’s regulators think about the markets they regulate.

What can it tell us about the loans market?

Behavioural economists have spent time studying the payday loans marker in particular. In studying this market, they have discovered that applicants study from what’s known as ‘present bias’, which means that not only do people want things immediately rather than tomorrow, but when tomorrow comes they’ll make the same choice due to their skewed preferences.

In short, it means that consumers are overly confident about their ability to pay back loans. Although customers are highly confident about their ability to repay, they in fact spend more than they plan to, leaving them in financial trouble.

The role of the FCA

This research has led to the Financial Conduct Authority (FCA) making interventions in the loan market. The FCA must answer two questions when it comes to regulation of all financial markets:

  • Are a regulator’s assumptions of utility or profit optimisations reflective of real people’s behaviour?
  • Whether an individual can make a logical and informed decision devoid of emotion.

With the first question, we have already seen the FCA step in to cap interest rates in an aggressive manner. The second question needs further practical application, as behavioural economists need to understand behavioural triggers of people looking for loans.

However, with providers such as Likely Loans streamlining their services and offering quote services that do not impact on credit ratings, we are seeing a move in financial markets where people can make an informed choice. This removes the emotional element of the process, allowing for informed decision making. A further drive from all providers to offer such a service will undoubtedly please the FCA and may lead to behavioural economics crossing the final frontier to the market.