Financial Literacy Criteria and Ways of its Improvement

While the need to have a financial literacy promotion program in Russia is obvious, there are still unclear issues, e.g.:

What is financial literacy? What are the criteria to tell a financially literate person from a financially illiterate one?
What level of financial literacy may be considered sufficient?
How to improve financial literacy of the people?
Who must/can do this, especially when even the bank officers are not always financially literate? Are the financial institutions committed to financial literacy improvement?
Will the improved financial literacy provide a positive or negative impact on the financial activity of the people?
What should be done to increase the effectiveness of this program?

In December 2007 - March 2008 a study was undertaken on financial literacy criteria and ways of its improvement in order to find answers to these questions. Representatives of the RF Central Bank, Federal Financial Market Service, Deposit Insurance Agency, representatives of major commercial banks, insurance companies, investment funds, payment systems and representatives of the non-government noncommercial organizations - Russian Union of Industrialists and Entrepreneurs, Center for Investment Education, and others took part as experts in the study. Executive officers of the above organizations were interviewed during the study, while in the case with banks and insurance companies, managers of retail departments were interviewed.

The survey involved 37 experts.

Main Conclusions of the Study

All the experts acknowledge that the level of financial literacy of the people is extremely low, and all the market players believe that its improvement is very much needed. Therefore the information about the Russian Ministry of Finance designing the financial literacy program is viewed very positively by all counterparts.

Positive outcomes of the improvement of financial literacy

Experts believe that the improved financial literacy will result in the steady growth of consumption of financial products. They criticize those who think that the number of consumer credit clients or capital market investors may reduce if people understand the risk and cost levels of such financial instruments better. The experts think that such a view is unjustified, especially in the long run, and cannot be accepted on moral grounds.

Just the opposite, the insufficient, rather than excessive literacy may result in the reduction of financial activity. The demand for financial services keeps growing with the growth of monetary wealth of the people, but the influx of the people with low financial literacy may create problems for the adequate operation of the capital markets. When people cannot differentiate between good faith and careless companies, investors may respond to the false signals and panic at the first negative news, the borrowers may refuse to repay the loans, that may result in a crisis following a short period of market growth, and a new fall of the public interest in the financial markets.

Although the market players themselves are interested in the improvement of financial literacy of the people, very few of them do something for its promotion. The main impediment is in the fact that the players are not committed to creating a public good for the entire market at their own expense, they do not even attempt to agree among themselves and resolve an issue of "free riders".

However, if the government becomes a coordinator for such a program, market players are prepared to participate in it.

The role of the government

In addition to the development of program objectives and methods for their achievement, the government shall:

Organize the public discussion of the topic;
Check that the financial literacy promotion programs do not turn into advertising and marketing activities on promotion of specific products and attraction of clients;
Make arrangements for data collection and analysis, e.g., regarding the public complaints processed through the financial market supervisors and regulators;
Improve the legal framework to prevent careless companies from provision of financial services to the people;
Pursue the transparency policy in relation to the financial institutions: information disclosure, standardization of contracts, etc.

Improvement of financial literacy should be followed by the increased transparency of financial institutions and a better access to the information on their services, comparability of terms on various products.

The law on financial services is needed to identify the rules of the game for any company offering its goods and services to the people with a prepayment condition.

Possible failures of the program

At a first glance the financial literacy program is "doomed to success': the current financial literacy level is very low and any actions will improve it, while any increase of the financial literacy level will be beneficial for the market.

However, a failure cannot be ruled out. There will be no effect of this program, if, first, we get an advertising campaign for certain products and services instead of a financial literacy program. In this case the people encouraged to use financial services because of advertising, will still fail to understand the nature of these instruments. Therefore any crisis or losses will bring them to the government with a question: Where did you bring us?

Second, a chance for a failure is in the fact that some activities may be excessive and if people are trained exclusively on the negative examples of potential losses, then a financial literacy promotion may create an image of financial institutions as complicated, non-transparent and selfish entities, concerned with only one thing: how to earn as much money on their clients as possible. Understanding of the complexity of financial instruments, acquiring knowledge of the market and products requires extraordinary efforts and the absence of guaranteed benefit may scare a significant portion of potential clients right away.

Third, the money would be wasted if the program turns into fragmented activities.

Fourth, if the financial literacy program does not create a mechanism for selection and involvement of most qualified and experienced contractors who realize the core of the issue and are aware of the problems which may be encountered in implementation.

Fifth, serious problems may appear in the organization and coordination of activities between the program participants: some duplication and omission may be experienced. It is necessary to understand how to coordinate and manage the program in the most efficient manner.

The concept of financial literacy

Experts interpret the financial literacy as knowledge of financial institutions and their proposed products, as well as the ability to use the knowledge when needed and awareness of consequences of one's own actions. Conceptually the financial literacy is broken into three interrelated parts: attitudes, knowledge and skills.

The first part, or attitudes, is the foundation of financial literacy. It deals with development of financial behavior culture, to start with the family budget planning, aimed at achievement of long-range perspectives, and development of implementation strategies to meet the life cycle needs. But before the knowledge and skills of long-range financial planning are not yet developed, the habit to think in the today's needs terms prevails. This is the attitude to be changed in the course of the financial literacy program implementation by changing the mindset of the people who should realize that any person's lifecycle includes many milestones, and one should be financially ready to address the challenges they pose. Such milestones may include marriage, birth of children, purchase of housing, education of children and one's own retirement. These challenges cannot be met without the use of financial instruments.

Another important pattern impeding the development of financial activities of common people is the lack of trust in the financial institutions. People should be persuaded that such institutions are the integral part of any modern society and a functional element of the market, in order to overcome such an attitude. The government program shall focus primarily on the development of behavior patterns, basic knowledge and skills in the financial market, some kind of financial minimal standard, and achieve it by disseminating the information on the possible models of behavior aimed at meeting particular needs.

The necessary knowledge shall include: understanding of risk and rate of return, discount rate, inflation, difference between real and face value, cash and electronic payments, capital market operation principles and arrangements, nature and functions of financial institutions and instruments, legal and tax literacy basics, awareness of the limits of financial institutions' responsibility before customers, as well as the responsibility of customers before the financial institutions, minimal financial terminology understanding, etc.ate, inflation, difference between a real and face value, may be experien

Required skills: ability to search and find information about the market, the habit to follow the main market indicator performance, ability to read a contract and understand its contents, compare the proposals from different companies, ability to submit a claim or complaint when a customer's right is abused, etc. It is necessary to develop a habit to follow the finacial market developments, e.g., the interest rate on credits and deposits, rate of return on unit funds, cost of insurance products, etc., develop the contract reading and understanding skills, etc.

Public- private partnership

Experts concur that the program should be implemented through a public-private partnership mechanism. The government may count on the major market players who pursue a long term market presence strategy and therefore they are committed to the idea of having a better financially educated clientele, and on the regional authorities, governors, who have to deal with crisis outbreaks when local population is affected by them.

Financial education at schools

The problem of targeting schoolchildren is the most important in terms of design and implementation of the financial literacy program. The secondary school is the only place providing for the highest possible outreach to all the social strata. But the work at school should not be limited just to the introduction of a new subject or section in the existing course in the curriculum, which would require as little as a return of economics to the federal component of the school curriculum. In addition to this, a system for extracurricular, optional school education is needed in the framework of public-private partnership, where some out-of-school activities can be implemented: e.g., open days for schoolchildren, tours, young financier societies, etc., with participation of banks, management companies, and other market players, as well as nonprofit organizations and universities.

Channels for public information dissemination

The main channels for public information dissemination are TV, radio, printed mass media, books, brochures, leaflets, financial history museums, open house in financial companies, etc.

The full version of the report is available in Russian.