The word “financial capability” was said multiple times in the Financial Inclusion 2020 London, by speakers who were giving solutions to eradicate poverty through financial inclusion. However, there is no clear definition of financial capability. Some say it is how well you manage money on a day-to-day basis, but there is no concrete definition to it.
Well, we have given a clear definition of financial capability and mentioned why it is important for our society. This article will try to cover the various facets of financial capability so that even laymen can understand what it is and why it is important. So let us get started.
Financial Capability: A Broad Insight
A Financially capable person has complete knowledge of how to manage his/her finances. This word was proposed at the Financial Inclusion 2020 London by the speakers who spoke of financial inclusivity. A person who can use his financial knowledge to his maximum potential to achieve his goals or do something better for society, in general, is considered a financially capable person. If a person possesses financial education he will be confident, and stress-free because he will have a stable financial life.
A financially capable person will not have a hard time in time in case of a financial crisis. He would have managed his credit in a way so that he did not have to face an economic crisis. Being financially capable does not mean just surviving a crisis, or just managing finances, it also means having an attitude.
Five Skills of Financial Capability
It means having the confidence to use your skills and making out money from everything. Financial capability means the combination of these five skills:
Having financial knowledge means a basic understanding of the financial system and its product. A person should understand how a bank functions, and what are the benefits of a savings account, debit card, and credit card. A person who is financially aware of these products that person is said to have financial knowledge. Financial knowledge is not limited to just banking, it also consists of interest rates, share market, etc.
Financial skills contain two parts, hard skills, and soft skills. In hard skill basic education comes, a person should know about numbers, and perform financial calculations. With the help of this, that person can differentiate between products that will have a profit or a loss. A basic arithmetic calculation is needed to compare the prices of two products. In soft skills, financial awareness falls, and an individual should understand which schemes would be profitable and which are potential scams.
The financial attitude would mean the mindset an individual has about how to manage his finances. A person with the right financial attitude has positive behavior when making an important financial decision, that person does not have stress related to spending and saving money. His view on our financial system is progressive and positive.
By financial confidence we mean, the confidence to manage your own credit. If a person can make financial decisions without any stress, that person is financially confident. This person will have knowledge about the current financial system its financial products and how efficiently you can use them to your advantage.
Positive financial behavior
Having positive financial behavior means having a plan for any future financial crisis and managing credit on a day-to-day basis. Any person who faces any financial obstacles in a positive manner and has a solution to come out of any rough situation can be said to have positive financial behavior. These persons manage their debt and credit in a well-managed manner.
If a person has a combination of all these skills, then only that person will have a full behavioral change toward managing his/her finances. Improvement in all these skills helps you build confidence. These skills are complementary to each other improvement in one sector will lead to the betterment of another sector, and with financial knowledge, you will have the confidence to make financial decisions when you are confident, that is an attitude which you will have. With confidence, you will have positive behavior also toward the management of finances.
Why Financial Capability is Important?
It is very important for an individual to know how to manage their finances. If you do not have a basic knowledge of how a financial system works or what are the benefits of financial products, you will not be able to reach your goal. Individual outcomes are the key results of financial capability, having financial knowledge and confidence allows an individual to make the right choices according to his personal life, and he will have a better chance of reaching his goal.
There are various reports that suggest when a person manages his/her finances are less likely to have stress. Only 58% of adults keep a certain amount of money from their income as savings. This just shows there is a lack of financial awareness in almost half the population of the whole country. People living in Pakistan, where an economic crisis is going on, MFOs present there researched what their common people wanted, the full report is on results from research in Pakistan: what do clients care about.
Eradication of Poverty
Lack of financial services also leads to a lot of divorces, and women that are not employed and do not have knowledge about finance face challenges to survive alone. Some women choose to stay with their abusive husbands, as they don’t have any financial access. Take any riot or protest, everything leads to poverty. Poverty can be eradicated if people are made aware of all the financial services that financial institution provides. Schools should start with financial education classes with academic ones.
According to reports, just 23% of school-going kids talked to their parents about finance. This shows why it is necessary for small kids to know about money management. When a person has knowledge, skills, and confidence in finance, s/he cannot be trapped in scams. It is easy for an aware person to avoid financial scams.
Live Stree Free Life
Reports reveal that if a person has financially secured his and his family’s future, that person is less likely to have stress. According to reports published by the National Financial Capability Survey, individuals who would look after their savings and spending, and who had made a proper budget faced less stress compared to people who didn’t have a proper budget. Around 29% of people had a proper budget and 48% of people didn’t have one. However, there is no general instruction for financially capable people, it depends on financial circumstances the choices that you make, and the choices that will suit you the best.
Smooth Financial Solutions
Financial education must be given at a young age, so that by the time you are an adult, you know about the financial system, financial products, etc. With experience, you will gain skills, which will give you confidence. This will allow a person to deal with their financial situation; they can take help from financial products and come out of a rough financial situation.
With Skills and knowledge, you can compare insurance or loans and select the best one which will give you more benefits. With financial awareness, you can look out for various schemes launched by the government for helping people facing financial misery. Now, with experience, a person can effectively eliminate the chances of them stepping into a scam, as that person can compare between schemes and select the one that gets him profit.
As we have seen that there can be any kind of an outbreak just as the covid pandemic or the Ebola virus which had microfinance and the economic toll of Ebola. One must be prepared how to survive at times like that. You need to have savings, you need to have a plan on how you will be spending your savings. The world is rapidly changing with technological advancement, you need to be aware of the changes in the financial system and learn those to get habituated, otherwise, you will be lagging behind others.
Factors Affecting Financial Capability
There are certain factors that lead to financial capability. Based on these factors personalized initiatives can be taken to address the problem. The environmental background is crucial to understanding, what kind of financial upbringing a person had. This even helps us understand their financial behavior and how it can be improved.
There are various factors that affect a person’s financial understanding, it can affect both indirectly and directly. Some of the factors include educational background, political atmosphere, social community, etc. Each one of these factors can affect the financial capability of a person. If you lack basic education you will have problems, calculating the amounts, and selecting which will positively benefit you.
In the case of a political atmosphere, you may live in a place where a political party has its own financial schemes and you are allowed to only use them. This can affect your behavior as you will not be exposed to all the financial products. In the case of taking a microinsurance, you need to be aware of the benefits. You will be getting more information; check the report on microinsurance can the Cinderella of financial inclusion join the global ball?
Lastly, the community plays a huge role in shaping your behavior as all communities have a different kind of understanding of the financial system. This shows us that it is important to identify these factors that have made a change in our financial understanding. Our families, friends, and community behavior towards money influences our behavior, It can have a positive effect and sometimes a negative effect also.
Economic factors, such as informal income, poverty, etc. can lead to exclusion from the financial system. People facing economic problems will then not have support from financial institutions, and they will not get loans or any other financial product that they can use. This can hinder a person’s chances of joining a financial institution.
There are some other specific factors also that have an impact on the financial capability of a person. We need to find these factors to provide personalized methods for achieving financial capability. In case of a lack of education, the government can focus on the financial literacy level in youth So that from a young age onwards people can get financial education. Financial confidence has a lot to do with the community you are born and brought up in.
Lastly, in the case of financial attitude, a person should have all the skills and knowledge about the financial system to make the right choices in life. However, one must keep in mind that overconfidence can lead to bad choices, you may be tempted to invest in products that you have no knowledge about and lose money. You need to be aware of all the scams that are going on nearby to avoid them effectively.
Is Financial Education Enough for Financial Capability?
By financial education, we mean the knowledge part of the financial system. Some of the institutions give financial education to low-income individuals and rural populations about the usage of financial products. If we check the microfinance institutions present in Lebanon, we can see how they have expanded the financial inclusion of refugees Al Majmoua in Lebanon. The lessons contain how individuals should track their savings and spending, and how to prepare a budget and follow it.
Obviously, a person should know all these things to build skills in saving money. A person should know how it is beneficial to keep track of all the spending so that he can reduce it, he should have a separate account for savings and income. That person should even know how to invest some part of their earning to earn returns on them.
However, just by knowing how to save money and how to invest money, a person does not become financially capable. Financial capability has a lot to do with behavior rather than knowledge. With financial education, a person will have the knowledge to take decisions, but their intentions and motivation cannot be changed by financial education.
A financially capable person has a positive attitude they have clear intentions about what they are doing with their money. Confidence and attitude are key social concepts that describe how a person takes a financial decision, and how that person evaluates between financial choices. If a person is financially cognizant that person will have more skillset and prowess, this cannot be achieved by financial education.
People are born in different communities and economies. The decisions a person takes cannot be followed by another person as their economic background is different. The decision taken by a person having financial issues may be working for him, but it might not work for someone who does not have the same issue. It shows financial capabilities have a lot to do with one’s economic background and community. Here also we can see that financial education that is given to all, irrespective of economic differences does not differentiate between people, it does not offer targeted initiatives like in the case of financial capability.
So with this, we can conclude that financial education cannot guarantee behavior change in people. It just educates people about the financial services that are out there. It cannot help people to form habits that they have been following due to the environment they were brought up in. Financial knowledge can build skills that will enhance your confidence and you will have attitude, but it cannot change the enabling environment (Political, social, and economic contexts where people live).
So to make this happen financial education must work with institutions that can have a positive effect on the enabling environment. The institutions may be some savings group promoters, activists running an NGO, or those people who are trying to come up with a model that will help people who face issues with their past financial experiences.
Just with financial education or financial inclusion, we cannot eradicate poverty. Some micro-financial institutions that are helping women control their financial lives through digital financial services should also know that financial education is not enough. Financial institutions should aim at financial capability. It is not productive to give people education about money management or financial products. Financial education must help people build behavioral change. Only through this, we can help people come out of poverty.
Frequently Asked Questions (FAQs)
Q1. How do you show financial capability?
Financial capability refers to people who have knowledge about the financial system, who have skills to analyze and take informed decisions, who are confident enough to talk about money, and who have a positive attitude about money management.
Q2. What are the financial capabilities of a company?
The financial capability of a company may include its efficiency in handling credit inflow. They should have proper command over their debts or equity. They can liquidate or deploy capital whenever they want.
Q3. What is an example of financial capacity?
By financial capacity we mean, the ability to calculate and analyze financial transactions, such as counting coins, and calculating bills. It shows how a person judges and analyzes every financial decision before taking it. Financial capacity makes a person independent to make their own financial choices.
Financial capability means having knowledge, skills, confidence, and attitude for handling money. Financial institutes must try to make people financially capable, just giving them financial education will not help. Financial education just focuses on giving knowledge about financial services that are provided by financial institutions. With just financial education people do not develop good financial behavior.
Financial behavior depends on enabling environments, like economic, social, and political factors that a person has lived in. To completely make people financially capable, financial service providers that give financial education must work with institutions that help people develop financial habits, who live in rough environments.
- Jonas Taylor is a financial expert and experienced writer with a focus on finance news, accounting software, and related topics. He has a talent for explaining complex financial concepts in an accessible way and has published high-quality content in various publications. He is dedicated to delivering valuable information to readers, staying up-to-date with financial news and trends, and sharing his expertise with others.
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