Financial literacy is an essential skill in today’s economy, especially for the economically disadvantaged. But financial education is not the only skill needed to navigate a complex and fast-changing economy. Some things are better addressed through regulation, such as products and services that are very obviously tilted against consumers, writes MOIN QAZI.
HE importance of giving the poor access to financial services is now accepted wisdom. What is not appreciated, however, is how this crucial need is undermined by a lingering lack of trust in banks among the people who are most in need of these services.
Many disadvantaged customers feel alienated because financial solutions are usually not tailored to their needs, and when they are, they are often not clearly explained.
Knowledge and trust are significant hurdles in any financial transaction. Access to mobile phones is nearly universal, for example, yet the robust use of mobile financial services is still rare, mainly because of a lack of knowledge and trust.
One of the prime causes of financial exclusion is financial illiteracy. To make successful use of financial services, people need to know enough to at least understand the basics of how to manage money. In simple terms, financial literacy refers to a set of skills that allow people to manage their money wisely along with some understanding of essential financial concepts and an appreciation of the trade-off between risk and return. It is a combination of awareness, knowledge, skill, attitude, and behaviour necessary to make sound financial decisions ideally for a lifetime of financial well-being.
Financial literacy entails knowing about financial products and services and having the rights skills for healthy financial practices. It is a key pillar for financial inclusion, and a critical success factor to achieve at least nine of the 17 United Nations Sustainable Development Goals (SDGs). For instance, eliminating poverty and achieving gender equality is simply not possible when two-thirds of adults worldwide remain financially illiterate and women continue to trail men in financial decision-making.
Finance has entered every family and every individual’s life in a much more significant way than ever before. The consequences of financial illiteracy have also become more severe because people now have to take much more responsibility for their financial lives. Everyone needs to know the ABCs of finance.
Financial literacy and understanding the subtle nuances of finance have become increasingly important for governments and citizens. Failing to do understand finance can have broad implications for the economic health and stability of countries. Financial literacy can impart the confidence necessary to transform ordinary individuals into informed and questioning users of financial services.
A few fundamental concepts are the primary foundation for most financial decisions. These are universal concepts that apply to every context and economic environment. It begins with numeracy, which relates to the capacity to do interest-rate calculations, understand interest compounding, inflation, and risk diversification.
Due to their lack of financial literacy, people buy financial products and insurance policies without adequate planning and give up midway because they do not have money left to pay the installment or premium. Aggressive pushing of products by financial service providers without adequately assessing the financial profile of buyers can mean more harm to those who are from economically weaker sections.
Sadly, most poor people still believe that loans are meant only for big businessmen and traders. As a result, informal—often costly—credit sources thrive among the poor, even when financial institutions offer affordable lending schemes.
Millennials are exceptional in many ways. They are better educated than their predecessors and more economically active. Yet they confront greater difficulties—including economic uncertainty and student debt—than the earlier generations. As a generation carrying new personal financial responsibilities that have more complex forms, it is critically important for millennials to be on a path that leads to financial security.
Financial behaviour can be changed through a process that starts from early habituation. Therefore, an understanding of financial concepts needs to be given as early as possible because financial habits will be carried and built by children into adulthood. Our school curriculum needs to incorporate financial education. The idea is that school-going children should gain the required modern financial knowledge and awareness of financial instruments, which then they can bring home to their families, including to the seniors, and the wider community.
It is said that at the age of three, a child starts understanding the concept of saving and spending. Early experiences with financial decision-making become foundational skills and go a long way in shaping an individual’s attitude, preferences, and behaviour. By the time the child reaches the age of seven, typically, money habits are already set. If we do not introduce key money concepts to children in this phase, it becomes challenging for them to handle finances efficiently as adults.
A college student can spend three years studying the intricacies of atomic science, earning a first-class honours degree, and remain dangerously clueless about the merits of balancing a household budget.
Thanks to financial literacy, young people now understand the importance of savings over credit cards and EMI loans. Earlier, the refrain was “young people don’t save enough”. It represented the conventional wisdom about millennials. This is changing. This cohort of young people is putting away more funds, though for short-term goals. Millennials now have a savings discipline that preceding generations lacked. It is heartening to see people realise the wisdom of putting some cash aside.
Being financially savvy has clear payoffs. People with robust financial skills and a strong grasp of financial principles can better understand and negotiate the financial landscape and avoid possible traps. Conversely, people with a lower degree of financial literacy struggle to understand money matters and their potential impact on financial well-being.
Financial institutions often target unsophisticated consumers with their less-than-straightforward—and often very expensive—financial products. Consumers who cannot comprehend basic financial concepts, such as interest compounding and financial risk diversification, often end up paying higher transaction fees, pile up unmanageable debts and end up paying higher interest on loans.
India has always been a fertile ground for swindles that have bilked mostly low-income households of millions of rupees. The financially illiterate are usually easy pickings. Investors have been periodically lulled into dubious schemes by nefarious characters. The poor have become wary of investing money even in credible organisations. Financial education and awareness are the most powerful antidotes against risky investment traps. People need to understand that the price of financial illiteracy is very high.
Financial products have proliferated and become much more complex. Moreover, the exponential growth in financial technology (fintech) is revolutionising the way people make payments, decide what financial investments to make, and seek financial advice The financial marketplace has become a dizzying emporium of choice and easy credit. We have a head-spinning array of credit options (credit cards, mortgages, home-equity loans). So, financial decisions have become more numerous and complex than ever before.
Financial literacy has now acquired a new nuance with the onset of digital financial services (DFS), considered the most powerful tool for financial inclusion. Offering basic financial services through mobile phones, point-of-sale devices, and networks of small-scale agents, DFS has the potential to reach more people, at a lower cost, with greater convenience than traditional “brick and mortar” banking services.
However, millions of people cannot read, write, or understand the long number strings necessary to transact on mobile phones. We need to aggressively train users on the nuances of digital finance that will empower them to adopt technology with ease. Women are eager to learn how to use digital payments because it gives them greater privacy and financial control—something they value a great deal.
While individuals are increasingly being called upon to make complex financial decisions, a large fraction of households has only a rudimentary understanding of basic concepts. Moreover, participation in financial markets is far from universal, and individuals with low levels of education and financial literacy are the least likely to participate in these markets. These correlations have motivated policymakers to devote substantial resources to financial literacy and financial education.
There is still a lot of illiteracy on issues relating to loan defaults and how they can be handled. A deferment of repayment of loan instalments, which borrowers and their representatives usually clamour for in times of crisis, does not give any real benefit to the borrower; it is not even a palliative. A loan holiday or deferment is just a postponement of liability and the borrower continues to incur a cost by way of the accruing interest, thus actually increasing his financial burden.
Financial education is not a silver bullet. But it can be an effective tool when delivered at the right time, to the right audience, through the right channels, and in combination with other interventions. Several promising programmes have experimented with experiential learning and customised content that meets individuals’ specific needs. A new wave of research has identified many effective avenues for delivering financial education. The spread of mobile phones has opened up a vast new world of possibilities for digital delivery of content that can enhance households’ financial capability.
Can financial education even out the playing field and enable people to better navigate a complex and fast-changing economy? Some things are better addressed through regulation. If there are things that are clearly negative for consumers, then they do not need to exist. But changing the financial framework is also not enough. Financial literacy is an essential skill for thriving in today’s economy.
(Moin Qazi is a developmental professional with doctorates in English and Economics. He has written books on religion, rural finance, culture, and handicrafts. The views expressed are personal.)