Behavioral Economics for Market Regulation & Financial Education

Dear Hsin Ying
Thanks for this posting on human behaviour in MF realm which is very relevant and useful for MF community. In this regard I wish to share my views
In behavioral economics,the factors that lead to cognitive limitations are very important as they affect the desired outcome of the financial services provided and also making fair and equitable conduct difficult among service providers.
If one further probes on these cognitive factors, it could be discerned that these factors exist due to incompatibility of value system at client’s household level which ultimately influence one’s behaviour there by causing two types of behaviour –To wit, intended or predictive behaviour at the point of making financial decision and actual or performed behaviour at the point of utilizing the finance subsequently. In poverty segment living with diverse vulnerability and multiple social contingencies, it is not uncommon to perceive human behaviour on financial decisions with these types of cognitive limitations . In this regard, an illustration would be useful for better appreciation .

In the case of a small farmer his predictive financial decision through micro credit access is to apply more inputs for his crop cultivation in his farm something he values at the time of applying for credit. .It would be interesting to perceive what happens after micro credit access or reaches the poor farmer household ?
In the illustrated case, after financial access, the internal value system (predictive behavior) is shifted subsequently at household level from usage of the credit for purchasing of farm inputs to medical treatment for his wife’s malarial disease (performed behaviour ) resulting negative consequences such a s disposing cattle for repayment of loan in the reference case. In banking parlance, it is misutilization of credit since the intended or declared purpose( farm inputs) for which loan is raised, is defeated and it is unethical too. However, ethically from farmers’ perspectives, medical expense is a immediate necessity to take care of his wife’s health and it deserves priority value to him contextually. Here it may be noted that as the stability of internal values of the client is more influenced by the external factors like currently prevailing welfare situation of the individual and other family members in his household/society as well there by shifting intended values ( predictive behaviour for farm inputs)to performed values ( actual behaviour for medicine) later.
Further, in this case, another dimension of human behaviour is also cognizable. That is prevailing incompatibility of values at individual level since the client as a sincere borrower may wish to behave in utilizing the credit for farming purpose and repay the loan out of farm income loyally to the lender and at the same time contextually, as prudent earning member of HH he also wishes to spend for medical expenses for his family member/s for their survival on priority . This kind of field realities at micro level with the conflicting social situation after financial access, incompatibility of values at client level, human behavioural changes as per the contextual needs in the demand side on one hand, and structured product like micro credit for multiple utility options the supply side on the other, suggest an imperative need for kind of prudent micro management of value satisfaction at individual level through proper sequencing multiple diversified pro poor MF products integrated with welfare goods such health

This would facilitate for keeping the stable human behaviour there by reducing cognitive limitations.
. It therefore demands a change and not only the change in outcome , but also change in the process too which works for such change particularly in human behaviour Here besides financial education , two factors namely ethical nurturing for prudent micro value management system at poor client level and accessibility to integrated products from financial institution also appear to be inevitable in the demand side for ensuring financial competencies of both individual and households and benign financial empowerment to the poor segment at large. This could also serve as a kind of client protection service to the MF clients ..
Thank you for sharing my views
Dr Rengarajan

Dr. Rengarajan — Thanks for your thoughtful comments in response to Hsin Lim’s blog post. Your example is an excellent one that illustrates the real-world scenarios that can intervene between a consumer’s intent and behavior (and similarly, it illustrates how a financial service provider’s behavior to protect the client’s interest through careful loan screening could be necessary but not sufficient to achieve the provider’s and the client’s objectives of timely repayment without debt stress on the consumer).

Policy makers and regulators would need to take account of these real-world possibilities, which is one reason that at CGAP we recommend consumer research as an integral part of policy making. Regulation can help address these circumstances (e.g., by helping ensure that the consumer receives clear information about the loan’s terms and conditions, as well as the consequences of late payment or non-payment). In some cases regulators go further, by requiring that lenders realistically assess repayment capacity (although in the case you describe, this standard might have been met and the borrower could still end up in a difficult situation due to unforeseen circumstances) or by putting in place measures to encourage or require providers to provide “appropriate” or “suitable” products. This is where your point would arise about the superior value to the consumer if the provider were in a position to offer a range of well-designed products. It should be noted, however, that regulators might be hesitant to be too prescriptive about products and product features so as to leave space for innovation and specialization among providers.

Dear Kate McKee
Thank you for your subtle remarks on my comment acknowledging the fact on real world scenario at client’s household level.
Agreeing with you , I only reiterate the significance of providing ‘appropriate products’ in terms of integrated one ( credit plus services including welfare goods) tailoring to the needs of the poor client.. Thanks to CGAP for recommending ‘Customer research’ as an integral part of policy making. Here it may be noted that such a research demands inclusion of not only on the appropriateness of products and financial education but also ethical investment on human behavior also as this has DNA for all the eventualities ultimately in MF realm. In this regard two further clarificatory notes

In the first, the product appropriateness ( not one size fits for all now in vogue ) ensures ‘super value’ to the consumer in terms of meeting all his social and economic priority needs as per the internal value system at household level without any incompatibility and .at the same time keeping ‘prediction’ and ‘performance’ in behavioral pattern in the matter of utilization of micro credit without any distinction.
Applying this phenomenon in the illustrated case, one could perceive no shift in use of micro credit in the demand side from the original intent – purchase of farm inputs since his wife’s ill health is taken care of product such as health insurance or credit life insurance or private hospital linked to micro credit health insurance package. Further sale of livestock for repayment of loan dues is also avoided. Here one should note while designing appropriate product that poverty and health vulnerability go together and remain inseparable influencing the behavior on financial matters. Hence is the significance of health linked credit insurance product reflecting one dimension of ‘appropriateness’ of product design. On the other, in supply front, this process ensures proper utilization of micro credit to income generation activities (without any diversion )leading surplus and facilitating repayment of loan. This value chain leads to good recovery, reduction of NPA and RWA and provisioning etc. ,for prudential asset management too at lending institution level.
Second, regulator’s hesitance on prescriptive products, may be justifiable from their perspectives: however from client’s welfare point of view , innovation and specialization as pointed out, are inevitable need for getting the ultimate purpose of MF served . In this regard MF industry witness ‘partnering’ concept among the various pro poor service providers (MFI , Insurance and health service ) in experimenting some innovative integrated products. Examples include . Jami bora in Kenya- health linked credit product, Pro mujer in Bolivia credit linked health product, Opportunity Uganda Ltd in Uganda – credit life insurance with basic and enhanced credit life product., SEWA & SKS in India – insurance linked credit services , BRAC in Bangladesh –credit plus all non credit services

Dr Rengarajan