Financial literacyÂ is the ability to understandÂ finance. More specifically, it refers to the set of skills and knowledge that allow an individual to make informed and effective decisions through their understanding of finances.Â By contrast, raising interest in personal finance is now a focus of state-run programs in countries includingÂ Australia,Â Japan, theÂ United Statesand theÂ UK.Â Personal finance is to financial literacy what being able to read one's own handwriting is to literacy.
The Organization for Economic Co-operation and Development (OECD) started an inter-governmental project in 2003 with the objective of providing ways to improve financial education and literacy standards through the development of common financial literacy principles. In March 2008, the OECD launched theÂ International Gateway for Financial Education, which serves as a clearinghouse for financial education programs, information and research worldwide. In the UK, the alternative term "financial capability" is used by the state and its agencies: theFinancial Services AuthorityÂ (FSA) in the UK started a national strategy on financial capability in 2003. The US Government also established itsÂ Financial Literacy and Education CommissionÂ in 2003.
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Today's complex financial services market offers consumers a vast array of products and providers to meet their financial needs. This degree of choice requires that consumers be equipped with the knowledge and skills to evaluate the options and identify those that best suit their needs and circumstances. This is especially true for populations that have traditionally been underserved by our financial system. Financial education is also essential to help consumers understand how to prevent becoming involved in transactions that are financially destructive.
Several broad categories of financial literacy activities can help potential bank customers participate in the U.S. financial system and help banks strengthen their communities:
Basic financial services and asset building programs provide a working knowledge of financial products, financial planning, and an overview of the U. S. banking system.
Credit management and repair programs enable individuals to correct and learn from previous financial mistakes.
Homeownership counseling prepares individuals for what is often the largest single investment in a lifetime.
Education aimed at recognizing and avoiding abusive lending practices can protect individuals at risk of obtaining inappropriate loan products.
Small business and microenterprise technical assistance provides entrepreneurs with practical business knowledge.
What are the benefits of financial literacy programs?
Assists residents of lower-income neighborhoods build wealth and participate in the American financial system.
Enhances a bank's visibility in the communities it serves and contributes to a larger customer base.
Increases access to depository institutions by educating consumers about available products and services.
Enables consumers to make better-informed choices in the financial marketplace.
Participation in these programs may receive consideration under the Community Reinvestment Act (CRA).
Bank participation in financial literacy programs may receive consideration under the Community Reinvestment Act. Such programs must have a community development purpose, which is defined to include community services targeted to low- and moderate-income individuals.
A large bank's participation in, or support for, such programs may receive consideration under the lending, investment, and service tests of the CRA regulations. Intermediate small banks may receive CRA consideration under lending test and the community development test. Small banks may receive consideration under the CRA for lending to financial literacy providers and are eligible to receive consideration for investments and services if their lending performance exceeds satisfactory standards.
Examples of bank support for financial literacy include:
â€¢ Loans to organizations to be used for financial literacy programs targeted to low- and moderate-income individuals.
â€¢ Investments in, or contributions to, a program, activity, or organization that provides financial services education programs targeted to low- and moderate-income individuals.
â€¢ Providing bank staff to serve as educators in financial literacy programs targeted to low- and moderate-income individuals.
What are some examples of financial literacy activities?
Basic financial services and asset building programs
School Age Programs
â€¢ School savings programs and savings clubs in elementary schools.
â€¢ Educational programs that progress in complexity as students get older.
â€¢ Field trips to banks, guest speakers, investment clubs, stock market simulation games.
â€¢ School-based bank branches.
â€¢ Presentations to local community and religious organizations.
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â€¢ On-the-job financial literacy seminars conducted in conjunction with employers.
â€¢ Educational outreach tailored to consumers with limited English proficiency provided in partnership with community based organizations.
â€¢ Counseling, training, and offering of Individual Development Accounts (IDA).
â€¢ Providing assistance at Volunteer Income Tax Assistance (VITA) sites offered by the Internal Revenue Service (IRS) which can help qualifying low-income individuals apply for the federal Earned Income Tax Credit (EITC).
Credit management and repair programs
â€¢ Assistance to organizations that offer consumer credit education programs.
â€¢ Providing staff and materials for credit-training classes.
â€¢ Providing financial assistance to support programs or providing staff to lead classes.
â€¢ Jointly offering targeted counseling classes with realtors, private mortgage insurers, and employers.
Recognizing and Avoiding Abusive Lending Practices
â€¢ Supporting educational campaigns aimed at warning borrowers about these practices.
â€¢ Providing financial support to organizations that help individuals target and avoid some financial products that might pose threats to them.
Small Business and Microenterprise Technical Assistance
â€¢ Providing seminars on topics such as developing a business plan.
â€¢ Providing financial and teaching assistance to business development centers and small business incubators.
What Financial Literacy Involves
Financial literacy covers all aspects of planning your financial future. It includes:
Setting financial goals
Creating your budget
Itemizing your expenditures
Planning for high-budget expenditures (including buying a home)
Basics of banking (accountÂ types and interest rates)
Basics of investing (into stocks, bonds and mutual funds)
Planning for retirement (including 401K)
Understanding the impact ofÂ inflationÂ and interest on money and investments.
The Importance of Financial Education
Financial education is increasingly important, and not just for investors. It is becoming essential for the average family trying to decide how to balance its budget, buy a home, fund the children's education and ensure an income when the parents retire.
Of course people have always been responsible for managing their own finances on a day to day basis - spend on a holiday or save for new furniture; how much to put aside for a child's education or to set them up in life - but recent developments have made financial education and awareness increasingly important for financial well-being.
For one thing, the growing sophistication of financial markets means consumers are not just choosing between interest rates on two different bank loans or savings plans, but are rather being offered a variety of complex financial instruments for borrowing and saving, with a large range of options. At the same time, the responsibility and risk for financial decisions that will have a major impact on an individual's future life, notably pensions, are being shifted increasingly to workers and away from government and employers. As life expectancy is increasing, the pension question is particularly important as individuals will be enjoying longer periods of retirement.
Individuals will not be able to choose the right savings or investments for themselves, and may be at risk of fraud, if they are not financially literate. But if individuals do become financially educated, they will be more likely to save and to challenge financial service providers to develop products that truly respond to their needs, and that should have positive effects on both investment levels and economic growth.
This Policy Brief looks at the importance of financial education, and how the OECD is helping governments achieve it. One key challenge is convincing people that they are not as financially literate as they think they are.
HOW FINANCIALLY LITERATE ARE WE?
Research conducted for the OECD's study on financial education indicates that the level of financial literacy is low in most countries, including in developed countries. In Japan, for instance, 71% of adults surveyed knew nothing about investment in equities and bonds, while surveys in the US and Korea found that high school students failed a test designed to measure students' ability to choose and manage a credit card or save for retirement.
Perhaps more worryingly, consumers often overestimate how much they know. In an Australian survey, 67% of those taking part claimed to understand the concept of compound interest but only 28% could find the correct answer to a problem using the concept. So before they can even start work on providing financial education to their citizens, governments need to persuade them it is needed.
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The level of financial literacy tends to vary according to education and income levels, but the evidence shows that highly educated consumers with high incomes can be just as ignorant about financial issues as less educated, lower income consumers.
Countries are increasingly aware of the importance of financial education and are already providing a variety of financial education programmes, ranging from Web sites and pamphlets or brochures to training courses and media campaigns. They cover issues such as credit, insurance, investment and retirement saving.
But interesting consumers in financial education is no easy task. People taking part in a survey in Canada said they thought choosing the right investment for a retirement savings plan was more stressful than a visit to the dentist.
WHY IS FINANCIAL EDUCATION IMPORTANT?
Individuals are increasingly being asked to take on sole responsibility - and assume the burden of risk - for complex savings tasks which were previously at least shared with governments or employers, such as investing for a pension or for higher education for their children.
But how can individual workers or parents be expected to weigh the risks and make responsible choices in an ever more sophisticated financial market? This is true even in countries where consumers generally are familiar with financial instruments such as credit cards, mortgage loans and perhaps private saving to "top up" company pension plans. It is all the more difficult in emerging economies whose rapid development has given access to financial services to a large number of consumers, many of whom have only a limited experience with formal financial systems.
For emerging economies, financially educated consumers can help ensure that the financial sector makes an effective contribution to real economic growth and poverty reduction. But financial literacy is also crucial for more developed economies, to help ensure consumers save enough to provide an adequate income in retirement while avoiding high levels of debt that might result in bankruptcy and foreclosures.
The information available on consumer financial literacy is worrying for two reasons - not only do individuals generally lack an adequate financial background or understanding to navigate today's complex market, but unfortunately they also generally believe that they are far more financially literate than is really the case.
This has become a cause for increasing concern for governments for a number of reasons. For one thing, increasing use of credit cards in OECD countries has led to an increase in personal bankruptcies - in 2003, almost one in 10 US households filed for bankruptcy and the number of private bankruptcies in Austria rose by 11%. And similar problems are arising in countries where credit is becoming more widespread - Korea has experienced large increases in consumer debt, while in Germany there has been an increase in private insolvencies, at least partly due to increased availability of credit.
And for some people in OECD countries, the question of financial literacy is far more basic and boils down to whether they have a bank account. Across the OECD, between 3% and 10% of the population are without a bank account, and are therefore financially isolated in a world where financial transactions - including payment of welfare benefits - are increasingly carried out electronically.
RBI's ENCOURAGEMENT FOR FINANCIAL LITERACY
Stressing the necessity ofÂ financial literacyÂ amongÂ people in India, TheÂ Reserve Bank of IndiaÂ (RBI) has been veryÂ eager to include financial coursesÂ at both schools and colleges in different states of the country. RBI'sÂ financial literacyÂ programme is already being pursued in the state of Karnataka as a pilot study and now based on that experience, the bank plans to extend it to the Orissa.
RBI is aiming to startÂ financial literacyÂ programme in Orissa in association with Orissa state government and to put forward the idea RBI Governor D. Subbarao had met Orissa Chief Minister Mr. Naveen Patnaik in December 2009.
Kaza Sudhakar, regional director of RBI-Bhubaneswar while confirming the news said,
"We are awaiting the response of the state government to start the program."
'The financial inclusion drive of the RBI' which is the part of Platinum Jubilee celebration of the bank includes initiating financial awareness in all parts of India and also introduction ofÂ financial educationÂ in schools and colleges.Â
TheÂ financial educationÂ for all age group and for all sections has become a prime necessity in the country. RBI pointed out thatÂ financial literacyÂ in all sections can help to minimise frauds and malpractices in the society.
RBI Governor D Subbarao stressing onÂ financial educationÂ said,
"Financial inclusion and literacy is not restricted to opening of a bank account. The account should be operative, in the sense that the account holder should be benefited going beyond deposits."
Besides, RBI has already started working on setting up 200 model villages in India. The purpose behind setting up model village is not onlyÂ financial educationÂ but also complete awareness about banking activities like deposits, advances, credit facilities and other schemes among villagers. Mr. Sudhakar added that theÂ financial educationÂ programme has been already started in eight villages in Orissa and the ninth village will be added in the list soon
Financial Literacy among the Young:
Evidence and Implications for Consumer Policy
Consumers must confront complicated financial decisions at a young age in today's demanding financial environment, and financial mistakes made early in life can be costly. Young people often find themselves carrying high amounts of student loans or credit card debt, and such early entanglements can hinder young people's ability to accumulate wealth. In order to aid younger consumers, it is critical for researchers to explore how financially knowledgeable young adults are. Understanding the factors that contribute to or detract from the acquisition of financial knowledge can help policymakers design effective interventions targeted at the young population.
Financial literacy has been an issue in many countries including developed and westernized societies. The cost of low financial literacy rates is substantial for the society and has been clearly identified by researchers.
2. Defining Financial Literacy
Financial literacy is defined as the 'ability of an individual to make informed judgments and to take effective decisions regarding the use and management of money' (ASIC: 2003, Noctor, Stoney and Stradling: 1992). A more comprehensive definition appeared in the Journal of Financial Service Professionals which stated that 'personal financial literacy is the ability to read, analyse, manage and communicate about the personal financial conditions that affect material well being' (Anthes: 2004). From the many definitions of financial literacy, a few important paradigms have been considered in this study, namely the individual, level of financial knowledge and informed judgments. In terms of the individual, one has to consider that not everybody requires or need the same level of financial knowledge. With respect to the level of knowledge and informed judgments, it is important to be aware that developed societies such as Australia, the UK and the USA tend to have financial products that are complex in their make up with diverse scenarios applicable to different financial needs. This environment facilitates a plethora of financial products that can create uninformed decision making among consumers due to simply the complexity of technical jargon and competition among financial institutions.
3. Literature review
The financial literacy construct is very broad in that it does not specify the areas to which it is to be quantified. For example, it may be inappropriate to conclude that an individual is financial illiterate if they lack the knowledge of credit card interest rates or minimum balance payment; for that person may simply not believe in being in a debt situation or lifestyle. There are some sections of the society that do not concur to a debt lifestyle and may not be aware of credit card issues or loan interest rates such as compound interest or effective interest rates (EIR). Therefore, the definition of financial literacy does not identify the level or depth of an individual's literacy; therefore, it can be construed as being the least delineated construct. As stated by Mason and Wilson (2000), that there is an inadequate conceptualizing of financial awareness, this is due to the synonymous use of the term to mean financial awareness. Studies have shown that financial literacy does not mean that a person would be able to make the right financial decision, as that person may not be familiar with the financial awareness of the financial construct or particular instrument (Marriott and Mellett: 1996). Similar to the tests of Marriott and Mellett, there are a number of such tests and learning programs administered or established by financial institutions, governments and citizens websites. One such test revealed significant differences in the statistical analysis when structured modeling were applied to the data as compared to treating the evaluations as independent and disregarding the inherent correlation structures can result in erroneous conclusions.
It has been shown that stress is a resultant feature of financial illiteracy. Research studies suggest that financial stress is common among low-income families (Worthington: 2006), however there is no evidence to suggest that these low-income families are financially illiterate. Financial stress could be related to many social issues such as unemployment, large families and poor economic conditions. However, the authors would argue against the classification of financial literacy purely based on a questionnaire, test or in depth surveys conducted on individuals. The study conducted by Chen and Volpe (1998) can be criticized on the grounds that it was an accounting test with complex financial terminology. Stereotyping non-business major students as having a lower level financial illiteracy can be seen as being harsh especially when these students may not be financially knowledgeable in all aspects of financial matters.
The complex nature of a variety of accounts that are offered as differentiated products by financial institutions can be 'mind boggling'. In the current financial world there is a web of financial terminologies such as Annualized Interest Rate (APR), compound rates of interests and hybrid rates. There is also a plethora of products that involve fine prints and legal clauses that even a professional would struggle to comprehend. The youth of today is faced with financial intricacies such as interest rates, complex nature of repayments options and investment options when they apply for loans or credit and even when they want to save for the future.
In Australian society as is the case in most western democracies, from the age of 15, a typical teenager learns to drive, starts part time work and receives superannuation (pension) from the employer of the minimum statutory requirement of 9%. At 18, the youth buys a car, gets a credit card (normally offered through promotion by banks with special rates to university students) and works longer hours and or studies full time or part time. This scenario is typical as the youth is involved in complex and highly responsible and possibly demanding situations and has to make financial decisions on income and expenses, budgets and future investments.
In a major review of the Banking Code in Britain by Atkinson and Kempson (2004), it was disclosed that there were 6 million youth; most of them are single and living at home. Approximately, half of them are in full time employment and the rest are in full time education.
The following is a summary from the review of the literature pertaining to youth between the ages of 16-24:
â€¢ Banking relationships normally start when they move into work
â€¢ Common financial products are current account, an overdraft facility, a `credit card and a savings account
â€¢ Half of youth surveyed had an overdraft facility
â€¢ 83% had a current account, 50% had overdraft facilities and 34% had credit cards.
As is the case in the UK, Australian youth debts levels are also a major concern, in a major study by the ANZ in 2003 found that low levels of financial literacy was associated with low levels of employment, single and ages between 18-24 (ANZ:2005).
In the USA, undergraduate students carried an average of three credit cards and had an average credit card debt of $2,327 in 2002. This was a 15% increase since 2000 (Nellie Mae: 2002 cited by Tucker, J.A. (2003).
Financial literacy can be considered to be low among youth as most of the research had shown that it was due to the level of complexities and variety in the financial world. On the other studies in the UK have shown that numeric skills are also low among youth (Atkinson & Kempson: 2004). Numerical skills are important in assisting the understanding of financial skills. There is support in many countries such as Australia and the UK to have financial skills taught at middle school levels across the curriculum (ASIC: 2003, Atkinson & Kempson: 2004). This could be achieved in the mathematics syllabus when students are taught financial terminologies such various types of interest rates. Such studies should be compulsory for all students regardless of their streams of studies or careers.
The financial situation of today's young people is characterized increasingly by high levels of debt. Between 1997 and 2007, average undergraduate student loan debt rose from $9,250 to $19,200-a 58% increase after accounting for inflation. Average debt for college students graduating with loans rose six percent in just one year between 2006 and 2007, from $18,976 to $20,098 (Reed 2008). Additionally, median credit card debt among college students grew from $946 in 2004 to $1,645 in 2009 (both figures in 2004 dollars), a 74% increase (Sallie Mae 2009).
Recent survey results also suggest that these debt loads are causing anxiety among young people and influencing major labor decisions: a 2006 USA Today/National Endowment for Financial Education (NEFE) poll of young adults ages 22 to 29 found that, of those with debt, 30% said they worried about it frequently; 29% had put off or decided against furthering their education because of debt; and 22% had taken a job they would not have taken otherwise because of debt. There are other potentially costly consequences of accumulating high levels of debt early on, such as bankruptcy (Roberts and Jones 2001). For instance, the U.S. Senate Committee on Banking, Housing and Urban Affairs reported in 2002 that the fastest-growing group of bankruptcy filers was those age 25 and younger. These high levels of debt may also prevent young workers from taking advantage of employer-provided pensions, tax-favored assets, or building up a buffer to insure against shocks: 55% of young adults report they are not saving in either an individual retirement account (IRA) or a 401(k) account, and 40% do not have a savings account that they contribute to regularly (USA Today/NEFE 2006).
These debt loads are of particular concern given recent evidence that young people may lack sufficient knowledge to successfully navigate their financial decisions: for instance, a National Council on Economic Education study of high school students and working-age adults showed widespread lack of knowledge among respondents regarding fundamental economic concepts (NCEE 2005), confirming evidence provided by the Jump$tart Coalition for Personal Financial Literacy (Mandell 2004). Policymakers have become so concerned about young people's finances that the Credit Card Accountability, Responsibility, and Disclosure (CARD)
Act of 2009 included several provisions specifically targeted at protecting younger credit card consumers. For instance, credit cards will no longer be issued to young people under the age of 21 unless they have an adult co-signer or can show proof that they have the means to repay the debt; college students will be required to receive permission from parents or guardians in order to increase credit limits on joint accounts; and those under 21 will be protected from prescreened credit card offers unless they specifically opt in for the offers.
Previous research has found that financial literacy can have important implications for financial behavior: people with low financial literacy are more likely to have problems with debt (Lusardi and Tufano 2009), less likely to participate in the stock market (van Rooij, Lusardi, and Alessie 2007), less likely to choose mutual funds with lower fees (Hastings and Tejeda-Ashton 2008), less likely to accumulate wealth and manage wealth effectively (Stango and Zinman 2007; Hilgert, Hogarth, and Beverly 2003), and less likely to plan for retirement (Lusardi and Mitchell 2006, 2007a, 2009). Financial literacy is an important component of sound financial decision-making, and many young people wish they had more financial knowledge: 84% of college students said they needed more education on financial management topics, 64% would have liked to receive information about financial management topics in high school, and 40% would have liked to receive such information as college freshmen (Sallie Mae 2009).
Understanding financial literacy among young people is thus of critical importance for policymakers in several arenas: it can aid those who wish to devise effective financial education programs targeted at young people, and it can also aid those who wish to devise legislation to protect younger consumers.