Too much information? How financial transparency can backfire
A behavioural science expert says a more nuanced approach for mandated financial disclosures will improve consumer decision-making
Financial literacy and transparency are key pillars of consumer empowerment in a modern economy increasingly steeped in complexity. However, mandated financial disclosures – intended to help consumers make better decisions – can be a double-edged sword, particularly when it comes to credit card and loan offers.
Behavioural science expert Professor Dilip Soman, whose research on mandated disclosures suggests they might have negative impacts on consumer decision-making when applied homogenously, reiterated this warning in his recent keynote speech at an Academic-Industry Research Seminar hosted by the School of Marketing and the Media Engagement & Analytics Lab (Meal) at UNSW Business School. The seminar serves as a platform to discuss emerging behavioural science trends, particularly in commercial practice and public policy.
While transparency is desirable, the Canada Research Chair in Behavioural Science and Economics at the University of Toronto told the audience of academics and industry leaders, mandated financial disclosures come with a paradox: they can improve decision-making for some consumers, but they can also lead others astray. Sometimes, too much information can be a bad thing.
“It is important to note that this is an inherently complex problem,” Prof. Soman told BusinessThink recently in discussing the seminar and his keynote, “Do mandated financial disclosures help people make better choices?”
“In particular, it is not clear what the optimal amount and format of disclosures should be,” he added. “For example, regulators all across the world are interested in ensuring that people make the most informed decisions, and that would imply that the greater the information that is disclosed, the better off they are. However, research and behavioural sciences also show us that more information does not always translate to optimal choices. This leads us to the difficulty in determining what is the optimal/right amount of disclosure.”
Consumer challenges: One size doesn’t fit all
One of the most pressing issues for consumers is the inherent complexity of choosing the appropriate financial product, especially in the crowded credit card and loan market.
“There usually is no one dominant credit card that is the best for everybody in the market,” Prof. Soman said. “Instead, depending on several factors – such as the individual’s intention to use the credit card for borrowing as opposed to convenience, their ability to repay on time, and their future anticipated cash flow – there is a different optimal card for everyone.”
As such, he said, it would make sense for the nature of financial information disclosure to be different for everyone; however, current disclosure regimes don’t allow for this. Moreover, credit card choices are likely to be “sticky”, Prof. Soman speculates: “Once a consumer chooses a card, they typically do not switch cards as their financial circumstances might shift. Therefore, they might get locked into a situation of suboptimal fees or interest rates.”
Varying financial literacy rates also have significant implications for the effectiveness of financial disclosures, with some elements likely to be easier to understand for people with high financial literacy but challenging for those lacking it.
Read more: Financial illiteracy: The hidden threat to Australia’s economic future
Meanwhile, Prof. Soman’s research in Canada and the US suggests that these issues are all compounding even though financial institutions generally do well in complying with mandated disclosure regulations, underscoring the need for a more nuanced approach. For instance, lenders in North America are required to display certain elements of credit card loan offerings in a specified information table format, and they all do so. The problem is that it’s unclear whether such requirements are “actually consistent with the spirit of the regulation”, he explained.
“For example, the regulations were ostensibly designed with the view to help consumers make side-by-side comparisons, but the law does not require banks to display information tables in a side-by-side format,” Prof. Soman said. “Furthermore, regulations do not say anything about when the table should be disclosed, as long as it is done before the final purchase is made.”
As a result, a bank might design a website that displays the required information only after it has funnelled people through to a card. “In that sense, while all banks typically comply fully with the mandated requirements, it is not clear that both the structure and the requirements of the mandates and what banks actually do (in a fully compliant fashion) are optimal for decision-making.”
The ‘double-edged sword’ of disclosure
Regulators operate on the assumption that making financial terms for loan products more accessible helps borrowers make better choices. Still, according to Prof. Soman, improved access can also negatively affect consumers’ decision-making.
His research has examined the benefits of providing credit card terms and conditions in an easy-to-read table, such as the widely used “Schumer box”, and saliently displaying borrowing costs. It found that for people who use a credit card only for convenience – rather than as a borrowing instrument – the salience of borrowing costs may backfire.
“In particular, we find that making access to mandated disclosures easy helps the so-called borrowers (individuals who plan to use the credit card as a loan instrument) by drawing attention to various interest rate and fee elements,” he said.
“However, we find that the very same intervention reduces the optimality of choices for convenience users into those [for users] that fully repay every period,” he added. “This happens because their attention is drawn to elements of fees and interest rates, and they therefore have less attention to dedicate to other benefits of the credit card – for example, cashback offers or reward points – that this subset of consumers should be focusing on.”
In a second set of studies, Prof Soman and his fellow researchers asked participants to find the best credit card on a realistic replica banking website, randomly varying the relevance to participants’ financial situation of borrowing costs and the accessibility of this information. The results suggested that improved access led to better choices when costs were relevant, while it led to worse choices when they weren’t.
“Clickstream data show this effect arises because participants are exposed to more cost information with easier access,” Prof. Soman explained. “The effect is exacerbated with higher financial literacy.”
Towards smarter disclosure, better decision-making
So, how can financial institutions and regulators improve the effectiveness of mandated financial disclosures, given the dynamic landscape?
“The optimality of consumer credit choices is a complex issue given the heterogeneity in what is optimal across the population, as well as the fact that circumstances might change,” Prof. Soman acknowledged. He then noted that his research has shown so-called smart disclosure, or personalised information delivery tailored to individual needs, to be an effective and consumer-friendly solution.
“Imagine a situation where a bank website asks you questions about your financial status, as well as about your intention either to borrow or to use the card as convenience, and then serves a different disclosure dash, such that the total content of the disclosure remains the same, but the format and the sequence in which it is presented might differ across individuals,” he said, describing the smart-disclosure process. “This would allow the individual to consume information in a format that is most relevant to their own choices.”
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He also pointed to an innovative experiment at Commonwealth Bank of Australia – an industry partner of the seminar – in which the bank clearly presented the ‘pros and cons’ of various credit card offers on its website, with the results suggesting that this practice may “steer people towards more appropriate cards for their financial circumstances”.
Finally, Prof. Soman stressed that with the financial landscape continuously growing in complexity, high financial literacy remains an essential asset in consumer decision-making. “Gone are the days in which people faced a small number of options for a small number of financial products,” he said. “Today, with the number of offerings and types of products increasing, it’s particularly important to have a financially literate citizenry.”
At the same time, he emphasised the importance of being “careful about how and in what form the financial literacy is delivered”, noting that research shows it is best delivered “just in time” and accompanied by behavioural interventions, such as budgeting tools and planning prompts.
“Our research suggests that financial education alone is not enough,” Prof. Soman concluded. “People need to be able to convert that education into better decisions.”