The Importance of Financial Literacy Education: What we know and what we don't

Harvard Professor Shawn Cole and CMF Research Associate Nilesh Fernando recently wrote a very interesting paper that reviews how levels of financial literacy education effect financial behavior. The paper uses several assessments, both from the developed and developing world, to discuss the consequences of low levels of financial literacy, financial literacy's effect on savings and investments, and current efforts to improve financial literacy.

The review was written for the Asian Development Bank's quarterly microfinance newsletter, and can be found here, and below I review some key points discussed by Professor Cole and Mr. Fernando.

What we know
According to Cole and Fernando, a significant body of evidence demonstrates a strong link between financial literacy and household well-being. Accordingly, survey findings consistently show that households with low levels of financial literacy:
1) Borrow at high interest rates
2) Do not tend to plan for retirement
3) Acquire fewer assets

Partly because of this body of evidence, policymakers in wealthy and poorer nations alike advocate increased expenditures on financial literacy education. But, will this increased spending have its intended effect of increasing household savings and participation in financial markets, helping to reach the goal of reducing poverty?

What we don't know
While many organizations provide evidence that suggests financial literacy education is effective, Cole and Fernando could not identify a completed study in emerging markets that tests the value of financial literacy education. One ongoing study in Indonesia evaluates a literacy program that teaches unbanked individuals how to open an account. Preliminary results suggest that the program did not increase the use of banking services among households.

What does the lack of evidence on financial literacy education's impact on financial behavior mean for policymakers and for interested parties? We don't know whether financial literacy education dramatically impacts savings and investment decisions. Other factors (e.g., household income, education levels) may more directly effect individual behavior, or it may not. We are left with little evidence to guide policy or investment behavior that seeks to improve financial behavior of poorer households.

That said, the authors applaud the firms, governments, and organizations (e.g., SEWA Bank in India) that provide financial literacy education. Teaching low-income clients about financial products, and how to use them, will help clients understand how to use financial products (which is a definite plus). But, having a clearer idea of the impact of different types of educational initiative will help us make informed decisions about how to invest limited resources to improve the lives of the poor.

Once again, here is the link. I look forward to any comments or thoughts.