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There is a correlation between financial literacy and financial stability

There is a correlation between financial literacy and financial stability, said experts taking part at the International Conference on Financial Literacy and Education in Cyprus, organised by the Central Bank of Cyprus in Limassol, on Friday.

The Governor of the Central Bank of Cyprus, Constantinos Herodotou, at his welcoming speech, noted that studies indicate that poor financial decision-making preceded financial crises in the past. Quoting the 4th wave of the Household Finance and Consumption Survey in Cyprus, Herodotou noted that “financially illiterate individuals are 7-11% more likely to have late loan payments, providing evidence on the negative correlation between the level of financial literacy and financial stability risks.”

Defining financial literacy as the ability of individuals to understand and manage their finances prudently and effectively, to make prudent and informed decisions about financial matters, such as saving, investing and borrowing, Herodotou said that research finds that only 1 in 3 adults worldwide are financially literate.

“This is worrisome not only because of the negative repercussions at the individual level, but also, because of the potential impact it may have at the broader level of a country’s economy, including financial resilience and stability. Studies indicate that poor financial decision-making, including excessive risk-taking by individuals, preceded financial crises in the past”, he noted, highlighting that strengthening the financial literacy of individuals constitutes a key complementary and preventive tool, which enables financial regulation to achieve its goals more effectively.

“Financially knowledgeable citizens, in combination with a well-regulated financial system, are critical components and prerequisites for safeguarding a country’s financial resilience and stability. Financially literate citizens in addition to being able to protect their own financial well-being, also contribute to the efficiency of the economy and to sustainable long-run economic growth”, he added.

CBC’s Governor mentioned that in December 2020, an ad-hoc Committee was established in Cyprus with the aim of formulating a National Strategy for the promotion of financial literacy and financial education in the country. The CBC has coordinated the work of the ad-hoc Committee, which consists of members from the CBC, the Ministry of Finance, the Ministry of Education, Sport and Youth, the Cyprus Securities and Exchange Commission and two academic experts from the two public universities in Cyprus. The Committee was also supported by a Secretariat from the CBC and external scientific collaborators.

Finally, the National Strategy was adopted by the Council of Ministers last June, following a proposal by the competent Committee. The National Strategy drew heavily from the results of the CBC survey on financial literacy.

“A key finding of the survey was that the average financial knowledge score in Cyprus is below the minimum level considered by the OECD as sufficient for someone to be counted as financially literate”, Herodotou noted.

The results of the survey also indicate specific population groups, which are in greater need for financial education such as the young, the unemployed, women, low income and lower education citizens, and individuals who did not take economics courses during secondary education. They also indicate specific domains where lack of financial knowledge is evident, namely, interest compounding and diversification.

An OECD technical assistance project, with a €250,000 grant from the European Commission, is also undertaken, to implement specific actions for the promotion of financial literacy in Cyprus, CBC’s Governor said. These actions include the conduct of an updated national survey on financial literacy in Cyprus, the development of a website and application for smart devices that would provide useful information and financial calculators and tools to the public, and the development of a “train the trainers” program for adults, which would focus on strengthening financial education.

Additionally, since 2022 the CBC has assumed a coordinating role for the Global Money Week in Cyprus, a global public-awareness campaign coordinated by the OECD annually, aiming at raising awareness among young people on the importance of strengthening financial literacy, skills, attitudes and behaviours. Also, the CBC has recently become a full member of the International Network on Financial Education (INFE) of the OECD, in which it aspires to have an active role in the Network’s activities, Herodotou said.

Constantinos Herodoutou concluded, saying that CBC continues to devote resources on research of this topic, particularly in examining the link between financial literacy and financial stability.

Professor Annamaria Lusardi, a Professor of Economics and Accountancy at the George Washington University, in Washington DC and keynote speaker at the Conference noted the globally low levels of financial literacy, highlighting that this affects women, young adults, the elderly and those with lower income and education more.

She noted that employed males with higher income are more likely to be financially educated, thus increasing the gap further, leading to more inequality.

Lusardi said that financially literate people usually are more likely to make ends meet, to cope with financial shocks and to save and plan for retirement, and less likely to be debt-constraint. “These are indicators of financial resilience and ultimately well-being”, she noted.

The professor argued that a national strategy for financial literacy is needed and the intervention should be done at an aggregated level and should engage all stakeholders.

Some wide-reaching interventions she proposed include financial education in school and college, arguing that it should become mandatory, as well as financial education in the workplace and in the local community. She also proposed adding financial literacy to the national statistics and have a national target to achieve.

Finally, Lusardi highlighted that financial illiteracy, is, ultimately, more expensive, than the resources needed to fight it, causing not only problems to the individual, but leading to economic instability. “Financial illiteracy is very expensive. It’s much cheaper to do prevention”, she noted.

In the presentation of the Cyprus National Strategy that followed, it was noted that the low level of financial literacy in Cyprus seems to be linked to recent negative experiences in the country, like the high level of household debt and the amount of non-performing loans of Cypriot households, or the excessive exposure to the Cyprus Stock Exchange in 1999 and the excessive risk taking on bank securities in the period prior the 2013 crisis.

The strategic objectives of the Cyprus National Strategy, as presented at the Conference, include raising citizens’ awareness on the importance of financial literacy and education for themselves and their family, empowering individuals, starting from the young, with core financial skills and habits in order to be able to efficiently manage their personal or family finances, aiming to enhance their financial wellbeing. Also, it aims to raise awareness and enhance skills on the need for adequate financial planning for insurance and retirement and to raise awareness and increase knowledge regarding the use and associated hazards of digital financial products and services.

Source: https://www.stockwatch.com.cy/en/article/trapezes/there-correlation-between-financial-literacy-and-financial-stability