Emerging role of financial literacy in socio-economic development
Prof. Sirinimal Withane
Today, individuals across the globe make substantially more financial decisions over their lifetime, live longer and gain exposure in a variety of new financial products than ever before. Simultaneously during the last two decades consumers have shown a greater interest and responsibility for their financial well-being.
The 21st century changes introduced by many countries have increased consumer autonomy in making their daily financial decisions such as obtaining students’ loans, housing loans, credit cards, mutual funds and annuities; changed the pension landscape and provided opportunities to engage in complex financial decisions in a relatively sophisticated market.
In view of these developments across the overall financial sector, leading financial experts question whether consumers are equipped to intelligently navigate the more complicated financial decisions they face today and enhance their financial well-being.The literature shows however that only about 30 per cent of world population has a fundamental knowledge about financial concepts such as interest rates, inflation and risk diversification and capable of handling their day-to-day financial decisions effectively.
Definition of financial literacy
The construct of financial literacy is defined by the Organisation for Economic Cooperation and Development (OECD) as the knowledge and application of financial concepts and risks and skills, motivation and confidence to apply such knowledge and understanding in order to make effective decisions across a range of financial contexts to improve the financial well-being of individuals and society and to enable participation in economic life.
The construct of financial literacy comprises three concepts such as numeracy as it relates to the ability to do interest rate calculations and understanding interest compounding, understanding of inflation and understanding of risk diversifiaction. These three concepts which are known as the “Big Three” have been utilised to measure finacial literacy in many surveys in the US and in many national surveys around the world.
Correlations between financial literacy and financial decision- making
Recent studies across the globe have provided ample evidence of the impact of financial literacy on people’s decisions and financial behaviour.
Correlations between financial literacy and financial decision-making have been documented by various studies:
(a) Financial literacy has been proven to affect both saving and investment decisions.
(b) Financially literate people are more likely to plan for retirement probably because they are more likely to appreciate the power of interest compounding.
(c) Financial literacy is associated with higher returns on investments in more complex assets such as stocks, which normally offer higher rates of return.
(d) Financially literate individuals have a greater ability to cope with emergency expenses and weather income shocks.
(e) Those who are financially literate are less likely to have credit card debt.
(f) Individuals with the least financial literacy are more likely to buy costly mortgages.
The strong correlations between financial literacy and effective financial decision-making supports the fundamental argument of this article i.e., the policy makers should pay attention to improve the levels of financial literacy of the people for socio-economic development of any nation or country .
Financial literacy and
financial education
In order to improve the levels of financial literacy I believe that the policy makers should launch a well designed programme of financial education.
First, it is crucial to expose young people to basic concepts underlying financial decision-making from the high school stage. Second, schools and other government agencies should provide access to financial literacy to vulnerable groups such as women. Third, the governments should reduce the cost of acquiring financial literacy so that individuals can manage their own finances over their lifetime. Finally, the basic financial education should be provided to all employees at work places.
In conclusion the writer recommends that policy makers should embark on a concerted campaign to improve the facilities for financial education, at large.
In the absence of such a multi-pronged programme to educate the citizens of all levels, reaching the desired goals of socio-economic development in any country would be a forlorn hope.