Depth and breadth of financial systems determine the stability of any society. The triad of financial inclusion, financial literacy and financial stability will be very relevant in the coming days because our lives are going to be more complex
Money is the greatest and the most ill-used factor in life. People don’t know how to tend it, how to manure it, how to water it, how to make it grow, and when to pluck its flowers and when to pluck its fruits. These were the words spoken by Margayya, the people’s banker in the novel, “The Financial Expert” by RK Narayan.
Finance is the glue that holds all pieces of our life together. Ideal financial societies are those which provide safe and convenient ways of managing these simple monetary affairs. This philosophy is known as financial inclusion. It is providing financial tools to the people — tools that they can afford, and are safe and properly regulated and can be accessed conveniently from formal institutions.
These tools enable people to save, insure and to responsibly borrow — allowing them to build their assets and improve their well-being and financial prospects. The term most buzzed in this respect is “the unbanked” — usually defined as people who don’t have a traditional savings account. These are the people who have to be brought into the orbit of formal finance.
Financial services are like clean water and electricity. But for making successful use of these services, people need to be literate enough to understand the basics of managing money. This skill is known as financial literacy. It is a combination of financial awareness, knowledge, skills and attitudes necessary to make sound financial decisions and ultimately achieve individual financial well-being.
Financial knowledge is particularly important in times where increasingly complex financial products are easily available to a wide range of the population. To keep abreast even those who are financially literate need to brush up on financial skills. This is the single biggest skill that can ensure economic well-being and freedom. In modern parlance it is known as financial literacy.
This skill is a combination of financial awareness, attitudinal and behavioural changes necessary to make sound financial decisions. It’s necessary to teach people the basic nuances of finance so that they keep distance from nefarious characters whose schemes have lacerated the financial lives of so many after they got into serious mess with them.
Like all other rights, citizens have a right to the ability to participate in the economy using all financial tools they deserve and do what most people do on a daily basis —manage their money for a better life. Financial literacy minimises barriers that prevent the unbanked from using traditional savings methods
Financial literacy increases individual participation in the formal financial system and enables them to undertake meaningful financial transactions — both savings and loans. People with robust financial skills are able to plan their lives better. On the other hand, 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 also end up paying higher interest on loans.
The Organisation for Economic Co-operation and Development (OECD) has articulated a working definition of financial literacy. It considers it as “a combination of awareness, knowledge, skill, attitude and behavior necessary to make sound financial decisions and ultimately achieve individual financial well-being”. OECD further points out: “Financial education equips people with knowledge and skills, and strengthens their attitude and belief in themselves, to make and exercise informed, confident and timely money management decisions.”
A basic financial education comprises an understanding of financial planning, debt management investing, mechanics of interest rates and investment diversification so that people become aware of the devastating results of taking on too much debt or purchasing wrong insurance policies. The science and vocabulary of finance are now considered an essential part of even general literacy. The literacy rate in India is defined as those who can read and write with understanding. Numeracy is defined as the ability to do basic math. Only 30 per cent of Indians qualify as being financially literate based on this yardstick.
People must be trained in smart upending — prioritising needs over wants, using credit card wisely, avoiding wastes funding expenses from savings and not loans, understanding terms of equated monthly installments (EMIs) before buying on EMI.
People who have a strong grasp of financial principles are able to better understand and negotiate the financial landscape and avoid financial pitfalls. Conversely, people with a lower degree of financial literacy struggle to understand money matters and the potential impact on their financial well-being as also the various technical implications of various products and services they opt for.
Financial ignorance carries significant costs and results in people spending more on transaction fees, getting over-extended with debts as they are ripe prospects for predatory practices. They usually fall prey to aggressive marketing and end up with troublesome financial products. On account of lack of proper awareness and failure of institutions to properly guide them, people buy insurance policies without planning and give up midway because they do not have money to pay the premium.
Hard selling prevents agents from properly assessing the consistency in income streams of the buyers for servicing their policies. The customers end up losing heavily due to harsh penalties. It is almost impossible to salvage failed insurance policies. Several banked customers can’t manage even modest sums of money. Whilst financial products can be hard to understand for even highly literate consumers, the lack of this basic understanding leads to unmanageable levels of debt for illiterate, vulnerable customers, pushing them deeper into indebtedness and poverty.
Financial inclusion and financial literacy or financial capabilities are two sides of the equation. Financial inclusion works on the supply side by providing financial market/services that people demand whereas financial literacy stimulates the demand side by making people aware of what they need. Therefore, financial inclusion and financial education must move in concert; each trigger supportive reaction in the other.
The triad of financial inclusion, financial literacy and financial stability will be extremely relevant in the coming times because our financial lives are going to become complex. The depth and breadth of financial systems determine the financial stability of any society.
Financial education programmes focused on just imparting knowledge will not yield optimal results unless backed by a suitable product that demonstrates its proper use. Cognitive constraints rather than lack of attention are a key barrier to improving financial knowledge.
Those aspects in which a service provider was involved in the programmes observed a better understanding and product usage, according to the United Nations Development Program (UNDP) report on financial literacy programmes in India. It gave consumers a better handle on some of the financial nuances and enhanced their prospects for a stronger financial foundation. These hands on and minds on interventions improve basic awareness of financial choices and attitudes and lead to sound financial decisions.
This has led to the concept of financial capability which supersedes financial literacy as a way of better representing the phalanx of factors that shape financial decision-making. There are three main features of financial capability. First, the concept of financial capability seeks to capture the idea that individuals need skills and knowledge as well as the ability to put these into practice through their attitudes and self-efficacy.
Second, the dynamicity of the concept emphasising on financial decisions needs to be fit to different circumstances of life. Thus, financial capability may mean different financial practices for different people and even for the same people at various stages of their life.
Third, the concept brings the external environment into the picture, allowing for a consideration of those external features which may or may not regulate the exercise of financial capability by individuals.
Every movement, including the one towards making every citizen financially literate, is driven by the acknowledgment of the overwhelming importance of empathy — not a form of empathy that comes from superiority, but one born from a profound humility. Empathy remains an emotional foundation. It’s the prime attribute of successful leaders. Leaders must become more engaged by rolling-up their sleeves and getting their hands dirty, rather than expecting others to always do it for them. Leaders need to become more mindful of how they are leading others and how they are being perceived as they sit in the corner office.
(The writer is the author of Village Diary of a Heretic Banker)