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CHAPTER 1

INTRODUCTION

1.0 Introduction

Financial management is that managerial activity which is concerned with

the planning and controlling of individual or institutional financial resources.

The concept personal financial management is of immense interest to

researchers, academicians and policy formulators in the context of economic

crisis and financial inclusion. As in the case of a nation or business institution,

finance plays a crucial role in the life of an individual too-either rich or poor.

Mobilisation of finance and its wise and efficient deployment play a strategic

role in the wellbeing of a nation or institution and at the most in the case of a

person who is the base or starting point of any economic activity.

1.1 Finance Function

The term finance function is more often referred in the context of

business rather than individual. The definitions of the term fall into three broad

categories. One group defines finance function as procuring or mobilising fund.

Though this interpretation highlights mobilisation as the core of finance, it fails

to explain the deployment or use of funds. The second category says that finance

is related to cash and therefore, finance function is everything that takes place in

the conduct of a business. Obviously such definition is too broad to be

meaningful. The third approach envisages finance function as procurement of

funds from most economical source and its effective utilisation in the business.

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This approach is meaningful as it entails financial decision making after due

consideration given to the various options for procurement and use of finance.

1.2 Personal Finance Function

When the third approach to business finance function discussed above is

applied to an individual, it is personal finance function. Finance or money plays

a pivotal place in the life of a person, either rich or poor. Money is essential for

personal well being as well as well being of the family. Financial wellbeing

dictates the quality of life.

Personal finance function covers the following essential elements:

1. Planning - planning mobilisation or procurement of money

2. Organisinghaving a cordial relationship between source and use of money

with a specific goal.

3. Controlling- having some checks and balances in using money.

Personal finance is the application of the principles of finance function to

the monetary decisions of an individual or family. It addresses the way in which

individuals or households mobilize, spend and save money after seriously

considering various factors involved in it. Components of personal finance

include mobilising money, saving money in suitable avenues, spending for

consumables and other assets, borrowing and investing or asset building.

1.5 The Concept of Financial Literacy

A number of definitions of financial literacy exist in the literature.

Basically financial literacy refers to the knowledge and understanding of

financial concepts there by resulting in the ability to make informed, confident

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and effective decisions regarding money. Financial literacy can be interpreted

broadly or narrowly. In a broader perspective, financial literacy can be stated

as understanding of economics and how economic conditions and

circumstances affect household decisions (Worthington, 2006)1. A narrow

definition of financial literacy focuses on basic money management tools

such as budgeting, saving, investing and insurance (Natalie, Newton and

Chrisann, 2010)2. It is the narrow view of financial literacy that is particularly

relevant to individual decisions concerning financial matters.

1.4 Definitions of Financial Literacy

Different interpretations of financial literacy have been used in financial

literacy studies resulting in no uniform definition. A number of studies have

used financial literacy interchangeably with other names like financial

capability, financial empowerment, debt literacy, financial knowledge, and

economic literacy. Definitions used by major studies focus on knowledge and

ability to make informed judgments to reach an intended outcome such as

lifetime financial security and the skills required to realise those outcomes.

Following are some definitions used by research scholars in selected studies.

i. Financial literacy is the ability to make informed judgements and to take

effective decisions regarding the use and management of money. Financial

literacy is therefore a combination of a persons skills, knowledge, attitudes

and ultimately their behaviours in relation to money (ANZ Bank, 2011)3.

ii. Personal financial literacy is the ability to read, analyse, manage and

communicate about the personal financial conditions that affect material

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well being. It includes the ability to discern financial choices, discuss

money and financial issues without (or despite) discomfort, plan for the

future and respond competently to life events that affect everyday financial

decisions, including events in the general economy (Carol, A. 2000)4.

iii. Financial literacy is a basic knowledge that people need in order to survive

in a modern society (Kim, 2001)5.

iv. Financial knowledge is defined as understanding key financial terms and

concepts needed to function daily in society (Cathy, 2002)6.

v. Consumer literacy is self-assessed financial knowledge or objective

knowledge (Marsha et. al, 2008)7.

vi. Financial literacy refers to a persons ability to understand and make use

of financial concepts (Lisa et. al 2008)8.

vii. Financial literacy is the ability to use knowledge and skills to manage

financial resources effectively for lifetime financial security (Mandell,

L. 2008)9.

viii. Financial literacy is the ability to use knowledge and skills to manage

financial resources effectively for a lifetime of financial well-being (Sandra,

2010)10

ix. Confidence with managing money (ASIC, 2003)11.

x. Mathematical ability and understanding of financial terms (Worthington,

2006)12.

xi The ability of people to make informed judgments and take effective

decisions in managing their finances (MAS, 2005)13.

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A thorough analysis reveals that all definitions convey the same meaning

and attempt to define financial literacy as a state of understanding about finance.

This understanding equips a person with the knowledge and skills needed to

realise financial security of himself and his family and thus survive and achieve

lifetime well-being. The definitions of financial literacy also refer to broad

outcomes and explain that financial literacy provides lifetime financial security

and well-being, the ability to respond competently to life events to survive in a

modern society. The common thread of financial literacy is positive financial

outcomes resulting from proficient competence in key financial activities and

concepts.

1.5. Components of Financial Literacy

Financial literacy has three distinct but dependant components:

(i) Core competency

(ii) Proficiency, and

(iii) Opportunity

A financially literate person must be proficient in the core competencies,

and be given the opportunity and environment to acquire financial literacy and

its benefits.

1.5.1 Core Competencies

Based on review of literature, a financially literate person should be

proficient in the following core competencies.

i. Numerical ability

ii. Budgeting, including the ability to keep track of expenses and income

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iii. Saving

iv. Borrowing, and

v. Investment

The core competencies are applicable to all sections of the society

irrespective of socio-economic or regional basis and can be expanded or refined,

depending on the magnitude of spending, saving, borrowing and investing.

i. Numerical Ability

Numerical ability or basics of money relates to the knowledge required

for the most essential day to day calculations involving finance. This takes the

form of basic calculations connected with the cost of purchasing goods, paying

bills, interest and discount calculations etc. At the basic level it is addition,

multiplication, subtraction and division. Lack of numerical skills will certainly

affect financial literacy. At higher level, it is the ability to understand financial

statements or other accounting information, time value of money, risk analysis

etc.

ii. Budgeting and Living Within Means

Budgeting means keeping track of finances and reducing unnecessary

spending. Living within ones own means is a skill necessary for effective

budgeting, and budgeting is essential when there is limited income (MAS,

2005)14.

iii. Savings

Savings relate to setting aside some money for future use. It may be

either short term savings or long term savings. While short term savings relate to

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budgeting, long term savings are relevant to post retirement life or for purchase

of costly items required in life such as a house or a car or even for marriage

expenses of girl children.

iv. Borrowing

In modern era, borrowing is a way of life for all categories of people.

Many people take up loans or mortgages. An indicator of competent borrowing

is that loan amount should be relative to earnings. A large proportion of

respondents in various financial literacy surveys did not understand the

difference between an unsecured or secured personal loan, and fixed or variable

interest rate. Debt literacy determines proficient borrowing. The core

competency of a financially literate person is the ability to understand debt, and

the processes involved to avoid it, reduce it and repay it. It also relates to

competence in using loans (Lusardi and Tufano, 2009)15 and responses to debt

including the ability to determine whether debt is justified (World Bank, 2008)16.

Debt illiteracy is therefore related with over- indebtedness, and an inability to

reduce existing levels of debt (Lusardi and Tufano , 2009)17.

v. Investing

Competence in investing and choosing the most suitable investment

portfolio is another key feature of financial literacy. Selection of an investment

portfolio depends on the finance available for investment and the purpose of

investment. Investment may be in real assets or financial assets A Japanese

survey suggests three criteria for choosing investments: safety, liquidity and

profitability (Hiroshi, 2002)18.

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1.5.2 Proficiency.

All the five core competencies described above are essential for financial

literacy, but these competencies also require a degree of proficiency. Thus, a

financially literate person must be proficient in the core competencies, having

proficient financial knowledge, ability, skill and experience in the core

competencies supported by positive attitudes about money.

i. Financial knowledge

An important aspect of proficiency is the level of financial knowledge of

the people. This refers to a persons level of knowledge of the core competencies

and the conviction that financial knowledge will lead to financial wellbeing.

ii. Application of knowledge

Definitions of financial literacy in United States (PACFL, 2008)19,

Canada (Task Force on Financial Literacy, 2010)20, United Kingdom (FSA,

2011)21, and Australia (Financial Literacy Foundation, Australia, 2008)22 signify

the importance of application of financial knowledge in financial literacy. The

UK Treasury has stated that financially capable consumers plan ahead, find and

use information, know when to seek advice and can understand and act on this

advice, leading to greater participation in the financial services market (HM

Treasury,2007)23. However, knowledge cannot be usefully applied without

relevant skills.

iii. Skill and confidence

A financially capable person possesses all the skills necessary to

effectively manage finances to achieve well being, and this includes

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communication skills, interpersonal skills, reading skills, mathematical and

computational skills etc. The definition of financial literacy adopted in the

United States by the Jump$tart coalition is the ability to use knowledge and

skills to manage financial resources effectively for a lifetime of financial well-

being The element of confidence is added to the Canadian definition of

financial literacy also together with skills. Financial literacy means having the

knowledge, skills and confidence to make responsible financial decisions

(Sandra Huston, 2010)24. Remund in his search for a better definition to

financial literacy states: based upon a review of research studies since 2000, the

many conceptual definitions of financial literacy fall into five categories: (1)

knowledge of financial concepts, (2) ability to communicate about financial

concepts, (3) aptitude in managing personal finances, (4) skill in making

appropriate financial decisions and (5) confidence in planning effectively for

future financial needs (Remund, 2010)25. Financial literacy therefore requires

communication skills also. It includes the ability to apply knowledge and to

communicate that knowledge, making financial literacy vital to effective

decision making.

iv. Attitude and Motivation

Financial literacy is understood by the link from knowledge (Fox 2005)26,

to skills, to attitudes, to behaviour (Holzmann, 2010)27. This link is important,

because knowledge influences attitudes, which then manifests into particular

types of behaviour (ANZ Bank, 2008)28. Attitudes include whether people live

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for today or for the future, or whether insurance is necessary or preferences for

risk etc (Financial Literacy Foundation, Australia, 2008)29.

1.5.3 Opportunity to Acquire and Use Competency and Proficiency

It is important that a financially literate person should have the

opportunity to acquire skills, and use them. Participation in economic life should

maximise life chances and enable people to lead fulfilling lives and this

requires knowledge and competence, ability to apply that knowledge and

opportunity and environment to act (Elizabeth and Margaret, 2007)30.

The component of opportunity stresses the social aspect of financial

literacy, which requires the equitable distribution of social resources that allows

people to participate in the financial markets. This can be referred to as the

financial inclusiveness of a particular society. Thus financial literacy promotes

financially and socially inclusive society which is the ultimate outcome of

financial literacy. A financially capable person is one who has the knowledge,

skills and confidence to be aware of financial opportunities, to know where to go

for help, to make informed choices, and to take effective action to improve his or

her financial well-being while an enabling environment for financial capability

building would promote the acquisition of that skills. An enabling environment

refers to an infrastructure, business model and regulatory system which

promotes and allows participation, excluding no particular groups or people

from the financial market.

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1.6 Attributes Required for Financial Literacy

The research report by Capuano and Ramsay (2011)31 gives attributes

required for financial literacy. The attributes are linked together to form a

complete picture of financial literacy.

Knowledge of financial information and core competencies

which are understood;

which can be communicated;

that can be applied;

with experience and skills;

knowing where to go for independent and trustworthy help when necessary;

with the ability to assess long term and short term goals, to make informed

judgments and to plan and make decisions relating to finance;

with confidence and motivation to take action;

in a way that can be measured by knowing the core competencies of

financial literacy;

where a decision is considered in light of its context, such as economic

conditions or forecasts;

in an environment that allows the opportunity to acquire and exercise

financial literacy skills;

and the action results in positive outcomes;

thereby increasing lifetime wellbeing.

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1.7 Financial Literacy and Financial Wellbeing

Financial literacy and financial wellbeing are mutually related (UNDP

and PFIP, 2010)32. Financial wellbeing is the ability to have our wealth

serves our life - to have the financial means to comfortably attain whatever

personal goals we have to enjoy a gratifying lifestyle. Sociological research data

indicate that four factors strongly predict happiness and overall well-being in

most cultures: health, economic status, employment, and family relationships.

People are happier when they are healthy, employed, married or in a committed

relationship, and financially secure.

There is a relationship between an individuals ability to do something

(capability), the demonstration of ability to do something (competence) and

wellbeing (both self-perceived happiness and economic wellbeing). Wellbeing

is, at least in part, a product of competent behaviour enacted consistently over

time. Financial capability and financial competence therefore influence a

persons wellbeing. The opportunity accorded to people to engage with the

formal financial system and how well they manage the money they have will

influence their standard of living and the standard of living of those for whom

they are responsible. Like never before, researchers, public authorities,

community groups, industry associations and international organisations, are

initiating financial literacy programmes and want to understand how people can

become financially literate, or in other words, have the knowledge,

understanding, skills and competence to deal with everyday financial matters

and make the right choices for their needs.

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1.8 Financial Literacy and Economically Marginalised People

Access to finance, especially by the poor and vulnerable groups is a

prerequisite for employment, economic growth, poverty reduction and social

cohesion. Further, access to finance will empower the vulnerable groups by

giving them an opportunity to have a bank account, to save and invest, to insure

their homes or to partake in credit, thereby facilitating them to break the chain of

poverty. A well-developed financial system brings poor people into the

mainstream of the economy and allows them to contribute more actively to their

personal economic development.

People need the opportunity to participate fully in the life of their

community if they are to flourish and realize their potential. But certain groups

in the society suffer financial as well as social exclusion. Financial exclusion

often causes poverty. Economic marginalisation is a process that relates to

economic structure and in particular to the structure of the financial market and

their integration. To the extent that from the financial market, some individuals

or groups are segmented in general, these individuals or groups can be said to be

economically marginalised from the rest of the economy. This segregation

results in exclusion of the group from the financial market. The economic

behavior of the marginalised group is distinctly different from the dominating

group or elite group.

Marginalised people in India can be divided into two main categories;

traditionally marginalised and those marginalised in the wake and as a result of

capitalist transformation. Marginalised people are those sections of the society

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who are economically and socially depressed and alienated from the main

stream. According to Prahalad, C. K. (2010)33 these people constitute the

bottom of the pyramid and could be a source of much needed vitality and

growth. They represent extreme variety- in their levels of literacy, rural urban

mix, geographical mix, income levels, cultural and religious differences and

every other conceivable basis of segmentation. These people have to mobilize,

spend, save and invest money to escape from poverty. They are to be

streamlined into the main flow of the nation which is one of the objectives of

financial inclusion.

1.9 Relevance of the Study

The following reasons explain the relevance of the concept of financial

literacy as a research study.

i. Economic depression

One reason for the relevance of financial literacy lies with the severity of

the economic downturn in almost all nations in the last decade and the extent to

which it touched the lives of people in all walks of life and at all levels of

economic well-being. This economic crisis has captured virtually everyones

attention. Because the negative impacts have been so widespread and

indiscriminate in terms of who was affected, almost all countries have now taken

more interest in financial literacy and capability and are more concerned in

propagating the importance of financial education.

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ii. Increased financial responsibilities

Individuals have been taking on, or have been assigned, more and more

financial responsibility for managing money and debt, saving for education,

saving for retirement, and managing high-priced purchases, such as houses. As

they take up more responsibilities and as the responsibilities become more

complex and challenging, they should be equipped with more capabilities to

encounter the challenges they will face.

iii. Financial challenges in life.

Financial challenges in every individuals life are increasing day by day.

People are living longer, living longer in retirement, and often facing the need to

care for aging parents. As life challenges increase, there is mounting concern on

the financial capability of a person as money is essential to meet all the demands

either personal or relating to family.

iv. Causes of economic disparity

One of the causes of economic disparity is financial illiteracy. Economic

disparity is increasing in many countries. It is the order of the day that the rich

becomes rich or the poor becomes poorer or alternatively rich may become poor

or poor may become rich. To the extent people know that variations in financial

literacy and capability contribute to this growing disparity, the more interest they

will show in financial literacy.

v. Welfare and social security programme by Government.

From Governments point of view, there is the need to ensure the success

and impact of financial policy initiatives. This can be assured only if the

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policies and programs are better understood by those for whom they are targeted.

Financial education and improved financial literacy and capability contribute to

improved success of governmental programmes.

vi. Aging population and social security measures

Governments are, and will continue to be, financially stressed especially

with aging populations. The more people can achieve and maintain financial

independence and self sufficiency, the less they will be dependent on

government support and assistance. To the extent that financial education can

help improve the chances for an individual to achieve and maintain financial

independence, the more benefits government can reap from reduced financial

burden of social welfare programme.

vii. Workplace productivity

To the extent that financial education can help people better manage their

financial affairs and live within their means, the less financial matters should

contribute to stress, anxiety, ill-health, etc. This, in turn, should improve health,

relationships, and workplace productivity. Financial literacy leads to employee

productivity.

viii. Information asymmetry

Financial institutions, finance companies and professionals that offer and

sell financial products and services currently have a significant advantage over

those who buy them in that their knowledge and understanding of products

significantly exceeds that of their clients. As such, there are considerable

imbalances and inequities in the financial markets for products and services

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between the buyers and sellers. Financial education should help to overcome

some of these inequities in financial markets.

ix. Better debt management

One of the most significant problems encountered by many people relates

to debt management. This draws considerable attention to the need for people to

be better able manage their financial affairs and to help alleviate the potential for

debt problems and living beyond ones means.

x. Financial frauds

The proliferation of financial frauds and scams has also contributed to the

increased interest in financial literacy. People should understand and avoid

frauds and scams that may encounter in life.

xi. Inclusive growth

The concept of financial inclusion calls for the need for a financially

literate people so as to take the best advantage of inclusion programme.

Financial literacy and financial inclusion are two pillars of economic growth of

the marginalised people.

1.10 Benefits of Financial Literacy

Financial literacy is important because it benefits people, the financial

system and the economy in general. Financial literacy enables people to behave

in a special way, and develop positive attitudes concerning money. The

microeconomic benefits to the household extend out to produce macroeconomic

benefits for the nation and the financial system.

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1.10.1 Benefits to the Individuals

i. Increased savings

Financially literate people will have a greater capacity to save. This is

achieved by financial efficiency which results in saving money and an enhanced

ability to set realistic goals and select suitable investments to realise those goals.

Many Studies have linked financial illiteracy with low levels of savings

(Jappelli, 2010)34. A better-informed consumer will save for future and for

unforeseen circumstances and emergencies (EFEP 2011)35.

An earning individual may face a sudden decline in income when he faces

retirement or inability to earn income due to old age. Financial literacy is useful

in life stages where important decisions are made, and as such financial

education at these stages can successfully alter behaviour relating to retirement

planning and saving (Oehler and Werner, 2008)36

According to Kempson and Finney (2009)37, there are three types of

savers: (1) rainy day savers who save regularly, (2) instrumental savers who save

for a purpose and (3) non-savers, of which there are very few people. Their study

proposes that with the correct education, non-savers can become instrumental

savers, and instrumental savers can become rainy day savers. They further state

that while some low income families want to save, and exhibit good saving

behaviour, financial circumstances preclude them from acting in a manner

consistent with their desires.

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ii. More realistic assessment of financial knowledge

Frequently, there are news about cheating the public by money chain

groups and other fraudulent companies and it is a pity that the literate people are

more prone to theses frauds. Many financial literacy surveys found that most

people overestimate their financial knowledge (ANZ, 2008)38, (Jump$tart,

2008)39 and (Kuzina, 2010)40. Financial education ensures that people have a

realistic view of their own financial knowledge and accordingly approach

investments and financial decisions with due caution.

iii. Life skills and bargaining power

The best financial behaviour is achieved through the development of

knowledge and skills, which provides the basis for making informed decisions.

A skilful and knowledgeable person with positive attitude towards money will

plan spending. A study by the European Commission (2007)41 has found that

financial literacy gives consumers greater bargaining power through

understanding finance and terms when he deals with financial service providers.

As a result, consumers can gain better deals and demand more from service

providers. In light of the fact that contact with financial institutions is necessary

for a normally productive and enjoyable life, the ability to understand financial

institutions and the products they offer is an important benefit of financial

literacy.

iv. Financial efficiency

Rajat Nag, Managing Director General of the Asian Development Bank

stated that (2007)42 Financial literacy allows people to increase and better

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manage their earnings and therefore better manage life events like education,

illness, job loss, or retirement. An Individual is confronted with many products

and services in the market with varying offers and values with which he is often

confused. Financial efficiency can include selecting the best value product on

the market, and paying the lowest possible price on the market for a particular

product or service. Financial efficiency is achieved by resorting comparison

shopping, an important attribute of financially literate consumers. Comparison

shopping leads to savings by purchasing the best value products at affordable

prices.

v. Lifetime utility and financial wellbeing

Financial literacy should result in much more than realising financial

goals. The optimal enjoyment of life at the lowest possible price is the result of

financial literacy. That is, behaviour that result in unnecessary expenses, such as

spending more than ones disposable income, choosing the wrong financier,

paying higher interest rates, selection of wrong investment avenues etc. are the

outcomes of financial illiteracy. The end result of financial literacy is lifetime

financial well-being or realising financial goals and healthy household balance

sheets. Measures of financial wellbeing include increase in wealth, income,

savings, manageable debt relative to assets, home ownership, accumulating

retirement savings and an investment portfolio that reflects the needs of the

individual (Tatom J, 2010)43.

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vi. Active debt management

Financial efficiency, also linked with debt literacy, includes financial

knowledge of debt and how best to avoid and manage debt. Debt illiteracy can

be linked to a number of high costs financial experiences, such as borrowing on

high interest rates from local money lenders, using pawn shops etc. Prudent

borrowing or careful borrowing takes into account cost of borrowing, thereby

resulting in significant savings to consumers.

vii. Active participation in financial markets

Financially literate persons have been shown to possess more financial

products and be productive investors. Limited financial market participation, or

inertia (Shawn& Nilesh, 2008)44, may be a consequence of low levels of

financial literacy (Gallery 2010)45. Van Rooij (2007)46 found that people with

low levels of financial literacy are significantly less likely to hold shares and

stocks. Financially illiterate people avoid financial products which are perceived

to be difficult to understand (Jappelli, 2010)47.

viii. Investing and choosing the right financial products with confidence

A financially literate consumer will be more confident when making

decisions about finance, thereby increasing participation in the market. Financial

literacy can influence the types of products selected, and the types of

investments made. Financial education can contribute to financial stability by

helping consumers to choose appropriate products and services, leading to lower

default rates, for instance on loans and mortgages, and more diversified and

therefore safer saving and investment (Holzmann, 2010)48. An improved

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understanding of financial products and services develops greater financial

confidence in consumers, who select the most appropriate products and organise

those products in the best possible way.

ix. Knowledge of regulatory framework

Education in consumer laws is a component of financial literacy. This

knowledge gives people the tools and understanding to identify and avoid

fraudulent schemes and reduce the severity of falling victim to such schemes.

This translates into lower levels of regulatory intervention because consumers

are better able to take care of themselves. A financially literate person knows

where to go for help.

x. Prosperous, healthy and happy life

Financial literacy skills enable individuals to navigate the financial world,

make informed decisions about their money and minimise their chances of being

misled on financial matters. Having financial literacy skills is an essential basis

for both avoiding and solving financial problems, which in turn are vital to living

a prosperous, healthy and happy life. Financial problems are often the basis for

divorce, suicides, mental illness and a variety of other unhappy experiences. In

addition, financial hardship can increase isolation, emotional stress, depression

and lower self esteem, which in turn can generate or exacerbate marital tensions

that lead to divorce and even to suicide. Financial literacy is first and foremost

about empowering and educating people so that they are knowledgeable about

finance in a way that is relevant to their lives and enables them to use this

knowledge to make informed decisions.

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1.10 .2 Benefits to the Financial System

i. Efficient and healthy financial market

Financially literate people can create a more competitive, innovative,

safe, stable, accessible, disciplined and liquid financial system and markets and

also greater competition, innovation and quality products in the financial

market. Financially literate consumers are more financially efficient. Seeking

and purchasing better, cheaper and more appropriate products and services can

drive efficiencies in the financial industry. This leads to increased competition,

better quality products and greater innovation and diversity in the market.

ii. Coverage of risk

Financially literate people have a greater awareness of risk, and therefore

they fully insure their assets. It reduces the burden on the financial system from

under coverage of risk and underinsured ventures, reducing costly individual and

institutional insolvencies and bankruptcies.

iii. Self-funding for post retirement life and old age

The increased saving and financial planning resulting from increased

financial literacy also has positive effects on the financial system and economy.

It reduces the burden on the state to provide pensions and government funding

for people experiencing financial hardship. Financially literate people are more

willing to build wealth during their working lives to fund post retirement and old

age life.

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iv. Escape from the unfavorable lending policy of financial institutions

Financial institutions and banks usually lend freely during good economic

conditions and tighten lending when the economic climate turns bad. This

policy can have significant negative impact on a borrower who heavily depends

on borrowed funds. In a financially educated society, borrowers will be less

likely to take on more debt just because credit is cheap and freely available. As a

result, they will have a far better chance of riding out an economic downturn

without defaulting on their debt repayments which, in turn, will help minimise

the bad debt experience of financial institutions and by doing so help bolster the

stability of the financial system (Keith Hall 2008)49.

1.10.3. Benefits to the Economy

Improved financial literacy brings large benefits for both the economy

and the individual. Developing countries have especially low levels of financial

literacy. In India, for example, more than half of labourers surveyed (Max New

York Life, 2008)50 indicated that they store cash at home, while borrowing from

moneylenders at high rates of interest. This pattern of behavior high interest

loans and no interest savings, with the resultant high risk of theft-or frittering

away -of savings worsens the financial situation. Financial literacy and financial

education can change this phenomenon.

1.10.4 Benefits to the Community

Financial literacy brings considerable benefits to the community. It

enhances inclusion in the financial markets and increased awareness by the

public regarding financial issues, thereby creating an informed community.

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i. Financial inclusion

Financial literacy allows those sections of society especially the

marginalised and poor who are otherwise excluded from the opportunity to use

financial products and services. Knowledge of zero balance savings account

facility may prompt a person to open an account with a bank whereas no

knowledge of the existence of such a facility will result in exclusion of those

people. Financial literacy provides the understanding required to access financial

products and services which allows people to become financially active.

Financial literacy therefore increases social inclusion, and gives people the

knowledge to avoid highly priced, unconventional and riskier forms of financial

products.

ii. Awareness of financial policies

Changes in policies and programmes are taking place in the financial

sector frequently. Financially literate people are able to assess financial polices

of the government and the actions of financial institutions and the impact of

these changes on their financial status. This creates better informed citizens who

are able to make sense of policy reform to the financial sector and critically

evaluate such policies.

1.11 Conclusion

Financial literacy plays a pivotal role in todays complex financial

scenario. It is an essential component for the empowerment of all categories of

people as it gives them an understanding of how to manage their finances in the

real economy in order to avoid unnecessary hardships, excessive debt and

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possible financial exclusion. Moreover, it enables people to improve their

understanding of the financial opportunities that the formal financial market

offers to them. Financial literacy is best understood in terms of core

competencies, and proficiency in those core competencies. The core

competencies are: (1) money basics, including numeracy; (2) budgeted spending,

ie, living within means; (3) planning savings; (4) borrowing and debt literacy;

and (5) investment by choosing and understanding financial products and

services. Financial literacy starts with proficient knowledge in these five core

competencies.

The ability to apply the core competencies is complimented by skills and

experience in those competencies, which enhances the efficiency with which one

is able to act on their knowledge. Thus financial literacy is best defined by the

process of linking the core competencies with the proficiencies, and taking into

account whether the financial environment is inclusive such that people have the

opportunity to become proficient in the competencies with the ultimate goal of

financial well being.

27

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