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5 findings about the link between financial awareness and financial stability

27/05/2016
by Simon BROEK
Language: EN

The recent financial crisis has led to an increased desire for financial literacy. More and more people want to better understand how to be more responsible and prudent with individual saving and borrowing behaviour. Financial awareness has been linked to such prudent behaviour. Conceptually, its foundation is financial literacy, which is defined as:

The ability to use knowledge and skills to effectively manage financial resources efficiently at a personal-level and through the lifecycle.

It is more than numeracy, although numeracy is important in its own right. It includes for example the understanding of compound interest rates, nominal and real interest rates and financial risk diversification.

But can financial knowledge be linked conceptually to financial stability? Let's review some of the stylised facts in this modern and exciting literature:

  1. Individuals who are more financially literate have been shown to make more economically rational decisions pertaining to real estate purchases, insurance purchases, investing, saving, tax planning, retirement planning, pension and insurance planning. More generally, people who are more financially literate make better financial decisions (Lusardi Annamaria and Olivia S. Mitchell 2014).
  2. From an institutional perspective, increased financial capability can contribute to client protection and social performance target assessment by financial institutions.
  3. Recent evidence shows that financially literate individuals in the US are more likely to start their own business, and also perform better while in business (Klapper Leora F, Lusardi Annamaria, and Georgios A. Panos 2016).
  4. At the macro level, and in view of looming debt and retirement crises around the world, salient political choices − recently involving voting in referendums − are determined by attitudes towards redistribution, immigration, austerity, as well as the working of economic partnerships and monetary and fiscal unions etc. Such attitudes are likely to depend upon the understanding of the basics of macroeconomic accounts and public finance. Recent evidence shows relationships between financial literacy in the UK and attitudes to the Scottish referendum, the EU referendum, and towards immigration (Montagnoli Alberto, Moro Mirko, Panos Georgios A, and Robert Wright 2016).
  5. Recent evidence shows that financial knowledge is a key determinant of wealth inequality. 30-40% percent of retirement wealth inequality in the US is accounted for by financial knowledge (Lusardi Annamaria, Michaud Pierre-Carl, and Olivia S. Mitchell (2016)).

Ultimately, sound personal finance can contribute to increased levels of overall well-being, along with higher levels of satisfaction relating to income, retirement, housing and financial situation. So:

  • it benefits banks and other financial institutions to further the understanding of financial literacy.

  • it makes sense for policy makers, political parties, the media and active citizens to engage in financial awareness and the development of their financial literacy skills.

The first phase of the financial literacy research & policy agenda established that it matters a lot for a number of desirable economic behaviours and financial outcomes. It also showed that some key demographic groups, e.g. elderly, migrants, females, the poor etc., are characterised and affected the most by financial illiteracy and unawareness.

Therefore, the second phase of this important research agenda has been geared towards policy actions, aiming to uncover the activities and means best suited to deliver financial literacy training and increase financial awareness in practice. This important policy agenda requires the collaboration of policy makers, researchers and professionals with expertise across economics, accounting and finance, sociology information technology, computer/software engineering and education.

It also requires the involvement of a wide range of private, third-sector and institutional partners. Its goal is to lead to the development of a modern personal finance training curriculum that is compatible with best practices in adult and lifelong learning and benefits from technological developments and new capabilities.

Within this active agenda, the EU project PROFIT has recently been initiated as collaboration between members of a 6-party EU consortium. It aims to deliver a user-interactive online platform for the enhancement of financial capability.  The PROFIT platform (Promoting Financial Awareness and Stability), supported by a grant of nearly €1.6m from the European Commission (Horizon 2020), will run until 2019. PROFIT has been classified as an Open Democracy project, catering to the pivotal societal targets of client protection and social performance via increased financial awareness.

PROFIT will target three main goals:

  1. Increased financial awareness for informed decision making, via the development of a user-centred financial-capability platform aimed at promoting financial literacy.
  2. The creation of financial collective intelligence via automated techniques, which process data and extract collective knowledge in a systematic manner, and non-automated techniques through participation of users for creation of meta-data.
  3. User participation and community interaction by design and via appropriate incentive and reward mechanisms. The online platform will be pilot-tested by members of a large European federation of cooperative banks and financial institutions.

Georgios Panos is a Professor of Finance at the Adam Smith Business School of the University of Glasgow. He is working on the intersection between financial and labour economics and has written extensively on aspects of financial literacy and economic behaviour. He is a principal investigator for the Horizon 2020 PROFIT project and has served as a consultant to major financial institutions in multiple occasions on policy-relevant projects on finance, the private sector and economic development.

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