International Development Week in Canada takes place from Feb 6-12th and MEDA is examining several key themes and areas during this time. Today, we explore the role that tools like financial literacy and education play in ensuring that farmers and entrepreneurs can grow and thrive in their livelihoods and businesses.
Every day, we make financial decisions. This includes negotiating with a merchant, creating holiday plans, or watching a movie on its premiere release. Sound financial decisions can contribute to broader saving habits that boost earnings and increase savings.
While making sound financial decisions has substantial benefits, a lack of financial knowledge can have painful consequences, including a low credit score, shrinking wealth, indebtedness, poor health, and bankruptcy. There is also a link between poverty and gender inequality1 and can negatively impact individuals and their families education, health, and happiness.
Is there a difference between financial literacy, education, and financial capability?
In short, yes. While there are similarities between the three, there are also differences. We explain further below: 2
- Financial Education3 Is a tool for increasing consumer financial literacy. According to OECD4, financial education is the process by which financial consumers and investors improve their understanding of financial products and concepts and, through information, instruction, and objective advice, develop skills and confidence to become more aware of financial risks and opportunities to make informed choices, know where to go for help, and take other effective actions to improve their financial well-being.
- Financial Literacy5 Represents the level of aptitude in understand personal finance. It often refers to awareness and knowledge of key financial concepts required for managing personal finances and is generally used as a narrower term than financial capability.
- Financial Capability6 Is the ability of consumers to use the acquired financial literacy to make better informed decisions about managing their finances. According to the World Bank definition, it is the internal capacity to act in one’s best financial interest, given socioeconomic and environmental conditions. Financial Capability encompasses the knowledge (literacy), attitudes, skills, and behaviors of consumers regarding understanding, selecting, and using financial services and the ability to access services that fit their needs.
Deborah Sunday worked in rice milling in the Bauchi region of northern Ghana. After she participated in MEDA’s financial education program, she received tools to evaluate her present business position, assess how much more risk she should take, and how she could strengthen her business’ resilience and improve earnings from her existing resources. She chose to diversify her business to different processed rice flour varieties and enhance the capitalization of her fixed equipment. She also tightened her receivables portfolio and used its surplus to expand it further.
Daniel Joloba ran a maize processing plant in Mukono, Uganda. He noticed that delayed payments from customers were costing him valuable time since his cash was blocked, and he could not buy more maize from farmers. MEDA’s partner lending institution from its EASE project – FACTS Uganda, arranged to deliver a targeted financial education program that allowed Daniel to evaluate the option of shortening its credit period to the buyer by discounting the price against the possibility of borrowing to bridge this gap. Daniel concluded that borrowing against confirmed receipts of its reputable clients allowed it to process nine working cycles in the peak season compared with only three cycles he was undertaking in previous years. His operating profits tripled while his prices and profit margins stayed the same.
Financial literacy and education walk hand in hand– While financial education means that clients such as Deborah and Daniel can understand complex financial concepts, financial literacy supports them to put these concepts into action. This tool gives people like Deborah and Daniel the knowledge to analyze and make better decisions for their business, negotiate with market actors, and access appropriate products and services.
Why NGOs encounter challenges to offering financial literacy training
Clients of development programs face several challenges to becoming financially literate and educated. These challenges include:
- Financial literacy is often included as an add-on and not a goal in itself: Often, financial literacy is included as a component of a project. Becoming financially literate needs to be relevant and tailored to the task at hand and not included as an add-on aspect.
- Financial education programs can sometimes be irrelevant: Financial education that is outdated or not tailored to the individual’s needs is not practical. For it to be helpful, financial education programs need to be tailored and relevant to the needs of the individuals.
- Finance is complex: Finance can be challenging to understand. Financial education needs to be broken down into understandable, demand-driven, context-specific learnings for clients who lack formal education.
- Private Sector Engagement: The private sector needs to be better engaged and made aware of the benefits of providing financial education to its clients. So far, the private sector has only participated in corporate social responsibility initiatives.
- Access to credit: Unlike savings, accessing credit is dependent on time, a business’ financial situation, market expectations, etc. Providing credit training can better support a farmer and entrepreneur’s decision to know when to access credit and make more sound business decisions.
- Access to finance is seen as a goal and not a means: The end goal is strengthened financial capabilities, not just access to finance. A client with strengthened financial capabilities will have the ability to make better financial decisions. As a result, the client can run his/her business more efficiently and prosper.
A promising sign: The rise of Financial Education
People are beginning to view financial education as an essential life skill. A survey in 2019 by Credit Karma revealed that 95% of respondents believe financial education should be a part of the school curriculum. The remaining 5% thought it should be in the college curriculum.
About 4 out of 10 people in the US do not save for retirement. A survey taken in the UK found that consumers do not actively seek financial information9. These findings have led countries to create institutions that provide financial education to their people. Initiatives such as the UK government’s MAPS (Money and Pensions Service), Canada’s Financial Consumer Agency and Financial Literacy month in November, and India’s non-profit National Center for Financial Education (NCFE) under four major financial sectors regulators are designed to boost the financial literacy of their citizens.
Overall, it’s clear that there is a need for financial education. For financial education to be most effective, it needs to be accessible to a broader audience and emphasize that the end goal is financial inclusion. They can make more informed decisions that will positively influence their lives and their financial health through financial education.