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Prices or Knowledge? What Drives Demand for Financial Services in Emerging Markets?
Professor Shawn Cole of Harvard business school and co-authors (Prof. Thomas Sampson of Harvard business school and Bilal zia of the world bank) write on the effect of financial literacy & moderate subsidies on the probability of opening a bank savings account in emerging, highly populated nations like India and Indonesia.
Issue Date - 10/11/2011
What Does Financial Literacy Predict? A compelling body of evidence demonstrates a strong association between financial literacy and household well-being in developed countries. We find that use of financial services varies with household characteristics in our Indian and Indonesian samples. Higher household expenditure predicts greater use of bank accounts and formal credit in both countries, but predicts increased use of informal credit and insurance in Indonesia only. The results for human capital are mixed. Education is positively associated with use of bank accounts and formal credit in both countries and with insurance in Indonesia, but is negatively associated with informal credit use in both countries. Higher cognitive ability predicts greater insurance use in both countries and greater use of formal credit in Indonesia, but is otherwise insignificant. In both countries, none of the household preference indicators consistently predicts use of financial services. In Indonesia, a high discount factor is associated with lower use of both formal and informal credit, while risk-averse households are more likely to have a bank account or a formal loan. Fatalism is associated with lower use of bank accounts in Indonesia, but higher use of insurance in India.

Higher financial literacy is significantly associated with greater use of bank accounts in Indonesia and insurance in India, even after including a host of controls. The coefficients on the borrowing regressions are positive but insignificant. Although financial literacy is a significant predictor of use of bank accounts in Indonesia, the magnitude of the estimates suggest it is a less important predictor than expenditure levels. The estimates indicate that a one standard deviation increase in financial literacy is associated with a 2.2% point increase in the probability of having a bank account, while a one standard deviation increase in household expenditure is associated with a 14.9% point increase.

Conclusion: Using two new surveys from two of the most populous countries in the world, this paper presents compelling new evidence that financial literacy is an important predictor of financial behavior in emerging market countries. These correlations, well-documented in developed countries, have spurred governments, non-profits, and firms to promote financial literacy as a means of expanding the depth and breadth of the financial system. The benefits of better financial literacy may be great. On a personal level, individuals may save more, and better manage risk, by purchasing insurance contracts. There may even be general equilibrium effects: increased demand by households for financial services may improve risk-sharing, reduce economic volatility, improve intermediation, and speed overall financial development. This in turn could facilitate competition in the financial services sector and, ultimately, more efficient allocation of capital within society.

Despite the potential benefits of financial literacy, there is to date no credible evidence on the effects of financial literacy programs. This paper reports the first randomised evaluation of a carefully-designed and delivered financial literacy training program. We find that the education program has modest effects, stimulating demand for bank accounts among uneducated and less financially literate households. A second intervention providing small subsidies for opening an account demonstrates that, given proper incentives, many individuals could open accounts, even without financial literacy training. A follow-up study conducted two years after the initial intervention shows that those who were originally ordered the high incentives are significantly more likely to have used bank accounts in the past year to deposit, withdraw, send or receive funds.

Where does this study leave us? On the one hand, the survey data from Indonesia and India demonstrate that financial literacy is an important correlate of household financial behavior, and household well-being. It is one of the strongest and most consistent predictors of demand for financial services. These results provide evidence that financial literacy is important, and that educated consumers will make better financial decisions. Finally, demand for financial education is quite high: 69% of those invited choose to attend the course. Yet, our experimental results show that this financial education program is not an effective tool for promoting the use of bank accounts. It is useful to think about a simple cost-benefit analysis. Even if targeted to those for whom the intervention is most effective, the program is not cost effective. The literacy training cost approximately US $17 per head to deliver. Among those with low levels of initial financial literacy (i.e. below median score on baseline financial literacy assessment), the training program increased the share opening a bank savings account by approximately 5 percentage points. Thus, inducing the opening of one bank account cost $17/0.05 = $340. In contrast, for this same sub-sample, increasing the subsidy from $3 to $14 led to an increase in probability of opening a bank savings account of 7.6 percentage points, suggesting a cost per bank savings account opened of $11/0.076 = $145. Thus, subsidies are almost two an one-half times more cost effective than financial literacy education.

Of course, financial literacy may have additional value if it promotes asset accumulation; a buffer stock of savings may be far more important than simply having a bank account. Nevertheless, our evidence does not support the view that low financial literacy is a severe impediment to demand for formal financial services. Our study clearly demonstrates that prices matter for both opening of bank accounts and for savings, and that individuals who open bank accounts in response to incentives do keep them open for the long term. This finding is consistent with the common practice in U.S. banks, whereby banks offer cash incentives or other gifts to those opening a new account. The financial literacy program we evaluated was based on global best practices, using experienced, highly educated facilitators, and likely represents a higher quality intervention than could be delivered on a mass scale. Nevertheless, we acknowledge that this was a short program, and that many respondents reported in the baseline that they did not previously open a bank account because they had insufficient funds. The point estimate on the impact of financial literacy on savings decisions is positive, though statistically insignificant. We of course cannot rule out the possibility that a more intense, more comprehensive and better targeted education program could have positive, measurable impacts on individuals’ lives.

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