Behavioral finance challenges traditional economic assumptions of rational decision-making. Nudge theory, developed by Richard Thaler, suggests subtle interventions can guide better choices without restricting freedom. Common biases include loss aversion, anchoring, and herding behavior. RBI uses nudges in financial inclusion through simplified KYC and direct benefit transfers. SEBI applies behavioral insights in investor protection through risk disclosure formats and cooling-off periods for IPO applications. Policy applications include automatic enrollment in pension schemes and simplified mutual fund categorization.

Behavioral finance integrates psychological insights with economic theory, recognizing that humans make predictable irrational decisions. Traditional finance assumes people are rational utility maximizers, but behavioral research shows systematic biases affect financial choices. Key biases include loss aversion (losses feel twice as painful as equivalent gains), anchoring bias (over-relying on first information), and confirmation bias (seeking information that confirms existing beliefs). Nudge theory proposes 'choice architecture' - structuring options to guide better decisions while preserving freedom. In Indian policy context, this translates to practical interventions: RBI's simplified account opening for Jan Dhan Yojana, automatic enrollment in EPFO with opt-out rather than opt-in, and SEBI's simplified product labeling for mutual funds. These applications recognize that small changes in how choices are presented can significantly impact outcomes. The approach is particularly relevant for financial inclusion, where traditional economic incentives may not overcome behavioral barriers to formal financial services adoption.