The moral conundrum of BNPL

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 seems that fintechs are bending their clients’ ears and, consequently, their money.

A separate charge is that bankers 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 debt is more profitable so it’s in a banker’s interests to prolong it.

I cannot speak for every lending practice but, as a behavioural scientist, I am prepared to defend what bankers do. I am not, of course, referring to keeping people in debt. Instead, I intend to focus on the practice of ‘Buy Now Pay Later’ (BNPL) finance. I will endeavour to show that, rather than an attempt to profit from charging higher interests rates and putting a customer into a debt spiral, it is rooted in the Choice Architecture Axiom and ultimately in a client’s best interest.

The 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. I believe that, as a behavioural scientist, I must always advocate for the Choice Architecture Axiom. I borrow this from Level Financial Technology’s ‘Nudge Management 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 the Nudge Management Strategy. Similarly, as a behavioural scientist, I must ask myself, do these products or services reduce or eliminate available choices for customers with different risk appetites? If the answer is in the affirmative, then they do not serve clients’ interests. My belief is that banking should always promote the Choice Architecture Axiom because it ultimately serves 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 is usually in line with how long it takes to arrive.

In simpler terms, people desire an immediate reward rather than a higher-value, delayed reward. 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? That depends on what it is we are talking about, and our will power. 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 their needs from the short to long term. The assumption, often misconstrued, is that consumers use discounting in the same way it is taught in business schools. ie. That people are ‘economic agents’ – rational thinkers using optimised strategies. Behavioural economists have now corrected that assumption and bankers need to acknowledge that consumers 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

Satisficing

What exactly is ‘Satisficing’? Herbet Simon’s ‘Bounded Rationality’ theory (1957) stated that people make decisions which are not entirely rational. These decisions are ‘bounded’ because of 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 what satisfies. The flip side to this is that we shorten the decision-making process, optimise our available time and invariably become more efficient. Customers use satisficing because of constraints that bankers cannot reasonably contemplate given the infinite permutations of variables. Bankers have historically assumed that they aren’t able to determine how customers should optimise their choices. What is evident from recent studies is that, regardless of the source of money, customers create shortcuts because of the sheer volume of information that needs to be computed. People do not have the time to evaluate all possible outcomes and they make decisions without carrying out a cost-benefit analysis. People instinctively choose the ‘option that is good enough’ but not necessarily the best option. Bankers should not expect customers to make financial decisions by following an a priori approach that relies on statistical or theoretical models. Customers rarely make decisions about money that way; that is what the empirical evidence is telling us. No two customers are alike. For each individual, satisficing will vary according to their expertise or knowledge, their environment and their specific financial need. BNPL is a solution for customers looking to satisfy their immediate need, whatever that may be.

Conclusion

Bankers must start to look at behavioural finance in the same way fintechs and savings apps do. They should personalise their services and product offerings by understanding their customers’ psychology and defending their practices. They should stop being defensive about how they provide for customer’s wants and needs. Instead, they should go back to basics. They should boldly proclaim that they 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.

About the Author

Dr. Jim Coke is a member of the Chartered Banker Institute and the Chief Behavioural Officer at Level Financial Technology The views and opinions expressed in this article are those of the author. They do not necessarily 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