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Blind Spots in Banking: Fraud, Branches & the Brains of Gen Y

Bankers should educate themselves on the biases that distort perceptions.

Bankers often fancy themselves “numbers people”.

Interest rates. Balance sheets. Performance metrics. Bankers will calculate a Return on Anything (ROA) and Everything (ROE).

So, if there is a subset of our species who are rational, surely it’s bankers. Right?

Wrong. Bankers are no more rational than the rest of us. In fact, confidence in their own numbers can sometimes blind bankers to probabilities governing areas of uncertainty and to trends shaping alternative futures.

Over the past 40 years, behavioral psychology has documented over 60 cognitive biases that skew our perceptions and impair our judgment. Bankers aren’t immune to cognitive biases, but recognizing the most prevalent biases and their attendant blind spots provides an opportunity to control for them and to make better strategic decisions as a result.

Fear Factor

According to both Gallup and the Pew Research Center, most Americans feel less safe this year than last—a perception that has grown steadily over each of the past 15 years—even though America is safer now than at any time in its past. Violent crime in the U.S. is down 70% since the early 1990s. Homicides are down by 50%. And wars today kill 90% fewer people than in the 1950s.

Most of us don’t maintain a proportionate sense of fear. We are hardwired to overreact to dramatic threats and to ignore others with a less compelling narrative. Preventable harm in hospitals claims between 200,000 and 400,000 American lives each year. And you are 4X more likely to die in a bathtub in the U.S. than at the hands of a terrorist. So which scares you more: hospitals, bathtubs, or terrorists?

I recommend you avoid taking baths in hospitals. Just saying.

In banking, most fear centers upon security threats and fraud. Last year’s unprecedented number of data breaches fueled alarm across the industry. But was there more identity theft in 2014? No. According to Javelin Strategy & Research, there was actually less: fewer victims of identify fraud, lower fraud losses, and faster fraud resolution times. The reality is that 2014 was a banner year in the fight against fraud, but you probably won’t hear much about that since fear sells and good news doesn’t.

The real challenge with security is understanding where fraud is growing and where it’s declining, but we often give the past much more weight than the future. This year, EMV chip cards are dominating bankers’ radar while the real story is beyond the point-of-sale (POS) where card-not-present (CNP) fraud is exploding online. By 2018, CNP fraud is expected to grow to 4X that of card-present fraud at the POS.

Missing the bigger picture of CNP fraud, bankers may delay allocating resources to the tokenization, online authentication, and real-time transaction analytics necessary to protect them and their cardholders against what is by all counts a materially bigger threat.

Branches and Historical Bias

The FDIC’s recent report, Brick-and-Mortar Banking Remains Prevalent in an Increasingly Virtual World, has reignited debates surrounding the future of branches. The report looks backward to 1935, cites a fairly steady rise in branch density, and concludes that technology hasn’t significantly impacted branching in the U.S.

This despite a 45% decline in branch transaction activity since 1992. Despite a 68% decline in check usage since 2003. Despite the U.S.’ top 50 banks all reducing their branch networks. And despite the decline in branch density generally since 1989. Despite it all, the FDIC report leaves bankers thinking the status quo of branching hasn’t changed and therefore won’t change anytime soon.

Classic. Historical. Bias. As Brett King correctly points out, the problem with the FDIC’s report is that it focuses upon lagging rather than leading indicators of branch health in the U.S. Crucially, it doesn’t measure or track the “average number of visits to a branch per customer per year.” If it did, it might discover—as 4 of the U.S.’ largest banks have reported—that that number of visits per customer has plummeted to 1-2 per year—from approximately 24 visits per year twenty years ago.

Past results do not guarantee future performance. This is a well-worn admonition against historical bias, i.e., our tendency to assume that the past is a sufficient predictor of the future. But clarity on the future of branches is made especially difficult given we are at a tipping point. For the first time in the history of banking, digital channels reached parity with the physical branch in 2014—half of applicants opening new checking accounts did so online, or via smartphone or tablet.

And here’s the kicker: while half of consumers opened new checking accounts through digital channels last year, 70% plan to do so this year, according to Javelin.

Adjusting for historical bias requires deeper insights into present trends and better extrapolations into future developments.

Brain Bias

Our brains are the very last organ of the body to mature, and that process doesn’t end until a person reaches his/her mid-twenties or early thirties.

Several females I know insist this process never actually ends in males.

Gender politics aside, neuroscience research has established that the brain matures from the back to the front—which means that throughout childhood, adolescence, and young adulthood, the executive function of the pre-frontal cortex (front of the brain) isn’t mature enough, i.e., isn’t processing fast enough, to keep the impulses of the amygdala (back of the brain) in check. The amygdala, incidentally, drives appetites for food, fire, physical affection, and shiny things.

This has big implications for financial services. In recent years, several innovators in mobile Personal Financial Management (PFM) apps have incorporated real-time feedback loops to help Gen Y and others control spending impulses and save more. The idea is that if you show someone in real time that he doesn’t have enough money to buy the thing he wants, he won’t buy it.

But there’s a problem. Providing real-time feedback isn’t effective when provided to people whose pre-frontal cortexes can’t process that feedback quickly enough to stop the amygdala’s impulse to buy.

So, what can bankers do to help? Automate. That is, help Gen Y automate savings and investments in the background by moving small amounts from checking to savings/investment accounts when cash flow is positive and upcoming bill obligations are not threatened. Digit and Acorns are two notable innovators on this front.

Last week, Moven, a third-party debit card and mobile PFM solution, unveiled an “impulse savings” feature that proactively presents a one-tap savings opportunity whenever the consumer is comfortably under budget (and flush with funds) throughout the month.

Return on Bias (ROB)

Whether its allocating resources in the fight against fraud, transforming branches, or serving Gen Y, bankers would do well to verse themselves in the biases that distort perceptions and impair judgment—both in themselves and their clientele.

And whatever you do, stay away from hospital bathtubs.

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