Behavior-influencing and behavior-analyzing science should be used in financial supervision and regulation in order to better understand and prevent misconduct at firms, said Kevin Stiroh, an executive vice president responsible for policing banks at the New York Federal Reserve.
Misconduct in the banking sector has continued after the crisis of 2008, Stiroh said, despite tighter controls. Citing a worldwide cost to shareholders of about $320 billion in the last 10 years as a result of rulebreaking, he said it was time regulators look at less orthodox approaches to curbing misbehavior.
"The official sector must experiment and innovate," he told a London finance conference organized by City and Financial on Oct. 4. "In terms of influence, fostering productive behavioral change is at the heart of cultural reform. Behavior, in turn, is driven by a multi-faceted set of factors including incentives, cues from peers, observations about leaders, and the formal policies and procedures," the regulator said.
"Most of us in supervision are not experts in human behavior, and I believe we should be open to incorporating lessons from behavioral economics and other social sciences into our programs to mitigate conduct risk and promote cultural change."
Blending psychology and economics, said Stiroh, would provide the state with insights into why humans behave the way they do and why they make choices that "may not be in their economic best interest."
Regulators should not shy away from using new techniques such as "nudging" people toward desired behavior by using subliminal influence, he said.
The official alluded to a technique developed by the Behavioural Insights Team, informally known as the Nudge Unit, a part of the U.K. government since 2010 which was privatized in 2014. It successfully advised the government to use a mix of shaming and peer pressure-stimulating methods in its communications with the public in order to generate higher and earlier tax receipts, increase charitable donations and improve medical services.
"How can we nudge in order to reduce misconduct risk?" asked Stiroh.
Critics have accused the nudge unit of being manipulative and warned that its ideas could easily be employed toward less noble goals.
Stiroh said banks and regulators needed to begin collecting and analyzing data about everyday behavior of bank employees in order to find ways of influencing them toward better conduct.
"Both financial firms and the official sector should focus on investigating and asking questions to better understand the underlying drivers, the motivations and the risks behind the behaviors of individuals and groups."