Financial Literacy in Europe

Assessment Methodologies and Evidence from European Countries

Gianni Nicolini

• Publisher: Routledge
• Year: 2019
• ISBN:
  9780429777554
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Are people ready to take pivotal financial decisions like choosing a mortgage, saving for retirement, or investing their savings? How does the degree of knowledge about financial products and services affect the quality of their choices? Can financial fraud be prevented by increasing consumer financial knowledge?

Financial Literacy in Europe addresses these important questions and more. In the first part, the author investigates the concept of financial literacy by analyzing its components and comparing different definitions from previous studies. This then forms a comprehensive measure of financial literacy to be applied in empirical studies that analyze the role of financial literacy in explaining consumers' financial behaviors. In the second part of the study, the author uses brand new data collected by the Consumer Finance Research Center (CFRC) from several European countries (the UK, Germany, France, Italy, Sweden, and Spain) to assess financial literacy in Europe and highlight similarities and differences across countries.

Filling an important gap in previous research, the author develops a rigorous approach in the measurement of financial literacy in order to examine European financial literacy issues in great detail. This book, therefore, is a useful resource for assessing the effectiveness of single financial education programs or planning national strategies on financial education. It can also support policy makers in developing financial regulation and consumer protection strategies, considering the consumer perspective and their ability to deal with financial markets and institutions.

Part I

Financial literacy

A theoretical framework and evidence from previous studies

1 Financial literacy

Definition and measurement

1.1 Financial literacy: a definition

In a study on financial literacy a clear definition of its meaning and understanding of its constructs are pivotal issues, regardless of the aim of the study and the analysis proposed. A definition of financial literacy requires pinpointing the key elements and the peculiarities that make it different from other similar (but different) concepts. The lack of a clear definition paves the way to misunderstanding about what should be taken into account and measured in order to analyze the role of financial literacy in explaining other phenomena, with the risk of testing the relevance of financial literacy by a misleading yardstick.

From the dictionariesd

A starting point to develop a definition of financial literacy can be the semantic analysis of the words “financial” and “literacy”. The meaning of each word will contribute to shaping the meaning of financial literacy itself. The definition of “literacy” in the Oxford English Dictionary is “the ability to read and write” and “competence or knowledge in specific area”. The same dictionary reports for “financial” “relating to finance”, where “finance” means “the management of (large amounts of ) money, especially by governments or large companies”. Matching these word definitions, financial literacy can be defined as “competence or knowledge in the management of money”. Even though this definition includes the essence of financial literacy, this is not enough to distinguish financial literacy from other concepts and cannot be used as a reference point in a research study.

As the Oxford English Dictionary reports that (1) “economy” is “the state of a country or region in terms of the production and consumption of goods and services and the supply of money”, (2) “economic” is something “relating to economics or the economy”, and (3) “economics” is “the branch of knowledge concerned with the production, consumption, and transfer of wealth”, the distance between the concepts of “financial” and “economic” suggests that the former refers to the use of money, and the latter to production, consumption, and transfer of goods, services, and wealth.

From this basic conceptual explanation it follows that “financial literacy” and “economic literacy” represent different constructs and should not be used interchangeably.

From previous studies

Bearing in mind that the key concepts in financial literacy should be (1) knowledge and (2) competence about (3) the use of money, an analysis of the definition adopted in previous studies will help to build a comprehensive definition of financial literacy by an examination of other elements.

In one of the first studies on financial literacy Noctor et al. (1992) refer to financial literacy as “the ability to make informed judgements and to make effective decisions regarding the use and management of money”. This definition starts from the ability (competence) but makes a step forward pointing out how financial literacy should be related to making financial decisions. If the word “knowledge” is not mentioned in this definition, it can be argued that it is included by default. If knowledge and competence are different concepts a hierarchic connection between them can be stated due to the fact that knowledge represents a sort of pre-requisite to develop competence, where “competence” means the ability to apply knowledge on practical issues to solve a problem or make a decision. Hence, if it is possible to have knowledge and not be able to apply it (competence), the opposite is not possible, due to the fact that you cannot apply knowledge that you do not have. It follows that, including competence, the definition of Noctor et al. (1992) assumes the relevance of knowledge too and includes the three basic elements of financial literacy: knowledge, competence, and the use of money.

Similar definitions, based on the concept of “ability”, were used by Mandell (2008), for whom “financial literacy refers to the ability of consumers to make financial decision in their own best short and long term interest”, and Servon and Kaestner (2008), for whom “Financial literacy refers to a person’s ability to understand and make use of financial concepts”. Within this first set of definitions, the one of Noctor et al. (1992) is closer than others to the aforementioned word-by-word analysis of financial literacy and suggests the need to refer to financial literacy as a decision making process. This definition was used in several other studies such as Schagen and Lines (1996), Beal and Delpachitra (2003), ANZ (2008), Atkinson and Kempson (2008), and Worthington (2013). In their study Schagen and Lines (1996) tried to figure out which abilities related to the “use of money” have to be considered, arriving at the conclusion that (1) the understanding of key concepts central to money management and (2) a working knowledge of financial institutions, systems, and services are the main abilities to develop in order to be financially literate. In Bowen (2003) there is an attempt to specify the skills within the “use of money”. The author talks about financial knowledge “as the understanding of key financial terms and concepts needed to function daily in American society”, saying that “it includes knowledge about items related to banking-checking and savings, auto-life-health and homeowners insurance, using credit, taxes, and investing”.

For Vitt et al. (2000) financial literacy is “the ability to read, analyze, manage and communicate about the personal financial conditions that affect material wellbeing”. Referring to “reading”, “analyzing”, and “managing”, the authors develop the concept of “competence” in specific areas, all related to the use of information. The key role of information as the input of a financial decision making process is quite evident in Mason and Wilson (2000). For these authors financial literacy is “an individual’s ability to obtain, understand and evaluate the relevant information necessary to make decisions with an awareness of the likely financial consequences”. The words “ability” and “understand” recall “competence” and “knowledge” even if the need for access to financial information introduces a new issue and highlights how much knowledge and competences risk being meaningless in a scenario where information is not available. The same issue is stressed by Johnson and Sherraden (2006), who note how the application of knowledge and competence requires access to financial information and financial institutions.

The need to analyze financial literacy in a decision making framework – implicit in the definition of Vitt et al. (2000) – is even more clear in Danes and Haberman (2007), where “financial literacy is the ability to interpret, communicate, compute, develop independent judgment, and take actions resulting from those processes in order to thrive in our complex financial world”.

If financial literacy should be related to both knowledge and competence, some studies paid more attention to “knowledge”, as Kim (2001) did reporting that “financial literacy is a basic knowledge that people need in order to survive in a modern society”. Similarly the FINRA (2003) adopted a definition of financial literacy as “the understanding [knowledge] ordinary investors have of market principles, instruments, organizations and regulations”. The NCEE (2005) also addresses a pivotal role of knowledge in its definition of financial literacy as “familiarity with basic economic principles, knowledge about the U.S. economy, and understanding of some key economic terms”. Lusardi and Tufano (2015) defined financial literacy as “familiarity with the most basic economic concepts needed to make sensible saving and investment decisions”, and Almenberg and Widmark (2011a) refer to financial literacy as “familiarity with basic financial concepts and products”. Again, Lusardi (2009b) talks about financial literacy as “the knowledge of basic financial concepts”. Definitions of financial literacy merely shaped around financial knowledge and, on a general basis, studies that use financial knowledge as a proxy of financial literacy are typically the result of the need to fill the gap between available data – usually on financial knowledge – and the information needed, which involves financial skills and competences too. If the need to cope with the lack of data by using financial knowledge for measuring financial literacy is reasonable, a rearrangement of the definition of financial literacy itself that ignores financial abilities and refers simply to financial knowledge is not. Reshaping financial literacy to make it fit with data can have positive effects on the consistency of results in empirical analysis, but risks extending conclusions from knowledge to competence assuming that a broader knowledge involves broader competence, even when people could be confident in answering a test about knowledge but not as confident in making a financial decision. So, a definition of financial literacy should refer to both knowledge and competence (on financial issues), keeping in mind that financial literacy should be assessed within a financial decision process, even if difficulties in measuring all these aspects can necessitate the use of proxies.

The need to stress the different roles of knowledge and ability in financial literacy is evident in different studies. Moore (2003) highlights how individuals can be considered financially literate if they are competent and can demonstrate they used knowledge they have learned. Huston (2010), in a study that reviewed more than 70 studies, arrived at the conclusion that “financial literacy consists of both knowledge and application [ability] of human capital specific to personal finance”. Knowledge and competences are included in a definition as different concepts by the Jumpstart Coalition (2007), and the US Financial Literacy and Education Commission (FLEC) (2007) defined financial literacy as “the ability to use knowledge and skills [competence] to manage financial resources [money] effectively for a lifetime of financial well-being”.¹ This last definition clearly includes the three key elements of financial literacy (knowledge, competence, and the use of money), matching the core meaning of these topics. If financial literacy is related to the achievement of financial goals (the “use of money”), the awareness that different goals require different financial knowledge and abilities was included in a definition of financial literacy by Remund (2010) that takes into account both the short-term and the long-term perspectives of the decision making process. We gather from his study that “financial literacy is a measure of the degree to which one understands key financial concepts [knowledge] and possesses the ability and confidence to manage personal finances [money] through appropriate, short-term decision-making and sound, long-range financial planning, while mindful of life events and changing economic conditions”.

Financial literacy and financial capability

The need to build a definition of financial literacy including knowledge, abilities, and money does not imply that these topics have to be the only ones.

If financial literacy starts with knowledge, passes by abilities, and arrives at (effective) financial decisions, the chance that other issues could affect this process has to be taken into account and should be included in a more comprehensive definition of financial literacy. Beal and Delpachitra (2003) noted how financial knowledge and competences (skills) can be neutralized by a lack of attitude in the management of financial affairs. A financial background based on a theoretical approach to finance, without the self-confidence to make a financial decision (the so called “attitude”), could make people unable to apply their knowledge and skills in real terms, failing to complete a decision making process. The role of attitude in making decisions is stressed by Atkinson and Messy (2012), for whom “financial literacy is a combination of knowledge, attitude and behaviour”, and is clear in ASIC (2013), which reports how financial literacy cannot be just related to knowledge and skills, but should take into account even people’s attitudes.

If the relevance of attitude in making financial decision is clear, its inclusion within the fundamental concepts of financial literacy is not as clear. Part of the literature supports a definition of financial literacy as a combination of knowledge and skills, referring to attitude and behaviors as part of a broader concept, which includes basic knowledge and abilities, and is called “financial capability”. From this point of view financial literacy and financial capability are different concepts, with the latter including the former as a part of it, and should not be used as synonymous. Other studies tend to use the two terms interch...