Financial literacy—a regulatory cop-out

After I finished a masters in economics from the much venerated Delhi School of Economics where we worked on complicated three-page equations that would solve the economic problems of the world, I realized I was financially illiterate. I couldn’t sign a check nor manage my bank accounts properly. It took some hefty fines for going below the minimum threshold for me to push myself to understand basic banking. Now, 20 years later, I consider myself “financially literate” but the transformation has been facilitated by the work that I do. If I were teaching geography, for instance, or cutting open people for a living, would I have spent entire days poring over insurance policy brochures trying to work out costs and benefits? Never!

It worries me therefore when financial literacy, or getting people educated about their money, takes on the nature of a global good. Much like polio eradication, as the goal to get citizens “financially literate” gains ground, I cannot but see the long arms of predatory capitalism at work. Retail financial products have grown in a regulatory structure that rests on the twin pillars of disclosure and financial literacy. This means that the producing and selling agencies will make a full disclosure of the material facts about the product and the person buying will be “financially literate” enough to understand and take the most efficient decision. This is nonsense. Pick up the disclosure document of any retail financial product and tell me anybody (other than the lawyers who wrote it) who can fully go through it, understand it and then take a decision based on reading through 20 such documents. When you see a row of biscuits on a shop shelf you can see the picture of the sweet treat and taste it once you’ve bought it. Your risk is limited to the 10 or 20 buck note you forfeit for that packet. If you don’t like it, you’ll buy another one tomorrow. No major harm done. Financial products are different. They are invisible. It is in their description that they are created for you and you’ll get a taste of the product only in the future. Sometimes that future is more than 30 years away.

I see the focus on financial literacy as a regulatory cop-out. Instead of making producers and sellers responsible for what they make and sell, regulators and policymakers across the world are pushing for financial literacy. The Indian capital markets regulator has asked mutual funds to earmark 2 basis points of the assets under management for financial literacy each year. That is over 150 crore this year just by the Indian mutual fund industry. Before we embark on this ambitious journey, should we not look at some evidence coming out of academia on this subject? A recent paper titled Financial Literacy, Financial Education and Downstream Financial Behaviors by professors Daniel Fernandes, John G. Lynch, Jr. and Richard G. Netemeyer (you can download it here: http://goo.gl/H3ftfM ) says that “interventions to improve financial literacy explain only 0.1% of the variance in financial behaviours 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 behaviour 20 months or more from the time of intervention”. The conclusions are based on a meta-analysis that maps the relationship of financial education and literacy to financial behaviour in 168 papers covering 201 prior studies. They conclude that financial education “as studied to date has serious limitations”.

What works? I agree with the authors who suggest a “just in time” financial education tied to specific goals. For instance, I believe that a person looking for a home loan will be most open to a quick two-hour intervention on how to choose a home loan rather than a workshop in office that you are forced to attend. I would look at financial literacy as something that changes money habits rather than workshops that tell you how a mutual fund works. A World Bank paper (read it here: http://bit.ly/176EkqC) documents the positive impact of a soap opera titled “Scandal!” in South Africa based around the theme of predatory pay-day loans: “Scandal viewers were almost twice more likely to borrow from formal sources, less likely to engage in gambling, and less prone to enter hire purchase agreements.” Instead of a silo approach to financial literacy where the mutual fund regulator asks funds to carry out the exercise and the insurance regulator asks insurance companies to...ok, forget that, won’t happen! The point is this: what is needed is very basic interventions that help people think about their money life as a whole and not as broken up by product regulators. Interventions that help people understand the role of various products in their lives and offer resources that help people develop the habit of regular cash flow management, understand the true role of insurance and then come to investment products.

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