The recent Financial Inclusion Insights (FII) survey of more than 45,000 respondents across 22 states in India provides some initial insights as to the status in this regard (Box 5).
Box 5: Financial literacy in India: What is the evidence?
The Financial Inclusion Insights (FII) survey contains a section on financial literacy, although the survey focused mainly on access to finance and mobile money (Intermedia, 2014). The Survey focused primarily on financial knowledge (Panels A and B) and financial behavior (Panel C), but did not touch upon the issue of financial attitudes (see Box 6). Considering the expected divergence in the extent of financial inclusion in urban and rural areas, the analysis differentiates between the rural and urban areas.
Panel A, which asks questions about basic knowledge of calculus that is needed for financial matters, indicates that India’s urban population performs slightly better as compared to their rural counterparts. Yet, people appear to be financially less literate when asked a three-fold set of questions on how interest rates impact their money over time, especially when taking into account the inflation aspect.
Panel B enquires about financial knowledge by asking respondents who currently have a loan (formal or semi-formal/informal) whether they know what interest rate they pay. While the results could be driven by a rural bias in the data (69% of respondents are defined as rural dwellers), the interviewed rural population performs noticeably better. Informal financial services still seem to dominate, consistent with the AIDIS data.
Finally, Panel C indicates that the surveyed urban respondents have adopted a slightly prudent financial behavior, or in other words, are better at managing income and expenses and take long-term financial considerations on board. This emphasizes the fact that access to finance in rural areas might not alone suffice but behavioral constrains also need to be considered in order to achieve greater progress on the financial inclusion front.
Utilizing data from the survey, Gunther and Ghosh (2018) focus on evaluating financial literacy in India. They categorize financial literacy into three sub-components — financial knowledge, financial attitude, and financial behavior — akin to the procedure followed by Atkinson and Messy (2011) in their cross-national study. The authors construct an index of financial literacy, which ranges from a minimum of zero (i.e. when the respondent does not provides a correct response to any of the questions) to a maximum of 15 (when the respondent provides a correct response to all the questions). The findings show that at the all-India level, the average (resp., median) financial literacy score is 6.8 (resp.,7), with large and significant variation across states not only in terms of overall financial literacy, but also in terms of its sub-components.
Since financial literacy comprises a mix of several attributes, being financially literate therefore does not necessitate a perfect financial literacy score. Based on this logic, we consider an adult as being financially literate if the literacy score is at or above the 75th percentile of the literacy distribution. Using this criteria, we find that 26.2% of the adult population is financially literate. To put it differently, nearly three-quarters of the adult population do not possess sufficient financial literacy competencies.
Advancing the process further, a multivariate regression exercise is undertaken wherein for respondent i belonging to household HH in district D, the baseline regression is of the form:
where Y is the normalized financial literacy score, µD are the district fixed-effects which absorb any variation at the district level that can impact financial literacy, x is a vector of variables that capture the respondent’s demographic and socio-economic characteristics such as gender, location, age, educational and employment status, z represent characteristics of the household to which the respondent belongs, and finally, ε is the random error term.
Notes: Standard errors in parentheses. ***, **, and * denote statistical significance at the 1, 5, and 10%, respectively
The findings point to large and statistically significant gender-, location-, employment-, education-, technology-, and debt-driven differences in financial literacy. To provide some examples, the coefficient on Female (in col. 1) indicates that female respondents display 5.6% lower financial literacy as compared with their male counterparts, and the finding is remarkably robust and consistent related research (Hsu, 2011; Lusardi et al., 2014). In column 4, when we include education as a control, it is observed that higher the levels of education, the greater the financial literacy. As we move up the education scale, the magnitude of the point estimates increases and they are statistically significant as well. Thus, respondents with tertiary education exhibit 14% increase in financial literacy, five times the number obtained from the lowest category (see, for example, Christiansen et al., 2008; Gerardi et al., 2013; Klapper et al., 2013). The final column looks at household debt profile. Debt literacy — defined as the ability to make simple decisions regarding debt contracts — has gained relevance in recent times, because individuals with inadequate understanding of such contracts are often found to engage in higher-cost borrowing (Calcagno and Monticone, 2015), sloppier financial behavior (Gathergood and Weber, 2017), or less advantageous financial contracts (Van Ooijen and van Rooij, 2016). On balance, our finding suggests that less indebted households are financially more literate as compared with those who are more indebted. This is in conformity with prior research (Lusardi and Tufano, 2010) and highlights the risk of potential ‘debt traps’ in the Indian context (Reserve Bank of India, 2017). To see this, note that the coefficient on Savings are larger than Debts: Never equals 4.3%, whereas that on Savings are larger than debts: Always is 10.6%, nearly two-and-a-half times as large.
Around the world, people with access to formal finance are being asked to assume greater responsibility for their financial well-being. With financial products and services becoming increasingly sophisticated, consumers are constantly challenged to read the fine print to decode the inherent risks embedded in financial products. Rules and conditions for credit cards, mortgages, lines of credit, and other vehicles for borrowing have significantly altered over time, substantially raising the risk exposure of customers. In this changed milieu, financial literacy is being increasingly advocated by regulators as a first line of defense for consumers (Box 6).
Central Banks and Financial Inclusion
Our previous discussion suggests that while significant progress has been made on the supply side of financial inclusion, there is still distance to cover on the demand side. This raises the question as to how far central banks have a role to play and how has it changed in the new milieu. It has been argued that financial inclusion is a means and not the end of economic development, and as a result, there is a need to clearly demarcate the relative roles of the central bank and the government in achieving this objective (Reddy, 2015).
Box 6: Financial literacy around the world
While
