What do digital payments do to our brains?

Illustration by Aldo Crusher

What happens to our spending decisions when digital payment platforms ease the pain of parting with our hard-earned money? And how can community banks help customers make better spending decisions? This is what behavioral economists are trying to understand as we move toward a cashless society.

By Kelly Pike

Stripped down to its basics, spending is a calculation between pain and pleasure. A consumer must decide if the pain of parting with their hard-earned money is worth the pleasure of the purchase.

And when it comes to spending, nothing hurts more than ponying up cold, hard cash. Each bill counted out and handed to the cashier is a concrete reminder of what we’re giving up. As a result, studies have found that people spend the least when they are paying with cash.

It’s not just physically holding the cash that makes it painful to spend. It’s the action of counting. In one study, subjects made credit card payments by dragging and dropping images of cash. Those using an interface with $100 bills planned to spend more than those working with $20 bills.

8 %

Increase in contactless credit card spending when the consumer didn’t have to enter a PIN or add a signature

Source: Journal of Consumer Policy

“If I have to pay $50 and pay it in single dollar bills, every time I hand over a dollar bill, I see it as another payment,” says Emory Nelms, senior behavioral researcher at the Center for Advanced Hindsight at Duke University. “It exponentially increases the pain of paying with a $50 bill.”

Credit and debit cards are another story, since the transaction is quicker and less tangible. With no counting—or even the hesitation one feels when writing a large number on a check—spending increases. Restaurant tips go up. Consumers make quicker spending decisions.

The credit card premium

Always Leave Home Without It, a 2000 study from MIT’s Sloan School of Management, found subjects were sometimes willing to spend almost double for an item when paying by credit card, a phenomenon the researchers dubbed the “credit card premium.” Simply displaying credit card logos in stores and on collateral is often enough to boost spending. And then there’s the payment structure. Credit cards allow consumers to delay the pain of payment, and when they finally do pay, they make one large payment instead of many small payments, which their mental accounting translates into less pain, says Nelms.

Consumers also make poorer choices when using noncash payments. One 2011 study in the Journal of Consumer Research found that shoppers who pay with credit or debit cards are more likely to buy cakes, cookies and other unhealthy foods impulsively than those who pay with cash. This boost in impulse vice spending was surprisingly high in subjects the researchers identified as “tightwads”—those who were typically more reluctant to spend. Tightwads more than doubled their junk food spending when using credit cards instead of cash (although “spendthrifts” still spent more). This suggests that noncash payments can seduce even the miserly into overspending.

Credit card shoppers are also more likely to focus on the benefits of a purchase and misremember costs than cash shoppers, who focus more on price.

The impact of impatience

According to the Federal Reserve, cash still makes up 31 percent of U.S. consumer transactions, though mobile, contactless and other noncash payments are making inroads. While research into noncash payments focuses mostly on credit and debit cards, the concept of “friction costs” suggests that these evolving digital payment options are likely to goose spending further.

Nelms compares it to a website’s user experience. “Every field I have to fill out creates a hassle, or friction,” he explains. “Research shows every field decreases the likelihood I’ll carry through. The quicker they make [the process], the more likely people will finish.”

This prediction holds true for contactless payments, according to a 2014 study in the International Journal of Economic Sciences. It found that contactless credit and debit cards that don’t require signature or PIN entry lead to an 8 percent increase in credit card spending and a 10 percent increase in debit spending.

31 %

of U.S. consumer transactions are made in cash

Source: Federal Reserve

Then there’s the idea of mobile wallets and devices. If using a credit card induces less pain than spending cash, imagine what goes on in the brain when using a device that isn’t associated with money at all.

“A phone or Apple Watch doesn’t represent money. It represents a communication device,” explains Dr. Avni Shah, assistant professor of marketing at the University of Toronto Scarborough with a cross-appointment at Rotman School of Management, and a research fellow at Behavioral Economics in Action at Rotman. “As a result, there is no reminder of money.”

The importance of feedback

But as noncash payments increase in type and frequency, it doesn’t follow that consumers’ spending discipline has to go out the window. There are ways to add friction and make noncash payments more psychologically painful, resulting in better spending decisions.

Instantaneous feedback is one thing that has been proven to reduce credit card spending. A study published in the Journal of Consumer Policy found that customers in labs spent almost 10 percent less with their credit cards when their receipts displayed their cumulative spending for the month, along with their current credit card debt.

The Consumer Financial Protection Bureau (CFPB) explored this concept in 2017 with a small-scale study on how real-time feedback influenced credit card transactions.

The bureau developed two prototypes. The first was a payment card with an LED display that provided real-time information on the amount of money left in the consumer’s budget for the month, day and week. The second was a budgeting app that consolidated information from various accounts and synced with payment card data to show graphically how much allowable spending was left. Testing the prototypes in a lab with mock data, the CFPB found consumers were less likely to buy concert tickets when the app’s graphics showed they would go over budget than they were when they received that information in text form.

“The [card and app] made me aware of it actually being money that I’m spending, where a regular card sometimes feels like it is free,” remarked one of the nine participants in the CFPB study.

Nelms calls these cues “moments of reflection.” They are opportunities to remind consumers of the pain of spending—to create friction.

10 %

Drop in spending when study participants’ credit card receipts listed their cumulative spending for the month and their current credit card debt

For instance, a community bank could piggyback on existing fraud-alert technology by sending a consumer a text asking her to confirm that she wants to spend $50 when there is only $300 left in her account, says Nelms.

Shah also believes adding friction to the purchase process can help consumers make better decisions. She cites the example of Uber, which used to make customers enter the surge rate before requesting a ride at times when high demand resulted in higher-than-usual pricing. Entering the figure avoided unpleasant surprises for passengers. Community banks could leverage this concept by allowing consumers to set an upper limit for purchases, perhaps $50 or $100, and then be required to enter the cost of any purchase over that threshold.

On the road to change

Many community banks and apps already offer personal financial management (PFM) tools that allow customers to budget and track their spending by categories, notes Tina Giorgio, president and CEO of ICBA Bancard. Yet there aren’t really restrictions on transactions.
While PFM tools create a painful reminder that money flowed out of an account, Shah sees room for improvement.

“The more concrete reminders, the more pain after the fact,” she says. “I’d like to see email reminders saying, ‘Your purchase was approved,’ and then showing the cash quantity. You’d get something that says you just spent $104 with a picture of a $100 bill and four single dollar bills. I’ve always wanted to do that study.”

While cash will remain an important part of the U.S. economy for the foreseeable future (see The Ledger), noncash payments will continue to evolve and make it easier to overcome barriers to spending. The key will be helping consumers understand that pain can be a good thing.

Easing the pain of saving

Noncash payments make it easier to spend, but they also make it easier to save.

A variety of apps already help consumers budget, track spending and save money. Some send texts with updates on account balances, while others round up transactions to the nearest dollar and sweep the difference into a savings account.

Consider Qapital, which offers Qapital-branded debit cards issued by $1.2 billion-asset Lincoln Savings Bank in Cedar Falls, Iowa. (The community bank also partners with Acorns Spend to offer a checking account with a debit card that automatically saves and invests micro-investments through roundups and recurring investments.)

Purchases on the Qapital credit card trigger “defaults”—automatic transfers—between a linked checking account and savings account based on rules that the consumer sets.

For example, the “spend less” rule could let a customer save the difference if they spend less than $20 a week at Starbucks. Or the “guilty pleasure” rule would transfer a set sum to the customer’s savings account every time they orders takeout.

“One of the reasons defaults work is because you’re not making a decision. That’s even better than contactless payment, because you never saw it happen,” says Dr. Avni Shah of the University of Toronto Scarborough. “You don’t see the pain.”

Another default, proposed by Emory Nelms of the Center for Advanced Hindsight at Duke University and piloted at several financial institutions through Hindsight’s Common Cents Lab, is tying savings to other payment systems. For example, if a bank customer has a monthly auto loan payment of $213, they could work with the bank to make the payment $250, diverting the extra $37 into a savings account to cover car maintenance.

“You combine it into one payment so you don’t feel the pain,” Shah suggests.

Doing good—easily
The same forces that make it easy to spend and save also make it easy to donate to charity.

In Sweden, celebrated as the world’s most cashless country, more than half of bank branches no longer hold or receive cash. At least one church is conducting a pilot where it no longer accepts cash offerings at worship services, instead relying on popular payment app Swish, which was developed by the country’s major banks. And even panhandlers in Sweden have been known to accept donations via Swish.

What is ‘mental accounting’?

A lot of the pain of paying comes from mental accounting. That’s the act of assigning different values to different piles of money, says Dr. Avni Shah of the University of Toronto Scarborough.

Here’s an example. Think about transferring $25 to a Starbucks gift card. The consumer will feel pain when transferring the money out of their checking account, but once the money is on the gift card, in their mind, it’s spent. They’ll feel less pain using the gift card, because they’ve already made a down payment on their pain.

The same thing happens at the ATM. Some people feel the sting of withdrawing money because they see their account balance go down—even though they technically still have the same amount of money. Knowing they have plans to spend the money is enough to make them feel like it’s already been spent.

“Just taking money from an ATM shouldn’t be painful, because money should be fungible. It shouldn’t matter what form it’s in,” says Shah.

Understanding these pain points can help community banks guide consumers to make better decisions.


Kelly Pike is a writer in Virginia.

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