LECTURE ONE

INTRODUCTION TO FINANCIAL LITERACY

Definition:

“Financial literacy is knowledge and understanding of financial

concepts and risks, as well as the skills and attitudes to apply such
knowledge and understanding in order to make effective decisions
across a range of financial contexts, to improve the financial wellbeing
of individuals and society, and to enable participation in economic life.”
( OECD 2019b)

Purpose of Financial Literacy

There are four innovative aspects of this definition that should be

highlighted.

 First, financial literacy does not refer simply to knowledge and

understanding but also to its purpose, which is to promote effective
decision making.
 Second, the aim of financial literacy is to improve financial
wellbeing, not to affect a single behavior, such as increasing
saving or decreasing debt.
 Third, financial literacy has effects not just for individuals but for
society as well.
 Fourth, financial literacy, like reading, writing, and knowledge of
science, enables young people to participate in economic life.

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Introduction:

Financial literacy is an essential skill for making savvy financial decisions,

understanding the world around us, and being a good citizen. Changes
in the pension system, the increasing complexity of financial instruments,
inflation, and increased risks (from the war in Ukraine to climate change)
are some of the reasons behind the increasingly urgent need for
individuals to have the knowledge and skills that will increase their
financial resilience and wellbeing. The OECD Recommendation on
Financial Literacy, adopted in 2020, recognized financial wellbeing as
the ultimate goal of financial literacy.

Despite this urgency, levels of financial literacy are remarkably low, even
in countries with well-developed financial markets and in which
individuals actively participate in financial markets. According to the
latest OECD adult financial literacy survey, financial literacy is low in
many of the countries belonging to the G7 and G20 bloc. This aligns with
findings from a global survey on financial literacy that showed that only
a handful of countries rank high on very basic measures of financial
literacy.Not only is financial illiteracy widespread in the population, but it
is particularly acute in some demographic sub-groups that are already
financially vulnerable, such as women and those with low-income and
low-educational attainment.

Financial literacy is also low among high school students, indicating that
the next generation of adults is ill equipped to face the challenges and
changes that are ahead of them. According to the latest wave of the

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OECD Programme for International Student Assessment (PISA), in some
G7 countries, such as Italy, about 20 percent of students do not have
basic proficiency in financial literacy. In other countries, such as Peru or
Brazil, that proportion is higher than 40 percent.

financial literacy for the macro-economy covers financial inclusion and

how financial literacy can promote the use of basic financial instruments,
such as bank accounts. Moreover, it covers financial decision making in
the context of complex instruments, such as mortgages, reverse
mortgages, and crypto assets.

The overarching value of financial literacy

The benefits of financial education can be far reaching. For example,

there has been a push around the world, and significantly in the G20
countries, for promoting financial inclusion.A high proportion of people
in many emerging economies do not have easy access to even basic
assets such as bank accounts, let alone access to financial markets,
including the stock market. If finance can be important for growth, so is
financial literacy, as it can promote participation in financial markets
and savvy use of financial instruments. And as financial markets become
more sophisticated, the ability to take advantage of new investment
opportunities can help reduce inequality.

But there is another important and under-explored avenue related to

the impact of financial literacy, which is whether and how much policy

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makers can be successful in implementing economic reforms. Like
individual financial decisions, many reforms involve a trade-off between
a sacrifice today for a benefit in the future. However, if people have low
financial literacy, they may fail to appreciate future benefits or may not
be fully aware of the workings of government budgets and of institutions
such as Social Security and the pension system. Overall, attempts to
reform pension systems have been met with sharp opposition, even in
the face of increasing longevity, decreasing birth rates, and other
changes that put existing systems on potentially unsustainable paths.
Can financial literacy help with the implementation of those reforms,
thus improving the performance of an economy in the long term? In
addition, how important is knowledge of pensions?

it is very important to improve pension literacy, both because there have

been many changes to pension systems and because there are a lot of
complexities in those systems. Better pension literacy can, for example,
help people plan better for their own retirement. This can be particularly
important for women, who live longer than men, have lower labor
market attachment due to childbearing and other household
responsibilities, and have lower wages. The level of pension literacy is still
very low and is particularly low among women, both of which are factors
that can jeopardize retirement security.

Most importantly, financial literacy helps in the implementation of

pension reforms. From literature there is evidence that populations with
a higher average level of financial literacy are less likely to punish
governments for implementing reforms. Moreover, financial literacy can

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help individuals be better citizens (and more educated voters) and less
likely to suffer from fiscal illusion, i.e., voters’ failure to estimate the (net)
cost of a tax reduction (in terms of higher debt and/or the lower provision
of public goods and services).

It may be useful to note that the countries that started financial literacy
programs or were the first to create national strategies for financial
literacy did so because of their focus on the pension system and
changes in pensions. The focus has now expanded to other topics, but
pensions remain an important area of interest. And more than 80
countries have or are implementing national strategies for financial
literacy, i.e., policy makers as well have acknowledged the importance
of financial literacy at the national level.

Continuing on the topic of the global economy and pioneering work, if

we want to have a good understanding of how finance and the use of
financial instruments can be important for the wellbeing of individuals
and the economy at large, we need to turn to the World Bank Global
Findex. It is the most comprehensive database on financial inclusion; the
data, which are collected directly from users of financial services,
provide unique information on how adults save, borrow, make
payments, and manage financial risks. Findings are sobering. They
reminds us that, as of 2021, as many as 1.4 billion adults – or 24 percent
of adults – worldwide are without even the most basic asset, i.e., a
financial account, or are unbanked. Interestingly, the characteristics of
those without an account are very similar to those with low financial

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literacy: women, poor adults, less educated adults, young adults, and
those living in rural areas.

We can learn a lot from looking at the reasons why people do not have
an accounts, which speaks to the importance of collecting these types
of data. Specifically, the data show that a sizable number of
respondents cite lack of help or being uncomfortable using an account
as a reason for being unbanked. In developing countries, 64 percent of
unbanked adults said they could not use an account at a financial
institution without help, a proportion that becomes higher among
women and other vulnerable groups. This finding is further evidence that
we cannot underestimate the difficulties in using financial instruments.
And even those who have an account do not always make good use
of it. For example, in India – where every adult with a biometric ID was
de facto given a no-minimum-balance, no-fee accounts account as
part of the government’s Jan program – it was found that many
accounts were dormant or had little or no activity. Inactive account
holders in India often cite their discomfort level with financial services
among the top barriers to account usage. Specifically, about 30 percent
of inactive account holders do not use their account because they do
not feel comfortable doing so by themselves. And looking at a
subsample of 25 Sub-Saharan African countries, where mobile money
accounts are widespread, the paper reports that 31 percent of mobile
money account holders cannot use their account without help.

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These data point to an opportunity for financial education.
Strengthening financial literacy can result in more efficient and effective
use of basic financial instruments.

Financial education in school and the workplace

While financial literacy is an essential skill, particularly among the young,

many young people lack knowledge of basic financial concepts. Back
in 2000, the OECD started PISA, an ambitious project to assess student
performance in critical areas. PISA gauges whether students are
prepared for future challenges, whether they can analyze, reason, and
communicate effectively, and whether they have the capacity to
continue learning throughout their lives. Since its first wave in 2000, PISA
has tested 15-year-old students’ skills and knowledge in three key
domains: mathematics, reading, and science. In 2012, PISA introduced
an optional financial literacy assessment, which became the first large-
scale international study to assess youths’ financial literacy. The PISA
financial literacy assessment measures the proficiency of 15-year-olds in
demonstrating and applying financial knowledge and skills.

The PISA financial literacy data have become a critical source of

information with which to assess the level of financial literacy among the
young. Starting from the original wave in 2012, we have found that
several rich countries do not have high levels of youth financial literacy.
For example, both the United States and some European countries, such
as Italy, France, and Spain, ranked at the OECD average or below the

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average on the 2012 financial literacy scale. Moreover, and importantly,
financial literacy is strongly linked to socio-economic status: the students
who are financially literate are disproportionately those from families with
higher levels of education and income and from homes with a lot of
books.

The PISA 2022 financial literacy assessment will provide further insights into
young people’s financial literacy across 23 countries and economies,
and take into consideration changes in the socio-demographic and
financial landscape, such as the use of digital services, that are relevant
for students’ financial literacy and decision making.

Countries have started to add financial education in school, in some

cases making it mandatory. Notably, Portugal made financial education
mandatory in school in 2018, adding it to the civic education curriculum,
and many states in the United States have passed legislation to make
financial education mandatory in high school curricula. Recent
empirical evidence on the effectiveness of financial education in school
shows it holds much promise. For example, according to a meta-analysis
covering financial education programs from as many as 33 countries on
6 continents, and considering the programs evaluated most rigorously,
financial education is found to affect both financial knowledge and
downstream behavior. Remarkably, the effects are similar across age
groups, i.e., they hold among the young and the old, and they hold
across countries. Other work examining the effect of financial education
in high school also shows that young people who were exposed to high

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school financial education are much less likely to have problems with
debt as young adults.

Finance Concepts:

Income:

income is the money that an individual or organisation receives in return

for their services or goods. Income can have a variety of definitions,
which often depend on the specific context. That context may change
depending on economic analysis, financial accounting, or taxation.

Revenue is the total earned from sales or other sources, income is the
profit earned after accounting for all expenses. Understanding the
difference between revenue vs income is crucial for making informed
financial decisions, such as budgeting, investing, and pricing strategies.

Three of the main types of income:-

 Earned income includes wages, salary, tips and commissions.

 Passive or unearned income could come from rental properties,

royalties and limited partnerships.
 Portfolio or investment income includes interest, dividends and
capital gains on investments.

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Expenses:

An expense refers to any cost that contributes to a company's overall

cost of doing business. That is, any costs incurred as a result of a
company's attempted or successful revenue production. Expenses may
include cash, cash equivalents, and depreciation. Business expenses
are ordinary and necessary costs incurred to operate your business.
Examples include inventory, payroll and rent. Fixed expenses are regular
and don't change much — things like rent and insurance. Variable
expenses are expected, but they can change.

Asset:

An asset is a Resource that a firm has or maintains that aids in generation

of income to the business. It can be categorized as Non current or
current asset. Non Current assets are those that a life span of more than
a year. An example is Properties, Equipments, Fixtures etc. Example od
current asset is Inventory, Debtors, Cash (in bank, at hand)

Capital:

The capital means the assets and cash in a business. Capital may either
be cash, machinery, receivable accounts, property, or houses. Capital
may also reflect the capital gained in a business or the assets of the
owner in a company. It’s the owner injection to business.

Liability:

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A liability is a quantity of value that a financial entity owes. More
technically, it is value that an entity is expected to deliver in the future.

Income Statement;

An income statement is a financial statement that lays out a company's

revenue, expenses, gains, and losses during a set accounting period. It
provides valuable insights into various aspects of a business, including its
overall profitability and earnings per share.

Balance Sheet:

A balance sheet is a financial statement that reports a company's assets,

liabilities, and shareholder equity. The balance sheet is one of the three
core financial statements that are used to evaluate a business. It
provides a snapshot of a company's finances (what it owns and owes)
as of the date of publication

Investing:

Investing is about taking calculated risks with your money to try to earn
more with it. Most people invest to achieve a goal, whether it be a long
term goal like retirement or short term goal like saving for a down
payment on a house.

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Budgeting

 A budget is simply a spending plan that takes into account

estimated current and future income and expenses for a specified
future time period, usually a year.
 Having a budget keeps your spending in check and makes sure
that your savings are on track for the future.
 Budgeting can help you set long-term financial goals, keep you
from overspending, help shut down risky spending habits, and
more.

Sources of Income
 Dividend income from stocks.
 Earned income from a paycheck.
 Rental income from real estate.
 Royalty income intellectual property, inventions, etc.
 Capital gains from selling assets that have appreciated in value.
 Profits from a business.
 Interest from savings, bonds, or lending activities.

Financial Stability

Financial stability is defined in terms of its ability to facilitate and

enhance economic processes, manage risks, and absorb shocks.
Moreover, financial stability is considered a continuum: changeable
over time and consistent with multiple combinations of the constituent
elements of finance.

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 How to maintain Financial Stability
Here are 7-step instructions.
1. Invest in yourself. Having further education, more knowledge, and
required skills for work can support your career advancement. ...
2. Make money from what you like. ...
3. Set saving and expense budgets. ...
4. Spend wisely. ...
5. Set emergency fund. ...
6. Pay off debts. ...
7. Plan for retirement.

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