Leveraging Behavioural Economics to Optimize Personal Insolvency Policies 

Shikha, Neeti

Abstract

Personal insolvency is a multifaceted issue shaped by legal, economic, psychological, and social factors. Despite its complexity, existing scholarship often relies on rigid theoretical frameworks, offering limited practical insights into how individuals navigate financial distress. Behavioural economics, with its focus on bounded rationality and cognitive biases, presents a unique opportunity to enhance the effectiveness of insolvency policy. By examining how individuals make decisions under stress and how those decisions are affected by emotions and environments, this paper highlights the potential of behavioural insights to strengthen the current regulatory and policy approaches.
One critical area of exploration is the implementation of Breathing Space provisions, which provide a temporary moratorium on creditor enforcement actions. While effective in reducing immediate pressure, these provisions can be further optimiszed by incorporating behavioural principles. For example, choice architecture—structuring the decision-making environment—can guide debtors toward more suitable long-term solutions. Defaults, reminders, and simplified information delivery can help counteract cognitive overload, enabling debtors to make better-informed choices during the moratorium period. It is possible that other key moments in the journey of indebtedness can also be identified at which behavioural economics- backed approaches can be implemented to help debtors to avoid over-indebtedness and/or choose appropriate solutions.
The paper also investigates the impact of public insolvency records, which often perpetuate stigma and hinder debtor rehabilitation. Drawing on behavioural experiments, such as game-theoretical models framed within insolvency contexts, this paper demonstrates that finite disclosure periods may achieve a balance between creditor trust and debtor reintegration.
Behavioural economics offers a bridge between these approaches, emphasiszing how cognitive biases like overconfidence, hyperbolic discounting, and decision fatigue shape debtor behaviour. For example, financially distressed individuals may prioritisze immediate relief over optimal long-term outcomes, underscoring the need for policy measures that simplify and incentivisze better choices.
Policy implications extend beyond individual decision-making to systemic reforms. Incorporating behavioural insights into Breathing Space and related schemes can refine their implementation, ensuring that interventions are both empathetic and evidence based. For instance, extending the use of financial counselling during the moratorium period could mitigate decision fatigue and help debtors better navigate complex options. Similarly, regulating the quality and transparency of publicly available insolvency advice could address biases that often misguide financially overwhelmed individuals and prevent the vulnerability of individuals to enter into processes that are poorly matched to their needs.
This interdisciplinary approach demonstrates that insolvency law is not merely a mechanism for resolving debtor-creditor disputes but a societal tool for addressing over-indebtedness. By integrating behavioural insights into current frameworks, this paper advocates for a more modern, inclusive and effective policy landscape. Such reforms have the potential to enhance not only the individual outcomes of personal insolvency but also the broader social and economic health of communities. In doing so, behavioural economics provides a critical lens for rethinking insolvency policies to foster resilience and fairness in an increasingly uncertain financial world.
Keywords:
Personal insolvency, behavioural economics, consumer credit, debt rehabilitation, financial distress, insolvency law reform, over-indebtedness, cognitive bias, regulatory design, breathing space, stigma and debt, financial inclusion, financial decision-making.
Sustainable Development Goals (SDGs): SDG 1 (No Poverty), SDG 8 (Decent Work and Economic Growth), SDG 10 (Reduced Inequalities), SDG 16 (Peace, Justice and Strong Institutions), SDG 17 (Partnerships for the Goals).

• Presentation Conference Type: Presentation / Talk
• Conference Name: Forward Thinking Conference
• Start Date: Apr 8, 2025
• End Date: Apr 8, 2025
• Deposit Date: Jun 10, 2025
• Publicly Available Date: Jun 11, 2025
• Peer Reviewed: Peer Reviewed
• Public URL: https://uwe-repository.worktribe.com/output/14556011
• External URL: https://www.youtube.com/watch?v=j798n4J9yA8