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Can Financial Inclusion and Financial Stability Go Hand in Hand?

15.06.2015María José Roa Garcia, Researcher, CEMLA

Financial inclusion institutions in emerging countries are increasingly important as expansive savings and investment vehicles for households and the public in general. A large part of these institutions carry out financial activities that play the part of bank credit, but within a regulatory framework that is either non-existent or much more lax than that which exists for formally-constituted banking institutions. The same thing happens with regulation of new financial inclusion instruments - such as electronic and mobile phone banking - which in many countries is limited or non-existent.

In order to guarantee the stability of the financial system, it is necessary to do more than provide greater financial access to the population. The nature and characteristics of access and use, the so-called quality dimension of financial inclusion, is a key element in ensuring that greater access and use do not endanger financial stability. This dimension is related to the change in the nature and risk levels entailed by the new financial inclusion instruments and institutions, as well as new clients. Although concrete indicators still do not exist, it is commonly accepted that the referential framework to measure this dimension ought to take into account the existence of: i) adequate regulation and supervision of new financial inclusion instruments and institutions, ii) effective financial consumer protection policies, and iii) programs of financial education. In general, this dimension takes on greater relevance in more advanced stages of financial inclusion, when the problem of access is eventually resolved.

The fundamental measures that should accompany greater access and use, in order that they not endanger stability, might seem to be related to those that were outlined after the crisis for the most advanced stages of financial development: prudential regulations, financial consumer protection policies and financial education. Nevertheless, the risks and frictions associated with financial inclusion are different to and less pronounced than those associated with financial development in its most advanced stages, as are the measures to be applied.

In this regard, it is important to specify what type of state intervention or regulation is necessary in the particular case of financial inclusion, rather than automatically applying measures derived from the financial crisis. The application of standards and other measures that guarantee financial stability might prove to be a setback to the inclusion processes, hence, a key element is the application of the principle of proportionality: the balance of risks and benefits in the face of the welfare costs of regulation and supervision of different financial inclusion instruments and institutions [1]. An example of the application of this principle is delegated supervision, which seems to be the most recommendable alternative, as in the case of federations and confederations for the supervision of cooperatives.

It seems fitting to conclude by highlighting the need to continue studying the potential links between financial stability and inclusion through the development of theoretical frameworks, evaluated with adequate empirical methodologies. The theoretical framework of traditional financial markets could be extended to give space to new, stability-endangering frictions related to greater access to and use of financial markets. In addition, there are enormous gaps in the information on financial inclusion institutions, given that a large part of them are outside the regulatory perimeter of state authority. It is also necessary that databases be developed that contain information on the nature of financial inclusion institutions and instruments, as well as regulatory and supervisory structures.


References
 

[1] Basel Committee on Banking Supervision (2015), Range of practice in the regulation and supervision of institutions relevant to financial inclusion, January. 

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María José Roa is Researcher in the Economics Department at the Center for Latin American Monetary Studies, CEMLA (www.cemla.org). Her research is mainly on economic growth, financial inclusion, behavioral finance, personality psychology in economics, and financial education. She has been teaching for almost 20 years in different universities around the world. Her work has appeared in refereed international journals. She coordinates the Financial Inclusion and Education Program in Central Banks at CEMLA, and she is member of the Research Committee of the OECD/INFE. She is originally from Madrid, Spain, but she lives in Mexico City.

Individually Tailored Financial Education: What Research Tells Us Is Possible

02.04.2015María José Roa Garcia, Researcher, CEMLA

The following post was originally published on the Center for Financial Inclusion Blog website.

In the past decade, a group of key empirical studies have argued that a lack of education and financial knowledge can lead individuals to miss opportunities to benefit from financial services. Some may fail to save enough for retirement, others may over-invest in risky assets, while still others miss out on tax advantages, fail to refinance costly mortgages, or even remain outside of the formal financial sector completely. These studies suggest that such behavior is based on the reality that making financial decisions has become increasingly complicated. At the same time, as a result of sweeping changes in the economic and demographic environments, individuals have become increasingly responsible for their own financial decisions and the consequences of such decisions over the long-term. Changes in public pension plans, an increase in life expectancy, and an increase in the cost of health insurance have placed on the individual the weight of momentous decisions such as whether to take out private retirement insurance, or how much to save. Easier access to credit, a general increase in the accessibility and complexity of products and services, and a number of other factors make a range of financial decisions more consequential - and harder.

Governments, financial services providers, and related stakeholders have responded accordingly in recent years developing financial education programs and initiatives, but the results have been mixed. The bulk of the evidence available confirms that, in general, the level of financial literacy throughout the world is very low, especially among the more vulnerable groups: those with very low education or income such as senior citizens, young women, and immigrants. The lack of financial literacy within these groups has proven to extend beyond economic effects and produce negative consequences on health, general well-being, and life satisfaction. Many of the programs that have been introduced were part of empirical studies that evaluated the impact of financial education programs on subsequent financial behavior. There are many such studies that show that financial education improves financial decision-making.

Nevertheless, a body of work has opened an intense debate over whether financial education and information can truly affect the financial behavior of individuals (see here, and here). In many cases, despite the availability of financial education, persistently high rates of debt and default, and low rates of saving and financial planning for retirement have been shown to persist. The empirical evidence obtained from surveys and experimental work often shows that individuals pay little attention to the information and that their capacity to process it is limited. Most of the empirical literature to-date indicates that traditional financial education - clients receiving information in a classroom style setting or through printed materials - does not necessarily translate into behavioral changes, especially in the short-term.

However, this research also showed opportunities in the way financial education information can be transmitted, particularly, methods that factor in psychological aspects such as individuals' cognitive biases are key to transforming financial behavior over the long-term. The existing information is often excessive and tough for individuals to process completely. These studies concluded that in order to improve individuals' financial decision-making ability, the financial decision-making process must be simplified, and barriers for processing information must be reduced. For example, this might take the form of narrowing the number of options available or delivering text messages that may influence behavior at key moments. The latter falls within a group of practices identified as behavioral "nudges" by organizations working with behavioral science, like ideas42. In short, current research indicates that with financial education, effectiveness is largely a question of taking into account the psychological makeup of individuals.

In fact, nowadays there is a broad consensus among psychological, social, and economic studies that cognitive characteristics affect social and economic behaviors. Notwithstanding this, these studies tend to conclude that cognitive characteristics only predict a small part of personal behavior. Non-cognitive or personal characteristics seem to have a role as significant as that of cognitive skills. B.W. Roberts, a leading personality psychologist, defines¹ personal characteristics as "the relatively enduring patterns of thoughts, feelings, and behaviors that reflect the tendency to respond in certain ways under certain circumstances." Psychologists have sketched a relatively commonly-accepted taxonomy of personal characteristics known as the Big Five: Openness to Experience, Conscientiousness, Extraversion, Agreeableness, and Neuroticism. The papers² of J. Heckman, T. Kautz, and their research team (2013) review the recent evidence obtained by economists and personality psychologists regarding how cognitive and personal characteristics can be used to predict educational attainment, labor market success, health, criminality, and financial decisions.

Interestingly, these studies show there is hard evidence that both personality and cognitive characteristics are not "set in stone" and can change over the life cycle. Specifically, while genetics have a significant influence, parents, education, and social environments shape individuals, especially in the early years. However, there is some evidence that personality traits are more malleable than cognitive characteristics at later ages.

Financial education intervention programs should thus be based on these results. In particular, measuring personal characteristics makes it possible to identify people who tend to show weaker financial habits - high rates of debt, high default, low rates of long-term savings, etc. - and design tailored interventions. In addition, researchers conclude that most successful intervention programs are not as effective as the most successful early childhood programs. Consequently, as changing behaviors is not simple, teaching healthy financial behaviors from an early age allows the foundations to be laid for the development of strong lifelong money management.

Given the importance of these factors in effecting change, here are a few points that the research suggests would help financial education become more effective in supporting adults and older people.

  • Personalized counseling
  • Opportunities to gain experience by putting lessons into practice A focus on small changes in financial behavior, taking into account the individual's disposition to change
  • Programs that acknowledge the individual's socioeconomic situation
  • Continuing and ongoing education, support, and motivation

As factors that influence behavior are increasingly understood, a major challenge remains to incorporate those features into the design and delivery of financial education programs.

María José Roa is Researcher in the Economics Department at the Center for Latin American Monetary Studies, CEMLA (www.cemla.org). Her research is mainly on economic growth, financial inclusion, behavioral finance, personality psychology in economics, and financial education. She has been teaching for almost 20 years in different universities around the world. Her work has appeared in refereed international journals. She coordinates the Financial Inclusion and Education Program in Central Banks at CEMLA, and she is member of the Research Committee of the OECD/INFE. She is originally from Madrid, Spain, but she lives in Mexico City.

 

 

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