Financial Literacy: Challenges and Opportunities

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By Dan Runde and Erin Nealer | DECEMBER 14, 2015

Financial literacy is a growing challenge as developing countries experience an increased access to financial services. Financial access, formerly a serious problem in developing countries, is rapidly being achieved as geographic, technological, and national barriers are eliminated. Mobile phone technology, urbanization, the growth of microfinance, and the prevalence of remittances all ensure that even poor, rural populations can easily access a bank account from a mobile phone or Internet connection. Encouraging financial participation and providing access without creating literacy programs will create problems for new bank account holders who do not understand how to invest and budget their savings. Increasing financial literacy in developing countries is a public good and a potential function of foreign assistance in partnership with financial service companies, civil society, educators, and financial regulators.

Universal access to finance will be a possibility within the next decade. The surge in new bank account holders and financial consumers will create new responsibilities for regulators, educators, and donors as financial literacy rates remain low.

Financial literacy is defined as the ability to understand and execute matters of personal finance, including basic numeracy, interest compounding, inflation, and risk diversification. Someone who is financially literate understands compound savings rates, changes in value of money over time, mechanics of credit and debt, and how these various economic tools affect their choices. Those who are not financially literate are unable to make informed choices about personal finances.

The financial crisis in 2009 brought the need for increased financial literacy to the world’s attention. Even developed countries, the crisis proved, suffer from low levels of financial literacy, which can have a powerful impact on both local and global economies. Globally, financial literacy levels range from 13 percent to 71 percent, with a loose correlation between higher economic development and higher literacy rates.

In 2014, the Programme for International Student Assessment (PISA) published the findings of their financial literacy test. In their study of over 500,000 15-year-old students in 65 different countries, they found that students with a higher socioeconomic status perform better on a test of basic financial literacy than those with poorer families. In several countries, students who hold a bank account perform better than those who do not, all else equal.

Financial literacy is generally much lower among poorer populations. In the McGraw Hill Financial report Financial Literacy Around the World, the countries with the highest rates of financial literacy are Australia, Canada, Denmark, Finland, Germany, Israel, the Netherlands, Norway, Sweden, and the United Kingdom, where at least 65 percent of adults are financially literate. Major emerging economies, like the BRICS (Brazil, Russia, India, China, and South Africa) experience only 28 percent literacy among adults on average.

A broader definition of financial literacy, expanded to include understanding the use and meaning of data and trends, proves an ongoing challenge for the developed world. The United States has struggled with deficient levels of financial literacy, as was highlighted by the recent financial crisis, and currently experiences only 57 percent literacy among adults.

Some examples of financial literacy programs include inclusion and literacy initiatives at bothVisa and MasterCard, which encourage basic understanding of transactions, loans, and interest rates to make individuals smarter about money management. The Jump$tart Coalition for Personal Financial Literacy is a coalition of organizations including banks, insurance providers, and government entities that support financial literacy for children in the United States.

The World Bank launched a Consumer Protection and Financial Literacy program in 2010, looking at both sides of the financial literacy issue—transparency requirements of financial institutions and the literacy rate of consumers. Whileconsumer protection laws, supervisory structures, and oversight boards exist in the vast majority of the 114 countries the World Bank studied, the extent to which these structures advocate for consumers’ literacy is questionable. Accion, a microfinance and investment firm, has been working on financial literacy and basic business training since 1995.

As the McGraw Hill Financial report shows, teaching financial literacy in schools encourages students to think critically about financial needs versus wants, smart ways to save their money, and how to take charge of their future by becoming financially independent. While financial literacy is seen as a developed world problem, urbanization, the growing middle class, and expanding financial access means that individuals are more empowered to make financial choices and need to be better prepared for the consequences of those choices.

Daniel F. Runde holds the Schreyer Chair in Global Analysis and directs the Project on Prosperity and Development at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Erin Nealer is a research assistant with the CSIS Project on U.S. Leadership in Development.

Originally published by CSIS