Joshy Jacob
Content
Behavioral Economics Insights to Re-think
Microfinance
Prof.Joshy Jacob
Indian Institute of Management Ahmedabad
Asia Microfinance Forum, Shanghai
August 7, 2014
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Rational vs. behavioral individual
Rational individual
Individuals always act in their
best interest
Behavioral (real) individual
Misinterprets information
Incoherent choices
Process all the relevant information
Examine implications in the short
& long-run
Poor financial status, despite
the best efforts
Financial outcomes dependent on
the individual psychology
There is an enemy within, it
hampers the best efforts
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Under-savings, borrowings & poor self-control
Temptation to spend in the short-run and wishful thinking to save saving in the
future
People fail to achieve their own preferences
Micro-credits foster self-discipline and better financial behaviour1
Untapped saving potential?
1
http://www.nyu.edu/projects/morduch/documents/2009-12-Behavioral-Foundations-of-Microcredit.pdf
“Save me from myself”
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Lack of self-control
Commitment devices
Savings
Limit future choices
Recurring deposit & interest
rates
Commitment devices - hard and
soft commitments
Save More for Tomorrow (SMT)2
Micro-savings with commitments
partly offset lack of self-discipline,
premiums may take this into
account?
Restricted access savings (SEED)3
Use of ROSCAs as commitment
devices
Micro-credit
Is fixed loan repayment optimal?
Would it be better if payments follow income cycle?
2
Benartzi and Thaler, http://www.jstor.org/stable/10.1086/380085
3
Ashraf et al., http://www.jstor.org/stable/25098802
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Influence of anchors
power of default options
Deposits into bank accounts close to the minimum CARD Bank experiments
Similar behaviour in many other aspects, tipping, donations, choice of
investment portfolios
Neighbourhood effect
Individuals may not base their decisions on relevant information
Adjustments around the ‘anchor’ insufficient to obtain optimal outcomes
People are not choosing according to their preferences
Implications for microfinance?
4
I
Set high enough targets for savings
I
Insurance bundled with credit
I
Default golden rules of savings
http://ideas42.org/content/Applying-BE-to-Improve-Microsavings-Outcomes.pdf
4
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Does labelling of money help?
Mental accounting5
Money and wealth into in-fungible silos
Apparently irrational and reduces wealth
May help to improve effectiveness of lending & savings outcomes
Lending
‘in-kind’ grant vs. money
Savings
Does labelling helps to commit
stronger?
Labelling the credit
Emergency, education, house
purchase
Public vs. private mental accounts6
5
Richard Thaler, http://elearning2.uniroma1.it/pluginfile.php/101759/mod resource/content/1/Thaler1999.pdf
6
Salas,http://www.pro-savings.org/sites/default/files/Paper%20-%20Luz%20Salas.pdf
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Framing
Distortions in information processing
Even chance for gaining or losing $500 for investment of $1000
Chance
Loss/gain
Outcome
50%
50%
Gain of $500
Loss of $500
Invest
Skip
Framing influences risk-aversion and risk-seeking in the same context →
decision depends on the lens
Half-empty or half-full
Aggressive decisions often triggered by prior losses & gains
How do we help clients?
I
Prompt them to consider both losses and gains
I
Each decision should be independent
I
Need to look at a longer horizon
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Mis-reading of the laws of nature
Individuals often overestimate small probabilities
I
Lottery behaviour for ‘gains’
I
Often expects successes to continue
I
Failures to reverse
I
Over-interpretation of ‘small samples’ leads to wrong decisions
Implications for microfinance?
Likely to over-estimate business success
Probability distortions
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Psychological foundations & Microfinance
Psychological foundation
Optimal design
Time inconstancies
Develop commitment devices
Mental accounting
Use salient labels
Anchoring
Set high-enough anchors
Probability distortions
Provide more information
Framing
Nudge to optimal choices
Microfinance
Prof.Joshy Jacob
Indian Institute of Management Ahmedabad
Asia Microfinance Forum, Shanghai
August 7, 2014
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Rational vs. behavioral individual
Rational individual
Individuals always act in their
best interest
Behavioral (real) individual
Misinterprets information
Incoherent choices
Process all the relevant information
Examine implications in the short
& long-run
Poor financial status, despite
the best efforts
Financial outcomes dependent on
the individual psychology
There is an enemy within, it
hampers the best efforts
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Under-savings, borrowings & poor self-control
Temptation to spend in the short-run and wishful thinking to save saving in the
future
People fail to achieve their own preferences
Micro-credits foster self-discipline and better financial behaviour1
Untapped saving potential?
1
http://www.nyu.edu/projects/morduch/documents/2009-12-Behavioral-Foundations-of-Microcredit.pdf
“Save me from myself”
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Lack of self-control
Commitment devices
Savings
Limit future choices
Recurring deposit & interest
rates
Commitment devices - hard and
soft commitments
Save More for Tomorrow (SMT)2
Micro-savings with commitments
partly offset lack of self-discipline,
premiums may take this into
account?
Restricted access savings (SEED)3
Use of ROSCAs as commitment
devices
Micro-credit
Is fixed loan repayment optimal?
Would it be better if payments follow income cycle?
2
Benartzi and Thaler, http://www.jstor.org/stable/10.1086/380085
3
Ashraf et al., http://www.jstor.org/stable/25098802
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Influence of anchors
power of default options
Deposits into bank accounts close to the minimum CARD Bank experiments
Similar behaviour in many other aspects, tipping, donations, choice of
investment portfolios
Neighbourhood effect
Individuals may not base their decisions on relevant information
Adjustments around the ‘anchor’ insufficient to obtain optimal outcomes
People are not choosing according to their preferences
Implications for microfinance?
4
I
Set high enough targets for savings
I
Insurance bundled with credit
I
Default golden rules of savings
http://ideas42.org/content/Applying-BE-to-Improve-Microsavings-Outcomes.pdf
4
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Does labelling of money help?
Mental accounting5
Money and wealth into in-fungible silos
Apparently irrational and reduces wealth
May help to improve effectiveness of lending & savings outcomes
Lending
‘in-kind’ grant vs. money
Savings
Does labelling helps to commit
stronger?
Labelling the credit
Emergency, education, house
purchase
Public vs. private mental accounts6
5
Richard Thaler, http://elearning2.uniroma1.it/pluginfile.php/101759/mod resource/content/1/Thaler1999.pdf
6
Salas,http://www.pro-savings.org/sites/default/files/Paper%20-%20Luz%20Salas.pdf
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Framing
Distortions in information processing
Even chance for gaining or losing $500 for investment of $1000
Chance
Loss/gain
Outcome
50%
50%
Gain of $500
Loss of $500
Invest
Skip
Framing influences risk-aversion and risk-seeking in the same context →
decision depends on the lens
Half-empty or half-full
Aggressive decisions often triggered by prior losses & gains
How do we help clients?
I
Prompt them to consider both losses and gains
I
Each decision should be independent
I
Need to look at a longer horizon
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Mis-reading of the laws of nature
Individuals often overestimate small probabilities
I
Lottery behaviour for ‘gains’
I
Often expects successes to continue
I
Failures to reverse
I
Over-interpretation of ‘small samples’ leads to wrong decisions
Implications for microfinance?
Likely to over-estimate business success
Probability distortions
Introduction
Self-control issues
Anchors
Mental accounting
Framing of choices
Probability distortions
Psychological foundations & Microfinance
Psychological foundation
Optimal design
Time inconstancies
Develop commitment devices
Mental accounting
Use salient labels
Anchoring
Set high-enough anchors
Probability distortions
Provide more information
Framing
Nudge to optimal choices
