It is a pleasure to be here today at the launch of the Financial Literacy Agenda for Mass Empowerment (FLAME). So critical is the need for financial literacy in the country that every baby step taken will go a long way in improving the lives of our citizens and help them secure a better future.
The need for financial literacy cuts across all income spectrums. In India, the irony is that the long-term growth story is so strong and the markets are so attractive, yet financial penetration is abysmally low. On the other hand, look at an advanced economy like the US and one sees that the root of the subprime crisis lay in the mis-selling of complex mortgage products which customers did not understand, but readily lapped up. Both these are different but glaring examples of the need for a more focused and concerted approach towards financial literacy.
Alan Greenspan had said and I quote, "The number one problem in today's generation and economy is the lack of financial literacy." Fine words, but perhaps he should have said this sometime during his 20 odd years as head of the Fed and not after the subprime mess occurred. Unfortunately, we tend to be wiser in hindsight. Nonetheless, there are lessons for all to learn.
I've penned down a few random thoughts, which could serve as five key lessons on financial literacy, which I'd like to share with you:
Lesson 1: Financial literacy won't happen overnight
Financial literacy endeavours needs to have a long-term vision. At a very fundamental level, there is now an established understanding that financial literacy has to first be inculcated in the home environment and reinforced as part of the school curriculum. To provide a good financial role model, you need to 'catch them young', which is why I hope FLAME will soon start targeting the very young as well.
At a broader macro level, however, what is obvious is that India cannot grow at a sustained high rate without greater financial inclusion. Delaying the financial inclusion agenda can leave a permanent irreparable damage. We are already witnessing unrest from those who feel excluded from the India growth story; and this will only increase if there are no immediate concrete measures taken.
The oft-quoted financial exclusion statistics are staggering:
- 144 million excluded households;
- 73% of farmer households have no access to formal credit;
- 5% of India's 600,000 villages have bank branches; and
- 45% of the adult population of India has not accessed financial services from formal financial institutions.
These numbers signify that formal finance options are still few and mostly remain inaccessible to a vast rural population. It is important to create conditions to encourage financial institutions to lend in rural areas. Banks and financial institutions have pointed out that the 'last mile' or exorbitant cost of delivery is the biggest hurdle, but these issues are slowly being overcome.
There are implicit constraints as well, as the poor tend to be intimidated by banks. As formal service providers often find it difficult to establish a rapport with the rural customer, it is imperative that banks explore ways in which they can work together with a variety of channels. For instance, business correspondents should be encouraged to serve as additional credit delivery channels provided there are appropriate safeguard measures. Further, there is a need to design products and services that suit the requirements of the rural population.
Financial inclusion is not just about bringing savings, insurance and credit to people. It is in equal measure important that these people get the right counselling on how to access and use financial services. Financial literacy drives have to be customised for different target segments. Financial inclusion has to involve financial education, counselling and building close relationships with people. This of course requires time and considerable effort, and is no longer an option, but more of a necessity for an economy like India, where nearly two thirds of the population still reside in rural areas.
Lesson 2: A high savings rate is no indication of the level of financial literacy
India's financial markets are strong in terms of technology, regulation and systems. India also has amongst the highest household savings rate globally, estimated at 24% of GDP. While household savings may be higher in India, the key question is whether the savings are being optimally invested. It is estimated that around 40% of household savings are channeled into physical assets such as real estate and gold, while financial assets are dominated by bank deposits and cash.
One of the challenges impeding the Indian capital markets is the small retail investor base. In India, house-hold savings in shares, including mutual funds is around 7%. In the
US, 50% of household savings are in mutual funds and shares. This is one of the factors for low household net worth in India. Markets like Hong Kong, Korea and Taiwan, have retail participation that is much stronger than foreign investors. In India, it is the reverse where the share of retail investors is miniscule in listed companies while FIIs holds way on how markets move. A strong retail base helps lessen wild volatility in the stock markets.
Indians are more risk averse than their global counter-parts, but I believe the problem is more to do with a lack of awareness of the equity markets. I must complement the IIFL authors who have lucidly put together the descriptive snippets on various educative financial themes – I enjoyed reading it and I am sure the aam aadmi will benefit tremendously from this.
Lesson 3: Financial literacy promotes responsible lending
Today the financial system is increasingly complex and we all have to learn to navigate through a maze of sophisticated financial products and services. World over, we have seen that many financial service providers have actually profited from financial illiteracy – be it in the form of selling products with hidden costs or enticing customers by not being entirely transparent about products they are selling. For instance, if customers were more financially literate and loan originators more responsible with skin in the game, would there have ever been mortgage products like NINJA loans which resulted in huge defaults? So financial education has a big role to play in promoting responsible lending.
I would also go on to add that financial literacy is equally crucial for regulators as well. Many critics felt that the subprime crisis was an outcome of regulators sleeping at the wheel. But the real problem was that regulators were simply unaware of the extent of leverage and complexity of many financial instruments. For example, few regulatory and supervisory staff are trained to understand complex derivatives or have forensic accounting skills, but these skills are imperative for regulators today.
Lesson 4: Building trust goes a long way
In any market, there are always punters, casino players or the get-rich-quick players. We have seen enough of examples of rogue traders who have brought the best of financial institutions down to their knees. It can take just one rogue to ruin the reputation of an institution that has been built over decades. Financial literacy drives need to highlight these dangers and emphasise the importance of understanding the products that one is investing in. In good times, many investors tend to get attracted to riskier financial products to earn higher returns. But when the tables turn and investors get jittery, there is almost always a flight to safety and quality. In these times, investors flock to institutions where they have explicit trust in. Normally, banks are the safest institutions in uncertain times. But the subprime crisis saw many of the world's most reputed banks go belly up. In India too, though the subprime crisis virtually bypassed the financial system, during the liquidity crisis it was true that people believed that State Bank of India was the safest bank and as a result the bank was flooded with deposits of over Rs. 1,000 crores on a daily basis. Obviously, in the minds of depositors, State Bank of India was placed on a higher rung compared to even other nationalised banks. Similarly, HDFC is also a trusted household name and we deeply value the fact that depositors have explicit faith in the organisation.
Lesson 5: Financial literacy is an unending task
Financial literacy is a challenging task and the government, the central bank and other stakeholders have launched a number of campaigns and programmes for counselling and improving financial literacy. While these initiatives demonstrate a strong commitment to financial education, it is important to determine the impact and effectiveness of such programmes so as to understand what works and what does not. Further, financial literacy programmes require trained instructors, who must be available to clients at the time when they are making important financial decisions. There is no doubt about the importance of the timeliness of financial advice.
On the challenges of imparting financial literacy, Lauren Willis, a US-based professor of financial literacy education aptly said and I quote: "Teaching financial literacy is not like telling people that smoking kills, where the message is straightforward and unchanging. Even if consumers could master the intricacies of money management, the speed of financial innovation means much of what they learn would soon be out of date". Clearly, financial literacy remains an unending task.
To conclude, India's bright future cannot be disputed with a 9% GDP growth, rising disposable incomes, better job opportunities and growing confidence of India's youth. The speed with which India's economy is poised to grow will only intensify. It took 60 years for India's GDP to first touch the one trillion dollar mark in 2007. In another 2 to 3 years from now, India is expected to cross the two trillion dollar mark and by 2025, India should be a four trillion dollar economy.
A successful and sustainable existence of civilized society depends on having the greatest possible number of people who have a stake in society. All this is not possible without fulfilling the financial inclusion and financial literacy agenda. India's success story is directly linked to the prosperity of its people and every endeavor towards financial literacy will bring prosperity faster to our people.
I wish your endeavors all success.
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