Conduct & Ethics

Behavioral Finance Theory Gets Real in Risk Management

Banks form specialized teams; trend is fueled by artificial intelligence, analytics and fintech innovators

Friday, July 9, 2021

By Katherine Heires


Behavioral and cognitive science, a mainstay in economics based on the work of Nobel laureate Daniel Kahneman and others, is wielding greater influence in various areas of risk management. A growing number of financial firms, armed with advanced artificial intelligence and analytical tools, are applying behavioral precepts in efforts to enhance corporate culture and operations, and to nudge customers down desired decision paths.

Firms are calling on those academically trained in the discipline to assist in understanding people's tendency to make irrational or emotion-driven decisions, which can be detrimental, and drive toward better outcomes. A Harvard Business Review article last year, How Banks Are Using Behavioral Science to Prevent Scandals, said that some major European banks “have created behavioral risk teams composed of professionals trained in organizational psychology, anthropology, forensics and other disciplines. Each team has a direct reporting line to the chief audit, compliance or risk executive.”

Fintechs and neo-banks, some with chief behavior or science officers, are applying analytics and behavioral factors to help users save, invest, pay down debt and manage risks on their digital and mobile platforms.

According to robo-investment provider Betterment, which employs behavioral science techniques and partners with corporations in offering 401(k) retirement plans, 10 to 20 Fortune 500 companies have a chief behavioral officer charged with integrating the strategy into business decisions.

What's more,, a networking site serving the community, currently lists more than 30 job openings at firms such as Allianz, Booz Allen Hamilton and Swiss Re.

Hersh Shefrin Headshot
Prof. Hersh Shefrin: “starting to see serious diffusion of the ideas behind behavioral science in various areas of business.”

“The seeds have been planted, they are starting to germinate, and now we are starting to see serious diffusion of the ideas behind behavioral science in various areas of business, including finance,” says finance professor Hersh Shefrin of Santa Clara University's Leavey School of Business.

Stephen Wendel, head of behavioral science at Morningstar, who conducts surveys of applied behavioral science in the corporate world, reports “a massive increase in the use of behavioral science strategies around the globe, with approximately 5,000 individuals formally trained in the discipline.” He says that Fidelity Investments, JPMorgan Chase & Co. and Prudential currently employ behavioral finance teams to help improve online customer decision-making.

Getting at Root Causes

In the past year, behavioral science strategies have expanded in financial risk management. A Thomson Reuters article in March by change management and organizational development expert Anna Wood noted that the trend of hiring behavioral finance officers and teams is particularly prevalent in Europe, with ABN Amro, ING and NatWest as “early innovators.”

The objective is to assist in internal decision-making, compliance processes and risk management. This is aside from deployment as an asset management or wealth management tool.

“The added value for this type of risk mitigation stems from the ability to identify the root causes of behavior that may lead to misconduct that risks the integrity and reputation of a financial institution,” Wood wrote.

This behavioral evolution should come as no surprise, says Professor Shefrin, as “the most important risk management disasters in the past 15 years have all had psychological pitfalls at their root.”

Putting the Science to Work

Precisely how do behavioral risk teams function and produce results?

According to Wieke Scholten, an organizational psychologist and senior director, behavioral risk at Netherlands-based &samhoud Consultancy, the purpose is to help uncover employee behavioral risks so that management can intervene before a problem blows up.

When called in to assist, Scholten says, her aim is not to conduct an investigation focused on misbehavior, but rather to seek out the root causes of questionable behavior and then design a course of action that will be preventive, not punitive.

Wieke Scholten Headshot
&samhoud's Wieke Scholten: “looking closely at . . . how decisions are made, how teams communicate, and what are the group dynamics.”

“It's all about identifying those behavior patterns and the drivers that may lead to future risk issues as well as work processes that may have unintended consequences,” she says. “It allows firms to be more forward-looking in their risk management approach.”

Management also needs to understand, she adds, that “this is not an HR issue, but a risk management issue,” with the behavioral risk team or adviser reporting to the CEO or chief risk officer. “Our efforts are not about detecting misbehavior, but about looking closely at current behaviors and the drivers of those behaviors as well as how decisions are made, how teams communicate, and what are the group dynamics.”

The assessment process can involve one-on-one interviews, focus groups, data collection and the use of a behavioral analytics platform coupled with AI to study everyday communication patterns. The combination of people and technology tools allows her risk team to identify root causes of any risk issues and to prescribe an effective course of action.

Depending on the nature of the “hot spot,” Scholten says, her team may prescribe various interventions. In anti-money laundering compliance, a gamified training solution that guides employees to make better AML decisions can be effective. On a trading desk, a cultural revamp and dramatic change in leadership style may be called for.

Nudging Savings, Collecting Debt

An example in the fintech realm is Swedish app developer Dreams, whose chief scientific officer, Elin Helander, is trained in cognitive science. The platform uses “scientific methods to nudge and boost [bank] customers to save more, pay off debt faster,” and thereby increase their well-being through smarter financial decisions.

Customers are asked to identify, name and select images that match their dream goals and then are nudged toward them. “We turn the power of consumer emotions into strength by making their savings goals and money emotional to them,” Helander explains. “Our method is rooted in psychology and behavioral economics.”

Digital debt collector TrueAccord, according to co-founder and CEO Ohad Samet, studies behavioral cues - how consumers browse, the devices they use, times of day when they interact, etc. - to tweak messaging and determine how to give the debtor a sense of agency in the collection process.

Ohad Samet Headshot
TrueAccord's Ohad Samet: a 30% to 50% improvement over traditional debt collection.

“Anchoring is not a new behavioral concept, but anchoring in the context of a debt repayment system is,” Samet says, referring to the behavioral finance term for an irrational bias toward an arbitrary benchmark that can lead to poor decision-making.

Combined with empathy and digital communication, anchoring that aligns with a consumer's financial needs and ability to pay can significantly reduce the risk of nonpayment, he says, adding that the system delivers a 30% to 50% improvement over traditional debt collection.

Vocal Clues

Behavioral Signals' AI-mediated conversational technology is designed to distinguish emotion and behavioral signals in voice data, helping banks better manage conversations pertaining to non-performing loans. The patented bioprint technology analyzes 75 attributes of a voice and matches “the unique conversational dynamic of an individual” with a collection agent to aid in reaching a positive outcome, says CEO Rana Gujral.

Rana Gujral Headshot
Behavioral Signals' Rana Gujral: matching “the unique conversational dynamic of an individual” with a collection agent to aid in reaching a positive outcome.

“We are simply looking at pitch and tonal variance and completely ignoring the words being spoken when we make a match,” Gujral adds. Over time, he sees this technology being used in other types of financial interactions.

Gujral says that his clients can improve their revenue recovery by 12% to 18%, which can add up to hundreds of millions of dollars. "It is a very effective tool for managing and mitigating risk," he adds.

Proponents of these behavioral approaches point out that despite the demonstrated benefits, there are challenges and risks. More than one expert warns that such strategies can also lead to bad behavior, as in the case of online platforms that may encourage high-volume securities trading and taking on more risk than a client can safely handle.

On the other hand, many see reasons for optimism as behavioral techniques become more accepted and refined. “I see a future,” Scholten says, “where every bank will have a behavioral scientist in-house and behavioral risk team on board to help prevent problems and to increase the quality of risk management efforts.”

Katherine Heires is a freelance business journalist and founder of MediaKat llc.


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