The Hindu Business Line : Importance of financial literacy

Financial education seems all set to be reinterpreted as an essential component of public policy. As the Reserve Bank of India Governor, Dr Y. V. Reddy, pointed out in a recent speech, the overriding purpose of financial education is to equip individuals with "the capacity to have familiarity with and understanding of financial products, especially risks and rewards in order to make informed choices." This is especially important in the reform era.

As the role of the state diminishes, market mechanisms become the arbiters of risks and rewards. Consumers may have an abundance of choice but often lack the knowledge to make an appropriate selection. When pension reforms come through, employees would have a choice of four or five schemes, each of them investing their corpus in a variety of debt or equity instruments. To be able to choose the scheme right for them, subscribers will surely need to be educated on the risks and returns of each. Else, there could be a repeat of the Enron debacle, where employees were fraudulently induced to invest and retain their hard-earned pension contribution with the company, even when it was fast imploding.

Moreover, as in the developed markets, financial products, even those offered to individuals, are becoming increasingly complex. While a certain information asymmetry always existed between a service provider (say, a bank) and its customer — with the scales tilted towards the former — today some of the products such as the Over-the-Counter derivatives, — are so complex that even large corporations have not been able to fathom or comprehend the risks associated with them. Globalisation, aided by rapid absorption of technology, has integrated financial markets as never before. Financial education has, therefore, to address global issues as well.

Market discipline improves when individual investors are empowered through suitable education. From a regulatory perspective, financial education empowers the common man and thus reduces the burden of protecting him from failures attributable to information asymmetries. India has never been short of individual initiatives in this regard. Banks, insurance companies and capital market intermediaries as well as their regulators have conducted customer education programmes. What is now needed is an enlarged curriculum and perhaps more significantly an institutional mechanism to oversee all financial education programmes. Experience in the UK, the US, Australia, Singapore and other OECD countries suggests that furthering economic literacy should be a key component of public policy and that is best achieved through formal institutional mechanisms.

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