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Home»World common»Research Chapters»Why Is Financial literacy important ?
Research Chapters

Why Is Financial literacy important ?

ReikiomBy ReikiomSeptember 9, 2022Updated:September 10, 2022No Comments5 Mins Read
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why is financial literacy important ?

Financial literacy contributes to empower and educate the investors and as a result of that they become more knowledgeable and can evaluate the products and services and make good decisions and it believed that financial literacy would help to overcome the various problems faced by the borrowers in the credit markets (Mutegi, Njeru, & Ongesa, 2015) With the growing complexity of the financial markets, financial competence has become more important as, at present, the responsibility for a good investment and saving decisions for the future has shifted from the government and employers on to the hands of the individual clients (Lusardi & Tufano, 2009). Lack of debt-specific financial literacy is positively associated with over-indebtedness and general financial literacy does not have consistent considerable effects (Schicks, 2014). Gathergood (2011) proved the positive relationship between financial literacy and over-indebtedness. Liv (2013) also mentioned that financial literacy is very important as borrowers with high financial literacy are less likely to be struggling in the loan repayments other than the clients who have less financial literacy. Haas (2006) mentioned that the exposure of the households can be reduced by increasing the financial education among them.

Multiple borrowing

 The majority of microfinance borrowers are facing many difficulties and they are struggling to meet the repayment obligations and finally, they repay the loans by rolling of debts, and as a result, they end up with a debt trap with overlapping memberships. Khandker et al.(2013) defined multiple borrowing or overlapping membership as “ borrowing from more than one microfinance institution (MFI) source for the same or similar purpose, and the terms apply to both individuals and households” (p.4). Borrowers who have multiple loan borrowings are more likely to become over-indebted (Liv, 2013). In Bolivia over-indebtedness is not connected with multiple borrowing and over-indebtedness can even be occurred with one loan also (Gonzalez, 2008).

Sometimes there are no signals of over-indebtedness itself when the households net worth grows along with its loan portfolio and even with the multiple memberships and also some consumers who have borrowed either from one or multiple sourced are not over-indebted due to the reason of their net worth kept pace with or exceed their debt and however, this is not the most common for all the borrowers (Khandker, Faruqee, & Samad, 2013).

Lending methodology

 Hermes and Lensik (2007) stated that microfinance programs mainly use two lending methodologies, group lending, and individual lending to offer credit facilities for poor people. The original model that was initiated by Grameen Bank was the offer loans through the joint-liability groups without collateral and however, nowadays microfinance institutions have launched individual liability credit programs instead of only using the collateral and the guarantees by the others (Augsburg, Haas, Harmgart, & Meghir, 2012) As per the Attanasio et al.(2015), under the joint liability lending methodology, small groups of borrowers are responsible for the repayment obligation of each other members of the group, and when at least one member does not pay the loan, all of the remaining members are also treated as default because co-borrowers are treated as guarantors and further showed that joint liability lending methodology has the disadvantages such as frequent and time-consuming repayment meetings, social pressure which hurts the borrowers, and, due to those problems microfinance institutions have started to move to the individual lending methodology.

As all the group members are jointly liable, non-repayment by one group member will provide barriers for all group members to access the loans in the future from the microfinance program and therefore group lending provides some incentives for the individual group members to monitor the loan repayments of the other members as if one member fails to meet the repayment obligations on time, and defaults occur, all members have to suffer. Moreover, group members normally live closer to each other, they know each other and have good social tiers and therefore they can easily monitor and screen the activities of each group member and as a result of that repayment rates of loans is expected to be high. However, Sharma and Zeller (1997, as cited in Hermes and Lensik, 2007) conducted a study in Bangladesh among the members of the group lending programs and showed that repayment problems are high among the microfinance groups where there are relatives in the same group. Further, they stated that when the group members have less access to credit sources and no alternative credit sources, they tend to monitor and screen the activities of the group members and thus, repayment performances are high and also showed that microfinance groups which have formed after a better screening process also have fewer repayment problems. However, Study carried out by Ahlin and Townsend (2007) among the Thai borrowing groups showed that repayment is negatively associated with both joint liability rate, cooperation, and social ties while the strength of local sanctions and correlated returns are positively associated with repayment.

 Research conducted by Attanasio et al. (2015) concluded that, among households that offered loans under joint-liability, there was an increase in the likelihood of owning an enterprise of almost 10 percentage points more than the control village and also a positive effect on the food and total consumption and simultaneously individual-liability micro-credit programs did not have a considerable impact on poverty reduction. However, Liv (2013) showed that there is no relationship between over-indebtedness and the lending methodology.

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