Enhancing Financial Capability–How Do We Know What Really Works?

The preceding posts in this series have emphasized why individual financial capability matters more than ever and the importance of considering the quality of knowledge and behavior affecting the “demand side” of retail financial markets. These are essential strategic points and the theory behind them makes a lot of sense. However, like most everything else in development, implementation is often the most difficult part of the equation. In order to achieve the benefits of financial inclusion we need a far better understanding of how to achieve meaningful improvements in the capability of the financially disenfranchised.

Knowing how to improve financial behavior is especially difficult for several reasons. These are complex behaviors that rarely result from consistent or predictable thought processes. They are more often driven by emotions and strongly influenced by deeply held cultural and individual biases. Inconsistent and situational decision making, combined with procrastination and impulsive behavior, typically better describe savings and purchase decisions than the rational optimization models embraced by traditional economic theory. Moreover, the end of the results chain – effective risk management, protection against loss of income, adequate savings for retirement – are not evident until many years into the future.

For many decades enhancing financial skills and capability has been pursued primarily through training delivered in classrooms and workshops. This presumes that knowledge and cognitive processes are meaningful determinants of financial behavior. The evidence supporting this presumption is scant at best. All that we can conclusively say is that there are some limited correlations between demonstrated knowledge (typically how well people can correctly answer to questions about topics such as compound interest and portfolio diversification) and desired behavior, such as opening a bank account or higher levels of savings. We can observe in a few cases that people who demonstrate higher levels of knowledge, and those who have recently participated in some training, have slightly better patterns of participation and qualitative measures of engagement with financial products than those who haven’t. The nature of causality and how long these outcomes are sustained remains unclear. Alternative explanations for the enhanced financial engagements that are found, such as the idea that those who participate in training programs are predisposed for better financial outcomes – reversed causality – or that it is through the process of engagement (learning by doing) that knowledge is increased, remain largely unexplored.

Rather than the presumed similarity to, for example, learning mathematics, that can effectively be taught in a classroom, enhancing financial capability is likely to be far more akin to improving the behavior of individuals in relation to their health in the same manner that progress has been made in addressing the HIV epidemic and reducing smoking. Achieving real results requires creative multi-disciplinary approaches that recognize the inconsistencies, irrationality and foibles of human behavior. Strategies and programs that change behavior by reaching adults through raising the awareness of their children, new venues like entertainment education (television melodramas have been effective in changing health related behaviors) and innovative product design (what Thaler and Sunstein have termed “choice architecture” in their recent best seller Nudge represent promising new directions.

Equally important are better evaluations to determine what really works, how and why it works, and how this may differ in relation to context. The inherent methodological challenges in evaluating financial capability enhancement efforts are daunting and include defining desired outcomes in a measureable way, establishing counterfactuals, creating experimental and control groups to undertake randomized experiments as well as legal, ethical and political constraints. Complex processes of causality and long time frames to achieve results make these all the more difficult.

The kind of creative programs required to make meaningful progress in financial capability will necessitate equally creative evaluation designs.

To date there has been much more enthusiasm for the funding of programs than supporting meaningful evaluation of them. Given the complexity of behavior in this arena and dearth of knowledge on what really works and what does not, credible evaluations need to be designed into programs from the outset and adequately funded. Otherwise we risk squandering scarce resources on programs with no tangible results or that do more harm than good.

Fortunately awareness of this challenge is increasing. Research on the effectiveness of different forms of financial capability enhancement is beginning to emerge from a variety of sources including the MasterCard Foundation, which recently released a report taking stock of Financial Education Initiatives for the Poor and DFID, which has supported impact evaluation of a range of programs in Africa through its Financial Education Fund.

In 2009 the Ministry of Finance of the Russian Federation created the Financial Literacy and Education Trust Fund at the World Bank with the mandate to develop an evaluation toolkit specifically tailored to financial capability enhancement programs and to fund evaluations for a range of innovative initiatives in developing countries. The results of this effort will begin to be released in June of 2012.


24 August 2012 Submitted by Dr V.Rengarajan (not verified)

Richard Hinz
Interesting topic.I would like to share my views on more elaborated demand side dynamics for identifying what really works ?
In the context of enhancing financial capability for the poor if one wants to know what really works , it may be noted that the realm of ‘demand side’ does not confine to financially disenfranchised human being alone. Inevitably, there is a need to include economically disenfranchised geography also where such disenfranchised poor have to run their livelihood with the enhanced financial capability. Other wise the ultimate of purpose of enhancement in financial capability would not be adequately served Both these two factors justify the domain coverage of ‘ demand side’ for the subject anatomy in the process of sustainable goal achievement,.
1. Towards enhancing financial capability of the poor – more insights with value addition
A cognitive process for skill enhancement through training may help perceive correlation between demonstrated knowledge and desired behavior. during or post training period. However in reality at household level, one need to take cognizance of the correlation between desired behavior and actually performed one particularly with the sanctioned micro credit in the hand at the household. Prudent performance (utilization of credit) depends on honoring the prioritized social contingencies contextually . This phenomenon happens due to incompatibility of internal value system and influence of external values system (A.Sen) This could be illustrated as below

It would be interesting to perceive what happens after micro credit reaches the poor farmer household. with the positive freedom (intended freedom) for farm input access for some crop cultivation purposes which the farmer’s desired values at the time of financial access.? When the client reaches home, , the internal value system shifted subsequently from usage of the credit from ‘farm input’ access to his ‘medical treatment’ for malaria/HIV diseases resulting negative consequences ( disposing cattle for repayment of loan) in the reference case. In banking parlance, it is misutilization of credit since the desired purpose(farming) for which loan was raised, has been subsequently defeated and it is unethical too.. From farmers’ point of view, medical expenses is a necessity and deserves priority value. to him as it rejuvenates his survival & mobility . So to say, under instrumental freedom concept, there is conflicting values and also negative consequences at individual level. As the internal values are influenced by the external factors like currently prevailing welfare situation of the individual and other family members in the household/society as well there by shifting intended values to performed values later. Further, there is also ‘incompatibility of values’ at individual level since the client as a prudential borrower may wish to utilize the credit for desired farming purpose and repay the loan out of farm income and at the same time contextually, as socially responsible bread winner of HH, he also wishes to spend for medical expenses for his health cure on priority . Given the conflicting freedom situation, infested with incompatibility of values at client level on one hand, and structured products like micro credit with multiple options for utilizing it for meeting multiple needs, at institutional level on the other, suggest a kind of micro management of value satisfaction as a part of enhancement of financial capability .also as an useful strategy . Here social oriented financial education and nurturing has a role to play.

2. Towards strengthening economically disfranchised area

The whole purpose of such a enhanced financial capability particularly with the micro credit would not be served since productive utility of the financial service is impossible unless adequate supportive infrastructure for effective risk free credit absorption is adequately taken cognizance of in the post delivery stage ? Many financial inclusion attempts enabled to enhance financial capacity of the poor regardless of its innovative feature but many time have failed with too many assumption in the demand side of the given area/region.

To elaborate further , financially inclusive ecosystem calls for strengthening economically disfranchised area .This calls for filling up of two types of infrastructure gaps 1) financial infrastructure gap – in supply front for creating risk free delivery points or conduits and 2) supportive physical capital infrastructure in the demand side for ensuring risk free productivity of the delivered financial service or product for the poor.
It is therefore considered that state’s role assumes very significant in not only creating a conducive financial ecosystem by creating necessary infrastructure for delivery of financial services but also equally in parallel the same for productive functioning of the delivered services there by facilitating income increase and economic graduation of the poor and at the same time making the asset performing at institutional level. To further probe on details on functioning of financial product in Post delivery stage , these demand side supportive infrastructure for effective absorption of financial services could be conveniently broadly classified different types viz., physical capital infra, human capital infra, social capital; infra and others
Physical capital infra gap- Many area in rural front which are financially excluded regions and districts /villages suffer from low level of investment in roads, bridges, canals, power supply, market yards, and warehousing, .The absence of this leads to a general malaise in the local economy and disincentive for private investments in directly productive sectors. State intervention has become inevitable to fill the gap.
Human capital infra gap- Two vital prerequisites for financial inclusion are health and education.. Access to health services helps the poor protecting from health vulnerabilities and livelihood risks .Educationally the facts like illiteracy. School Drop outs, low skill, make the poor with poor capability to productively use the financial services . Here again the state role assumes great in filling the gaps in health and education as a part of inclusive financial eco system
Social capital infra gap
As there is also general correlation between financial exclusion and under developed or defunct local community institutions This development of social capital like village/gram panchayat, SHG, federation, Farmers clubs, Mahila mandals, J LGs, commodity cooperatives, local market/mandies, local welfare clubs/associations may go a long way in making financial inclusion more effective but also empower with smart power gained thorough these village democratic institutions towards helping themselves.
All these dynamic latent factors from demand side perspectives if perceived cognitively would certainly help us to know what really works at client house hold level
Dr V.Rengarajan

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