How we think, and how we think we think, and what does it have to do with financial regulation?
My name is Elena and I’m a second year PhD student at the University of Manchester School of Law. I research the ways in which the ideas of how people think and make decisions impact regulation of banks and banks’ handling of risk. This is an important matter because banks have a significant place in the economies of most countries, and their behaviour is key to the economic and financial welfare of society.
How I got here
I completed a 4-year law degree in Russia, after which I decided to continue my education in the UK. After a law conversion course (GDL) I enrolled on an International Business and Commercial Law Masters programme at the University of Manchester. I was particularly attracted to the financial regulation module because of the enormous impact financial services have on society – the crisis of 2008 being a stark example. One of the lectures included a small bit about behavioural economics – a study of how our psychological traits influence our purchasing, investing, and other economic decisions. I thought that that was a fascinating topic – and after reading more about it, decided to do a PhD on it even though I had never considered becoming a researcher before.
To make any (not necessarily economic) decisions, our brain needs to process large amounts of information in a short amount of time. Processing all of it in a comprehensive manner would require a lot of mental effort. Considering the amount of decisions we make on a daily basis, if every one of them required a lot of time and effort we would not be able to function normally. To rectify that, our brain developed thought patterns that help us to process information quicker. One of those thought patterns is called ‘availability heuristic’. When thinking about a certain topic or the probability of an event happening, our mind immediately refers to the most prominent belief or a vivid piece of information in our memory. This can cause a mistake in judgement. For example, people start worrying about a possible earthquake a lot more if they recently saw an earthquake report in the media. Another example is people estimating the crime rate in the area a lot higher after seeing a murder report on TV. And these are just a couple of examples – there are many thought patterns, or heuristics, that make our decision-making easier but also make us make mistakes along the way.
For a large part of the 20th century, the common academic opinion was that people tend to be rational, process all available information in a comprehensive way, and only make the most beneficial decisions for themselves. This approach became popular with governments as well, particularly in the US and the UK. This view resulted in designing policies and regulations that were aimed at those perfectly rational individuals. When confronted with human irrationality, government regulations and policies failed because people did not act as they were expected to. This was a part of the reason for the 2008 crisis.
Now that academic and government circles have largely accepted inherent human irrationality, policies can be adjusted to reflect the reality of human behaviour. In some areas – for example, consumer protection – there is a lot of progress. But others, such as financial regulation, require a lot of modification to reflect the true nature of human decision-making. My research aims to make regulation of banks more effective by designing a behavioural framework of board-level financial decision-making that can be used as a policy foundation.
I enjoy my research because I find learning about how humans make decisions, and how the way our brain works influences the law, fascinating. Here are some interesting websites where you can learn more about this area:
https://www.behavioraleconomics.com/introduction-to-be/ - a comprehensive introduction to behavioural economics, including the primary research in the field.
https://hbr.org/2009/07/the-end-of-rational-economics - a Harvard Business Review article explaining the role of the presumption of rationality played in economics.
https://www.ft.com/content/9d7d31a4-aea8-11e3-aaa6-00144feab7de - a Financial Times article on applications of behavioural insights in public policy.
http://www.behaviouralinsights.co.uk - Behavioural Insights Team’s website. It’s a social purpose company partly owned by the UK government that is dedicated to devising ways to apply the insights of behavioural science to public policy.
http://nudges.org - a blog about choice architecture.