Mapping Regulatory Behavioral Biases to Innovation in Financial Services

By Joseph Lutwama and Kim Kariuki

Technology advancements in the last two decades have resulted in a chain reaction of innovations in financial services never experienced in this generation. Whereas previously financial services would only be accessed in big, tall and intimidating bank branches, now a financial transaction can be completed in just under a minute without stepping into a bank branch or even talking to a banking relationship manager across the counter.

All this has been made possible by the internet and mobile telecommunications technology. These disruptions have not only changed the way financial services are delivered to the customer but also how they are regulated. The digitization of financial services presents a new range of risks never imagined before in an environment of paper and physical relationship-based transactions. For example, investment advice which was previously provided by professionally- qualified investment professionals and is now increasingly provided by computers (Robo Advisors) – what happens if this computer makes a mistake and a customer loses money?

Does the regulator go after the computer or the firm that deploys the computer? In a physical environment, it takes a longer time to lose billions of dollars; whereas in a digital environment it takes a far much shorter time. In 2012, a mishap of an electronic trading platform cost investors US$ 440 million in just 45 minutes[3]. The speed of digital financial services brings a level of efficiency and transparency to the financial system which has the potential to drastically bring down the cost of financial services and increase the frontier of financial inclusion. In same breath, digitization has a potential of multiplying risks in the financial system on a scale unimagined before.

The Regulator’s and Policy Maker’s Dilemma

Regulators and policy makers are faced with a dilemma between moving cautiously with new technologies or letting the doors wide open for such innovations to deepen the financial system and promoting financial inclusion especially for the previously underserved and unserved population segments. Some risk-averse regulators have been too hesitant to the detriment of innovation, while some markets have allowed for unfiltered access of all kinds of innovations to enter their markets at the risk of financial contagion and catastrophe.

To find the right balance, innovative regulatory approaches are emerging to better position the regulator to adapt and respond to the fast-changing and dynamic technological environment in the financial system. Most of these approaches have focused on structural barriers to regulating innovations such as improving inadequate policies, laws, regulations, procedures and institutional structures. 

However, more needs to be done beyond the well-known structural barriers and more attention paid to behavioral barriers. Regulation is not done in a vacuum. It is one thing to address the structural barriers to innovation but if nothing is done about the behavioral biases of regulators towards technological innovations in the financial system, little ground will be covered in promoting innovation. Financial Sector Deepening Uganda (FSDU) partnered with the Busara Centre of Behavioral Economics (BCBE) to explore the behavioral biases among regulators that would stand in the way of technological innovation.

Behavioral Insights in Regulating for Innovation

“Behavior is the range of actions and mannerisms made by people in relation to their environment. It is the response of the system or organism to various stimuli or inputs, whether internal or external, conscious or subconscious, overt or covert, and voluntary or involuntary[1].” Therefore, when making regulatory decisions, regulators will be influenced by their behavioral biases. Behavioral biases are the tendency of human judgements and decisions to include systematic errors due to cognitive factors rather than actual evidence.

In their behavioral study[2] on regulators, FSD Uganda and Busara Centre of Behavioral Science found five behavioral biases towards technology innovation by regulators; Risk Aversion, Availability Bias, Representativeness, Status quo bias and Social proof.

Addressing Regulatory Biases

  • Risk Aversion: Risk aversion is usually driven by the fear of the unknown. Therefore, if regulators can put in place systems of continuous learning and knowledge development of new and emerging technological innovations, they will attain a healthy balance of dealing with risks associated with innovations. Regulatory tools like regulatory sandboxes will be critical to achieving this.
  • Availability Bias: Consider adopting a culture of regularly reviewing regulatory decisions to assess regulatory judgements and decisions retrospectively. This process will be vital in determining the degree to which judgements and decisions have been influenced by availability bias.
  • Representativeness: Consider adopting principle-based regulation to allow regulators to act “in accordance with the spirit rather than the letter of the law”. Rather than being prescriptive, principle-based regulation provides boundaries within which the market actors should operate.
  • Status Quo Bias: Creating a collaborative culture which ultimately will serve to create a new social norm around innovation.
  • Social Proof: Leverage the existing platforms and forums for regulators to regularly exchange information about new and emerging technological innovations. These platforms and forums can also be enhanced to provide opportunities of peer review.

Parting Short

Changing behavior is not a one-time event, it is an on-going process that requires active engagement between the regulators and the industry. As the regulators’ understanding and appreciation of technological innovation increases, then we will begin to see a change in their perceptions and behavioral biases.

Joseph Lutwama is the Head Business Environment at Financial Sector Deepening Uganda and Kim Kariuki is an Engagement Director at Busara Centre of Behavioral Economics.  The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the positions of Financial Sector Deepening Uganda and Busara Centre of Behavioral Economics.


[1] accessed on 25th April 2019

[2] Busara conducted 10 key informant interviews with experts across 4 regulatory institutions and an industry association of FinTechs. The data was collected using semi-structured qualitative tools to (1) map the approval process and (2) unmask behavioral and structural barriers. We then employed our behavioral toolkit to overlay the barriers upon the approval process.

[3]  “High Frequency Trading and the US$ 440 Million Mistake” accessed on 3/05/2019

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