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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is the FT’s deputy editor, and chair of the FT’s Financial Literacy and Inclusion Campaign, which supports financial literacy programmes in the UK and around the world
Back in the spring Isabel Schnabel, a respected executive board member at the European Central Bank, added her voice to the growing chorus of support for financial literacy education — not out of any do-gooding sense of beneficence, but because, she said, monetary policy works better when citizens understand the basics of finance.
“Financially literate individuals react more strongly to interest rate changes, are more willing to take on risk and are more forward-looking when forming inflation expectations,” she told Bayes Business School in her Mais Lecture.
In other words, monetary transmission is more effective if society knows what the inflation rate is, and how interest rates might rise or fall over time, because that knowledge will make you more likely to borrow, spend and invest wisely, rather than randomly.
Now, a new report produced by the Centre for Economics and Business Research for US-based Principal Financial Group, has gone a few steps further, suggesting a direct link between improved financial literacy and lower loan defaults. In turn, the report suggests there is clear evidence that higher financial literacy levels can boost GDP growth.
First, let’s consider the debt question. Logic would certainly suggest that the more you understand of your own finances and what you can afford, the less likely you are to get into an unaffordable spiral of borrowing. But the theory is not easy to prove. CEBR researchers created a range of metrics to judge loan affordability, using for example debt-income ratios combined with non-performing loan data. Their conclusion? Financial literacy has a “direct impact on personal loan default rates”.
Overall, they conclude, each 1 percentage point improvement in financial literacy levels equates to a 2.78 point fall in household loan default rates. They highlight rapid improvements in financial literacy in Asian economies, notably China, Taiwan and Vietnam.
On the broader macroeconomic conclusion, a 10-point boost to financial literacy levels — a tally surpassed by those three Asian nations — equates to a potential boost to GDP growth, over and above expected growth rates, of 0.3 percentage points after four years, CEBR says. Smarter debt decisions and more productive investments should contribute.
The analysis is part of a broader report assessing financial inclusion, which puts financial literacy levels into a broader context of government, financial sector and employer support for a country’s population. Again here, Asian nations dominate, with Singapore maintaining the top rank out of the 42 countries assessed in this, the fourth year of the Global Financial Inclusion report. Hong Kong, South Korea and Thailand are also in the top 10, with those other three financial literacy champions rising fast up the inclusion rankings. The US ranks seventh and the UK tenth.
Out of a potential financial inclusion score of 100, the global average was virtually unchanged at 49.4, though it is markedly up on the 41.7 tally recorded in the debut 2022 report. The researchers blamed a decline in employer support in most regions for the stagnation.
Financial literacy charity
There are clearly shortcomings with this kind of analysis. Scoring financial literacy — for example using the recognised academic trio of questions on interest, inflation and investment diversification — is not a perfect science. Similarly, even a sophisticated econometric proxy for debt affordability may not entirely strip out distortive data effects, such as a rapidly expanding credit market. And attributing a correlated improvement in both to causation is probably a leap.
Schnabel’s theories are open to challenge, too. Suggesting that better financial literacy could spur people to make more logical responses to monetary policy decisions ignores the likelihood that the less well off may not have a choice about borrowing less or investing more; they may merely be making ends meet.
Even with such caveats, however, there can be no question that foundational financial education — both for young people at school and for adults as they encounter the challenges and opportunities of spreading digitisation, growing access to credit and a widening array of savings and investments — is of crucial importance. The more efforts are made to prove the case and boost provision, the better.
