Finlit is the escape door for regulators and big finance

There is increasing evidence to show that putting people in a financial literacy classroom does little to improve outcomes outside of that room


Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Take this test.

1. Suppose you have some money. Is it safer to put into one business or investment, or multiple businesses or investments?

2. Suppose over the next 10 years, the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today?

3. Suppose you need to borrow $100. Which is the lower amount to pay back: $105 or $100 plus 3%?

4. Suppose you put money in the bank for two years and the bank agrees to add 15% per year to your account. Will the bank add more money to your account the second year than it did the first year, or will it add the same amount of money in both years?

5. Suppose you had $100 in a savings account and the bank adds 10% per year to the account. How much money would you have in the account after five years if you did not remove any money from the account? $150, more than $150 or less than $150?

In 2014, the S&P’s Ratings Services Global Financial Literacy Survey tested 150,000 people in 140 countries with these questions to decide if they were financially literate or not. The results reaffirmed what we know. Developed countries had higher numbers of financial literacy. Men did better than women. Young people wear the smart pants and not the 65+. Tested to gauge the ability to understand concepts such as diversification, compound interest, inflation and interest, the results showed that Indians did better in understanding of inflation, interest and compound interest but simply did not get diversification. The study can be seen here: http://bit.ly/1YxPADb.

(Readers of this column would have cracked this test. The answers are: multiple businesses or investments, the same, $100 plus 3%, bank will add more in year two, and more than $150.)

If we define financial literacy (finlit) as the ability to take informed decisions about money, then it is a basic life skill that everybody must have—from choosing between two job offers that structure your salary differently to buying stuff, from choosing between renting a house or buying it to deciding a financial product to invest in for the future.

If this is a life skill, then why is the finlit industry mired in controversy the world over? Writes Helaime Olen, author of the must-read book Pound Foolish: “The organizations most interested in promoting financial literacy are the ones that benefit the most from laws that assume consumers can be educated—and don’t need legal protection from corporate financial predators.” (Read her column here: http://slate.me/1TeiBCy)

There is increasing evidence to show that putting people in a finlit classroom does little to improve outcomes outside of that room. A paper titled Financial Literacy, Financial Education, and Downstream Financial Behaviors by Daniel Fernandes, John G. Lynch Jr. and Richard G. Netemeyer showed that a meta study across 201 previous papers showed “interventions to improve financial literacy explain only 0.1% of the variance in financial behaviors studied, with weaker effects in low-income samples. Like other education, financial education decays over time; even large interventions with many hours of instruction have negligible effects on behavior 20 months or more from the time of intervention.” Not only is it ineffective, whatever little is communicated is rapidly lost across time.

Why then do regulators push for it and why does big finance spend so much so conspicuously on finlit? To understand why regulatory thought is wrapped around finlit rather than preventing mis-selling of financial products, we need to understand the premise on which free markets are based—disclosure, and rational economic agents who maximise utility by optimising their own welfare. Regulators tick their own regulatory boxes by thinking their job is done by asking companies to disclose information and pushing for financially literate consumers. But little thought has gone in making disclosures meaningful or even machine readable. Finlit efforts pushed by regulators usually fail. In India, mutual funds are forced by the regulator to spend 2 basis points of their assets under management on financial literacy efforts. A mystery shopping exercise by Securities and Exchange Board of India (Sebi) showed samosa and chai parties for distributors (and much worse) instead of finlit classes.

What works? Certainly not putting people in seminars where the structure of the market is discussed. Nor do booklets work, which are so badly produced that you’d only pick them up if forced to take an exam in finlit. Regulators would do well to collaborate with each other, pool resources, and fund a habit-changing edu-tainment exercise. A TV soap with all the drama and noise but with the underlying theme of sensible finance would put finlit on the dining table rather than a classroom. For the DIY consumer of finance, a not-for-profit website (http://bit.ly/1TeaVQx) had recommended an effort called the FINWEB, which would answer their questions.

For the mass market there is no recourse other than making the person selling the product responsible for the outcome. Financial literacy will accompany sales when we move to a seller-beware market in retail finance.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor , Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at expenseaccount@livemint.com

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