Financial literacy and financial inclusion in South Africa
CHAPTER 1: INTRODUCTION AND BACKGROUND
1.1 INTRODUCTION
Financial literacy has become a popular topic among various financial institutions such as banks, government agencies and community groups (Louw, Fouche and Oberholzer, 2013: 439). Although the issue of financial literacy was mainly a focal point in developed nations, there has been an increase in the number of studies on financial illiteracy in developing nations. This stems from the fact that it was found that consumers are not well equipped to make sound financial decisions that can enhance their economic well-being (Struwig, Roberts and Gordon, 2013: 19).
Financial literacy can be defined as the ‘ability to use knowledge and skills to manage ones financial resources effectively for lifetime financial security’ (Jump$tart Survey of Financial literacy, cited in Hastings, Madrin and Skimmyhorn, 2012:5). According to (Lursardi and Mitchell, 2006) there are a number of individuals in society who are unable to make basic calculations and have no financial knowledge to make sound decisions about their finances which contributes to their poor financial behaviour. Consumers also fail to understand that their unstable financial well-being results to their poor financial decisions (Pravin Gordhan, 2012, citied in Botha, 2013: 13).
South Africa is one of the developing countries that faces triple challenges of unemployment, poverty and inequality. With these challenges it is argued that such an environment makes it difficult to implement programmes that can assist users with their financial products and services. One of the difficulties faced in South Africa is that there is no publicly accessible micro-data on financial knowledge, attitudes, skills and behaviours of consumers (Struwig et al. 2013:19). A survey was conducted by the 2004 FinMark Trust on South Africa’s financial literacy. The study concluded that the rate of consumers’ financial literacy was low (Louw et al. 2013: 440). Empirical evidence has also shown that financial illiteracy is a significant contributor to various financial problems such as low rates of savings and bankruptcy (Kim, 2000: 1).
1.2 PROBLEM STATEMENT
Even though there have been significant advances in the number of financial products and services over the past few years, financial illiterate consumers still find it difficult to access these financial services (Lusardi and Mitchell 2013, cited in Fatoki and Oni, 2014:409). The issue of no access to
formal education as well as the lack of access to financial information remains a significant problem (Piprek, Dlamini and Coetzee 2004, cited in Engelbrecht, 2008:253). As a result poor households still face the problem of financial illiteracy.
Financial literacy may be regarded as a new concept, but the need for financial literacy is important as individuals need to make appropriate financial decisions. Thus financial illiteracy cannot be regarded as an isolated problem (Louw et al. 2013: 440). To be actively involved in the financial markets, consumers need to be aware of the products and services provided as well as have an understanding of the terms and conditions of these products. However, consumers are often challenged by the lack of knowledge which contributes to financial exclusion. Improving financial literacy can help consumers eliminate the problem of being financially excluded (Organisation for Economic Co-operation and Development, 2011:16). Financial literacy can ensure that consumers do understand these financial products and services as well as boosting their confidence in the ability to use them.
1.3 LITERATURE REVIEW
With the provided problem statement, the literature review will discuss the concept of financial literacy and financial inclusion used in this study.
Various studies (Gale and Levin 2010; Hastings, Madrian and Skimmyhorn 2013; Kim 2000) have used different methodologies to study the effects of financial literacy. According to (Kim, 2000: 13) being financial literate is one of the basic life skills that people need in society. As stated in the introduction, the topic of financial literacy was mainly focused on developed countries. Only until recently that studies in developing countries have now been conducted. In the United States, a study with a thousand participants was conducted about financial knowledge on saving and investing as well as retirement. The findings concluded that an average of sixty percent of the respondents failed to answer the questions correctly (Leyes 2006, cited in Louw et al. 2013:441). Furthermore a survey was conducted by the Bank Advertising News and the Gallup Organisation. Evidence showed that from the one thousand participants, thirty four percent had no knowledge about the rate of interest levied on their credit cards (‘Savings and Learning’ 1998, cited in Kim, 2000: 1).
According to Fatoki et al. (2014: 410) studies conducted on South Africa’s financial literacy focused on individuals, students and entrepreneurs. Empirical evidence has shown that financial
illiteracy has contributed in the high failure rate in South African businesses (Timmons and Spinell, 2007:388, cited in Kotze and Smit,2008:36). A study was conducted on the need for financial literacy amongst the South African third year students. The study concluded that South Africa was failing in terms of training university students on the basics of financial literacy. Therefore students are sent to real world without being financially prepared for the challenges (Louw et al. 2013: 439).
South Africa also took part on the national baseline survey for the first time which was conducted by the OECD in 2010. The primary goal of this survey was to determine the levels of financial literacy in South Africa. The survey had a total of 2518 respondents which were used to represent the 14,043671 number of households in South Africa. The survey was used to measure financial knowledge, attitudes as well as the behaviour of these households. Empirical evidence shows that South Africa has very low levels of financial literacy and a few individuals made use of financial advisors (Roberts, Struwig, Gordon, Viljoen and Wentzel, 2012:39). A study was conducted by Mishi, Vacu and Chipote (2012:1) on the impact that financial literacy has on financial inclusion in rural South Africa. The study concluded that the financial literacy does improve consumer’s financial inclusion. Studies have also shown that the lack of savings among individuals was mostly due to financial illiteracy than debt related issues. Thus financial literacy has a significant influence on savings in lower income and non-tertiary educated population (Snyman, 2014).
1.4 RESEARCH QUESTIONS
Based on the purpose of this study, the research questions are as follows:
‘ What is financial literacy and financial inclusion?
‘ What is the significance of financial literacy?
‘ How does financial illiteracy affect financial behavior?
‘ What is the link between financial literacy and financial inclusion?
1.5 OBJECTIVES OF THE STUDY
The objectives of the study are linked with the problem statement, and these objectives consist of primary objectives and secondary objectives.
1.5.1 PRIMARY OBJECTIVE
The primary objective of this study is to conduct a critical analysis on financial literacy and financial inclusion in South Africa. In achieving this objective, an investigation will be undertaken to understand the importance of financial literacy.
1.5.2 SECONDARY OBJECTIVE
To address the primary objective the following secondary objectives include:
‘ To conduct a literature review on financial literacy in South Africa;
‘ To compare how financial illiteracy affects households, individuals and entrepreneurs and
‘ To determine the factors that contributes to financial illiteracy.
1.6 THE SIGNIFICANCE OF THE STUDY.
South African consumers have limited knowledge and understanding about financial products and services thus the importance of financial education in South Africa is to improve the well-being of consumers (OCED, 2013:250). Several financial literacy surveys were undertaken worldwide. Empirical evidence indicates that most of the populations lack the basic knowledge of the financial services offered to them (Siluanovi, 2013:4). Financial literacy is an important factor that contributes to consumers being financially included as well as to prevent future economic crisis (Gurr”a, 2013: 5). Improvement of financial literacy and increasing access to financial products and services can contribute to an improved economy, create jobs and decrease poverty (OECD, 2013:5).
The global financial crisis which took place in 2007 was the reason the topic of financial inclusion became one of importance (Mminele, 2014:1). As a result there was an increase in the demand of financial literate programmes. As financial inclusion became a popular topic, South Africa also became a member of the Group of Twenty (G20). In the G20 summit, members agreed that financial stability and integrity can be achieved through financial inclusion. The G20 members adopted a strategy to encourage financial inclusion and strengthen the financial sector. Access to finance which can be attained through financial education is described as the ‘key accelerator’ to achieving the Millennium Development Goals (World Savings Bank Institute, 2010 cited in Cohen and Nelson, 2011: 3).
This study will analyse and compare results from previous studies on the influence that financial literacy has on South African households, students and entrepreneurs. Research (Louw et al. 2013; Lusardi et al. 2006; Struwig et al. 2013; Timmons et al. 2007) shows that the lack of financial literacy among these groups has a negative impact on their financial well-being. The importance of financial literacy is of relevance to individuals who make use of financial products. Consumers need to acquire financial literacy skills to make informed decisions about their finances. However if these consumers are financially illiterate, programmes on financial education can be implemented. The study will determine whether any programmes of financial education have been developed. If any, determine how effective these programmes have been. Research indicates that financial literate consumers are more likely to save (Kim 2000; Snyman 2014). The study can therefore be significant to employers, employees as well as government.
Research methodology is a term that is used to refer to specific techniques, tools or procedures that are applied in order to achieve an objective(s) (Ethridge, 2004: 25).
A research approach consists of two types of methods, namely qualitative and quantitative research. Qualitative research is a process which involves emerging questions and procedures as well as collecting data. This is followed by the researcher interpreting the meaning of the data collected (Creswell, 2014: 4). The qualitative approach is relevant in answering the research question of ‘what’, ‘when’ and ‘how’ (Tewksbury, 2009: 39). The quantative research focuses on testing theories by examining the relationship between two or more variables. These variables can be measured by statiscal procedures (Creswell, 2014:4).
The proposed study will follow both the qualitative and quantative approach to address the research problem and achieve the objectives. Under the qualitative approach the knowledge obtained will be through secondary data such as journal articles, books and unpublished sources. This approach will be used by looking at previous studies conducted in order to determine the role and importance of financial literacy. The quantative approach will be used to test the validity between variables.
1.8 STRUCTURE OF THE RESEARCH
The scope of this study will be divided into four chapters. A summary of each heading within the study will be briefly explained.
Chapter one provides a basic overview of the study as well as what is to follow in the study. The topics included in this section are the introduction and background of the study; problem statement; literature review; research questions; objectives of the study; significance of the study; clarification of concepts and research methodology.
Chapter two conducts a literature review. Financial literacy’s definition and importance will be addressed. The chapter will provide more detail on financial literacy. The chapter also provides the findings on the level of financial literacy in various countries.
Chapter three focuses on the research methodology and research methods used in the study. The collection of data and data analysis will also be addressed.
Chapter four presents a summary of the important findings of the study, conclusions and possible recommendations. This chapter will also examine whether the proposed study has met the research objectives.
1.9 CONCLUSION
Chapter one outlined the research problem and the goals to be achieved by the proposed study. This chapter presented a research methodology to address the research goals. A brief summary of each proposed chapter was also provided. Chapter two will focus on the role and the importance of financial literacy. The primary aim will be to conduct research on financial literacy and financial inclusion in South Africa.
CHAPTER TWO: LITERATURE REVIEW
2.1 INTRODUCTION
Financial literacy is considered an important factor not only to investors but to households at large. It is becoming a required skill for consumers who are economically active and trying to make sound decisions about their finances (Botha, 2013: 13). According to (Gallery and Gallery, 2013: 3) most households are responsible for their finances. However the advances of financial products have increased the need of consumers being financial literate. The lack of financial knowledge may limit an individual in managing their finances and may cause financial problems. Thus financial literacy can help in ensuring that consumers financial goals are achieved (Kim, 2000:13).
The proposed study aims to add to the body of knowledge in the field of financial literacy by investigating the role of financial literacy. The majority of research on financial literacy is centered on developed countries. However the proposed study will focus on financial literacy and financial inclusion in South Africa. This chapter will provide a review of literature relating to the study. For a better understanding of the study, the chapter is organised as follows. Firstly the literature review describes the definition of financial literacy and the factors that define a person as financially literate. Secondly the study will consider the importance of financial literacy, followed by a critical analysis on studies conducted in various countries on financial literacy. Next the literature review will analyse previous studies that have identified factors contributing to an individual’s level of financial literacy. Furthermore it will examine how financial illiteracy affects households, individuals and entrepreneurs. Finally analysing these studies will allow the study to focus on the level of financial literacy in South Africa.
2.2.1 DEFINING FINANCIAL LITERACY
The measurement criteria for financial literacy differ across different organization and research groups. As a result there is no common definition for financial literacy (Botha, 2013: 14). Therefore the definition of financial literacy varies by source and context (Hung, Parker and Yoong, 2009:4). A review by (Remund 2010, cited in de Beer and Coetzee) found that a number of researchers made use of the term ‘financial literacy’ loosely in an attempt to describe the required knowledge, skills and motivation to manage money. The following diagram demonstrates the concept of financial literacy.
Figure 1: Concept of financial literacy
Source: Adapted from Huston (2010: 307).
Financial literacy can be conceptualised into two dimensions, namely, financial knowledge and financial application. According to Huston (2010:307) it is incorrect to use the term financial knowledge as reference to financial literacy. Financial literacy requires both financial knowledge and financial application. Therefore an individual must not only have knowledge about the financial products. An individual must also have the ability to apply the financial knowledge to make sound financial decisions.
Remund (2010) and Huston (2010) conducted studies in an attempt to establish a more clear definition and a measure for financial literacy. Huston (2010) analysed seventy one individual studies drawn from fifty two different sets. Empirical evidence from the study indicated that the majority of the studies (seventy two percent) did not include a definition; fifteen percent included some discussion beyond identifying the specific elements in their measure and thirteen percent provided a formal definition. Furthermore the results indicated the following eight definitions:
1. Financial literacy is the ability to make informed judgments and effective decisions regarding the use and management of money (Noctor, Stoney and Strandling 1992, definition used by Beal and Delpachitra 2003 and ANZ 2008).
2. Personal financial literacy is the ability to read, analyse and manage and communicate about the personal financial conditions that affect material well-being (Vitt et al.2000, also cited by Cude et al. 2006).
3. Financial literacy is a basic knowledge that people need in order to survive in a modern society (Kim 2000).
4. Financial literacy refers to a person’s ability to understand and make use of financial concepts (Servon and Kaestner 2008).
5. Financial literacy is the ability to use knowledge and skills to manage financial resources effectively for lifetime financial security (Jump$tart Coalition 2007).
6. Financial literacy is the ability to use knowledge and skills to manage financial resources effectively for a lifetime of financial well-being (U.S Financial Literacy and Education Commission 2007).
7. Financial knowledge is defined as understanding key financial terms and concepts needed to function daily in American society (Bowen 2002).
8. Consumer literacy, defined as self-assessed financial knowledge or objective knowledge (Courchane and Zorn 2005).
Of the eight definitions identified in Huston (2010) study, definitions one and two focused on ability and definitions three, seven and eight focused primarily on knowledge only. Definitions five and six were similar and both definitions included knowledge and ability. Furthermore the definitions included the outcome intended of being financially literate within the definition. Servon and Kaestner (2008) included both dimensions of knowledge and ability in their definition.
Remund (2010) also conducted a study which classified various definitions of financial literacy into five categories:
Category One: Knowledge of financial concepts
Financial knowledge can assist an individual in managing their finances effectively. Thus financial knowledge can improve one’s financial well-being (Braunstein and Welch 2002; Vitt et al. 2000). Various researches (National Foundation for credit counseling 2008 and U.S Department
of treasure 2006) have provided an explanation of the need and importance of financial knowledge. However Redmund (2010) refers to these explanations vague as they provide little help in terms of future research. Therefore it is of importance to provide an explanation of the required knowledge that would qualify an individual as financial literate (Botha, 2013: 17).
Category two: Ability to communicate about financial concepts
Fox, Bartholomae and Lee (2005) are researchers who defined financial literacy differently. According to these researchers their definition was focused on the ability to apply the knowledge rather than how much information an individual has.
Category three: Aptitude in managing personal finances
Various definitions of financial literacy mention the ability or aptitude for managing personal finances. Some definitions even provide specific attributes of financial literacy and possible ways to measure financial literacy. However Redmund (2010) refers to literacy as going beyond just measuring knowledge. Literacy reflects an individual’s ability to perform tasks that are money related without the limitations of earnings and spending that money. However since personal finances varies among consumers groups. Researchers need to consider the consumer groups they are dealing with when focusing on managing personal finances (Botha, 2013).
Category four: Skill in making appropriate financial decisions
The decision making skill is included in most definitions of financial literacy. Researchers (Stone, Weir and Bryant, 2008) define a financial literate as an individual who successfully manages their debt. Decision making skill is therefore seen as a core competency when it comes to financial literacy (Redmund 2010).
Category five: Confidence to plan effectively for future financial needs
Very few definitions of financial literacy include financial planning. However when included, a clear definition such as ‘understanding about investing and financial planning’ is provided (Koening 2007 cited in Redmund 2010). Financial planning is classified under the long term financial management while decision making skills are the short term financial management. It is possible to make a decision without planning however both skills need to be developed (Redmund 2010).