Role of Incentive in the Financial Sector

An incentive can be understood as any stimulus which motivates one to behave in a certain way. It basically helps people to pursue their preferences; however, an incentive can be used both in a positive as well as in a negative way. In simple terms, an incentive can be understood as a way to improve the overall performance of a company or an institution. For instance a lot of banks want their consumers to purchase goods and services using debit or credit cards instead of cash; therefore, they often give discounts and offers on the usage of cards. Also, a lot of banks like SBI or HSBC provide zero balance benefit to their customers where these customers can avail the banking facilities without maintaining a minimum balance.

Rationality of Incentives

In Economics, a fundamental assumption is the rationality behaviour of a consumer. This rational instinct of an individual acts in such a way that it ideally improves his or her economic standings, and this is why people respond to incentive. A lot of theories in behavioural economics are derived from this behaviour; for instance, Ricardo’s Profit Wage Theory and Nudge Theory.
The Incentive theory began to develop during the 1940s and 1950s when psychologists aimed at understanding the forces behind human actions. According to a famous theory of human motivation, our actions are often inspired by our desire to gain external reinforcement. The incentive theory is one of the main theories of motivation and it has helped a lot of institutions and industries to use their labour power efficiently. A lot of financial sectors too have been able to obtain a strong customer base with the help of these incentives.

Types of Incentives

Broadly speaking, there are two types of Incentives- Intrinsic and Extrinsic Incentive. Intrinsic Incentive is one which comes from within, without any outside pressure or reward. It comes as a self motivation of doing something better for self interest. For instance, generally speaking, scoring good marks in a paper can come from the motivation for increasing the CGPA or an attempt to get placed in a good company.

Extrinsic Incentive on the other hand comes from an external force which provides us some kind of material or financial reward. Coming to same example, the same urge to score good marks can come maybe because, only if you get good marks you may be treated with cupcakes or your pocket money could be increased. Hence Extrinsic Incentive acts as a driving factor which acts with the help of outside pressure or reward. Most of the incentives in the banking sector and other financial institutions are extrinsic in nature.

Incentives Used as a Tool in Policy Making

The most important kind of incentive widely used, not only in the financial sector but in various other sectors is Tax Incentive or Tax Benefits. Tax Benefits are basically used to encourage spending and are also used by the Government for economic development. For instance, if an individual invests in certain shares, or invests in savings, he or she has the benefit of getting exempted from income tax. Again these are motivations for the consumer to help inculcate the habit of saving.

Another type of incentive is the Financial Incentive wherein monetary benefits are provided to an Individual in order to influence a certain type of behaviour. For instance, in order to encourage people to use digitalized methods of payment, Google Pay or Paytm often provide a lot of attractive offers and cash-backs which are exclusive to these forms of payments. Also banks such as Axis or ICICI provide a lot discount when it comes to shopping and travelling, which also entices consumers to join their family.

Subsidies are also a very efficient way to encourage people to adopt a particular habit, where they are used to provide monetary benefits to help an industry maintain the price of the commodity or the service it gives. Thus, in the year 2017, the government had given banks and other financial institutions various monetary incentives to help encourage merchants to adopt digital mode of payments, in order to turn India into a cashless economy.

Negative Incentive, as the name suggests, refers to the bad consequences that discourages behaviour from a monetary viewpoint; it is usually in the form of fines or losses. For instance if one cannot pay back a given loan at a particular point of time the person is charged with a heavy fine and therefore, as a consequence, the behaviour of delay or postponements is highly discouraged.

Limitations of Incentive Usage

There are always two side of a coin; we see that there is immense benefit in the implementation of an incentive, but on the other hand, there are also a certain number of restrictions that come with it. We may notice that when incentives are used continuously, they lose their very essence of existence, as people start seeing incentives as an entitlement and not as a motivator. Furthermore it has often been seen that whenever incentives have less clarity, the resultant consequences may be unintended. Moreover there is unhealthy competition among financial institutions to get consumer or market share, and they often indulge in various forms of malpractice and misuse. Besides, it becomes very demotivating for institutions as well as its employees, if an organisation cannot meet their goal and attain the extra benefit in the form on incentive. Therefore the very goal of the incentive can work completely in the opposite direction.

Hence, overall, it can be concluded that incentives have played a significant role for organisations not only when it comes to attracting the consumer market but also when it comes to their own employees. Also, looking from an economic point of view, an incentive helps employees to give in their full potential into the work which in turn makes the company more efficient and effective, and reaps huge profits. Therefore, obviously, there is a multiplier effect which can be discerned with this phenomenon, where companies are investing a little on incentive but are gaining a huge benefit from the consequences. Therefore, again, we see how behavioural economics has made use of psychology and human behaviour in its full potential.

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