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.

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
2

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
1

circumstances affect household decisions (Worthington, 2006) . 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
3

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.

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
5

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

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.
7

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
8

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 wellbeing 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

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
requires knowledge and competence, ability to apply

this

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.

10

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.

11

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.
12

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
13

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.

14

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.
15

This can be assured only if the

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
16

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.

17

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.

18

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
19

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.

20

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
21

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.
22

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.

23

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.
24

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
25

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.

26

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