Financial Literacy and why it matters

This is a continuation of the last week’s article, but today’s article aims at explaining why financial literacy matters, that challenges of financial literacy are far, wide, and global – not only for us – even though ours may be larger and with urgency for actions.

As it were, financial literacy is a key pillar for any financial inclusion framework, and a critical success factor for financial mobilization and in extension achieving not only the efforts to finance the socio-economic development intent, but also helping humanity achieving at least nine of the 17 United Nations Sustainable Development Goals (SDGs). For instance, it is being said — 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.

But, when people make reference to ‘financial literacy’ what do they real mean. Financial literacy may mean different things to different people. However, Investopedia defines it as an understanding of various financial areas including managing personal finances, money, and investing—which covers a range of applications that can vary from bringing marginalized communities into the mainstream in low-income countries to removing gender disparities in affluent countries, and everything in between.

In 2014, Standard & Poor’s in partnership with Gallup World Poll set out to get a handle on these issues. They surveyed 150,000 respondents across 140 countries regarding their understanding of basic concepts of risk diversification, inflation, numeracy, and compound interest. Those answering three of four questions correctly were deemed to be financially literate.

The survey revealed that although the problem of financial illiteracy is universal, women, low-income individuals, and the less-educated suffer from greater disparities in financial knowledge. Country-level financial literacy rates range from 71 percent (across Scandinavia) to 14 percent (Afghanistan, Albania) of the adult population. Worldwide, 35 percent of men are considered financially literate while 30 percent of women are considered financially literate.

Tackling Financial Illiteracy: The truth is, the problem of financial illiteracy is solvable, and when overcome, it can unlock solutions to an array of social challenges by making access to finance more widely available. Strategies to raise financial literacy rates are simple and require relatively low and non-recurring investments.

The stakeholder system for imparting financial literacy on a global scale is vast and disparate, but still there are adequate resources as explained here below:

Funding: Financing for the effort is coming from both public and private sources. One of the earliest champions of financial literacy, U.K.’s Department for International Development (DFID), created the Financial Education Fund to promote financial literacy in several African countries. The World Bank’s Universal Financial Access Program has recently led efforts to enable universal financial access for all. Other such as the Mastercard Foundation, Bill and Melinda Gates Foundation, etc have also actively invested in this cause. At some specific local levels, there are recognizable efforts by public and private sector actors towards this front.

Regulation: From the legal/regulatory perspective many central banks are currently working to strengthen financial literacy. In Tanzania for instance the Bank of Tanzania (BOT) through Financial Consumer Protection Regulations requires fair and equitable treatment of consumers who take out loans and other financial services and the BOT has directed banks to ensure consumer protection and education programs are implement across bank branches country wide. This is partly the recognition that a customer will typically never know enough and therefore informed consent and service provider liability should be introduced at the point of transaction.

Technology: on technology there are a number of start-ups, consulting firms, and quasi-governmental organizations that have developed low-cost assets or solutions for financial literacy. For instance, the Bill and Melinda Gates Foundation in partnership with other institutions have created mobile podcast videos focused on teaching financial literacy. Here at home, DSE runs an annual edutainment program (DSE Scholar Investment Program) to train and educate students on matters of savings and investment from the practical aspect.

Measuring Impact:  Impact assessments for financial literacy interventions are rare, however outcome indicators are well established. The simplest of these include the rate of literacy and gaps in literacy rates in terms of age, gender, nationality, or income group. One can rely on these and other indicators to demonstrate rising levels of financial literacy. For example, impact is measurable based on the level of activity in newly opened bank accounts or investment account in the stock exchange or the off-take of financial products, etc.

Nevertheless, as financial literacy improves, we would expect to see account balances continue to rise along with banking and investment activity. One measure of financial literacy is the increase in the average number of financial and investment products in a household. Therefore, impact assessments should determine, for example, whether there is an increased off-take in credit or life, accident, and health insurance policies, or if there is an increase in the number of digital financial transactions or there is an increase in investment activities at the local stock exchange, etc.

The need for collaborative efforts: If we are to achieve further economic growth, there is a recognition that financing such growth requires that sources are diverse, innovative and largely internally mobilized. This being the case, such approach and achievement will be made possible with the support of increased financial literacy and improved education. For wholesale improvements in education, the public, private, and social sectors must continue to seek opportunities to collaborate. Without partnerships and a systems approach, this herculean task cannot be completed. Efforts from organizations like the World Bank and OECD, laudable as they are, have only scratched the surface of the challenge. Such initiatives require the local support from a larger number of financial services players collaborating with key stakeholders to create an ecosystem of alliances that also include innovators, nonprofits, social enterprises, incubators, educators, and skills development agencies.

Forging true partnership toward this goal demands a different mindset, one that requires courage and compromise. Partners must accept that private players will drive business value through their involvement. It is logical that banks and financial institutions invest in inclusive finance and financial education as it will only contribute to enhancing the market pie for financial services. This is a win-win outcome, and a key to unlocking solutions to our “finance for growth”.

Enhancing Financial Literacy for Economic Benefits

Lack of understanding on how financial markets works is one of the significant deterrents to participation in the financial markets and in particular the stock market and share ownership. Research show that lack of literacy prevents households from participating in the stock market. Research further indicates the welfare loss from non-participation in the stock market can be sizable. Thus, the role of financial literacy should not be under-estimated. And as more people within societies live into a system where they have to decide how much to save for retirement and how to invest their retirement wealth, it is important to consider ways to enhance their level of financial knowledge or to guide them in their financial decisions.

As it were, individuals are increasingly put in charge of their financial security after retirement. Moreover, the supply of complex financial products has increased considerably over the years. However, we still have little or no information about whether individuals have the financial knowledge and skills to navigate this new financial environment. On the other hand individuals have become increasingly active in financial markets, and market participation has been accompanied or even promoted by the advent of new financial products and services. However, some of these products are complex and difficult to grasp, especially for financially unsophisticated investors. At the same time, in many economies market liberalization and structural reforms in social security and pensions have caused an ongoing shift in decision power away from the government and employers toward private individuals. Thus, individuals have to assume more responsibility for their own financial well-being. 

Are individuals well-equipped to make financial decisions? Do they possess adequate financial literacy and knowledge? Existing research on this topic indicate that financial illiteracy is widespread, and individuals lack knowledge of even the most basic economic principles.

Some of the aspects for consideration as our society evolves includes asking ourselves questions such as what is the importance of financial literacy and what is its relation to the stock market development? Are financially knowledgeable individuals more likely to hold stocks? Is there a causality relationship between financial knowledge and investing in the stock market? The truth is that the lower the understanding of basic economic concepts related to economic growth (GDP), inflation and interest rate compounding outperforms the limited is the knowledge of investing in stocks, units and bonds, and what about the concept of risk diversification, on the working of financial markets?

Given what we know with regard to the limited knowledge about economics and finance among us, then it somehow says that financial literacy should not be taken for granted is we pursue domestic financial mobilization in the financing of our development. The truth is that majority of households possesses very limited financial literacy. Furthermore, given that financial literacy differs substantially depending on education, age and gender — this suggests that financial education programs are likely to be more effective when targeted to specific groups of the population. As such, privatization programs or policies and legislature actions for listing of companies from specific strategic sectors should take into account that, when put in charge of investing for their retirement, financially unsophisticated individuals may not invest in the stock market, not because they lack funds for investing in targeted companies but largely due to lack of the specific financial knowledge. Thus, to work effectively, privatization and strategic sectors’ listing programs need to be accompanied by well-designed financial education programs.

It is noted that the challenge of limited financial literacy is not only for us, but most financial literacy surveys also conducted worldwide show that a majority of the population in most nations do not have sufficient knowledge to understand even the basic financial products and the risks associated with the products. Thus, the majority of individuals may not adequately plan for their future and are likely to make ineffective decisions in managing their finances. The same is true for us where a significant proportion of the population has a very limited understanding of financial products and services. This is particularly the case among the rural poor but also across the relatively more affluent peri-urban and urban mass market.

As a result, efforts on improving financial literacy and educating consumers around financial products and services has become an essential means toward greater economic, social and financial inclusion as well as an important complement to market conduct and prudential regulation. For capital markets in particular, investor education is important to promote greater retail participation in the market on a sound basis – in other words the best protection for investors is education.

Again, for us, financial literacy, consumer education and investor education is in its early stage and programs for educating the public are conducted on a sectoral basis across the financial services sector. In most cases, within each sub-sector, whether banking, pensions, insurance or capital markets, these are done separately by the regulator, self-regulatory agencies, industry associations, and among individual firms. There are also external based efforts, mostly by non-profit, donor-funded, organisations which also provide financial literacy and education targeted at lower income groups. However, such pursuance are largely in silos and not coordinated.

That is to say though each of these initiatives is useful in its own right, a holistic and coordinated approach to financial education is needed to ensure consistent messaging and to educate consumers as to the benefits and risks of the full range of financial products on offer in market, including banking, insurance, retirement, capital market products as well as informal financial products.

At the same time, however, it is important to recognise that different strategies need to be applied to different groups of the population, owing to the heterogeneity of demand for financial services across the country, both demographically and geographically. By way of example, the content of financial education targeting the Tanzanians in the rural areas should differ significantly from the financial education provided for the urban retail mass market.