Financial services leaders, you have a problem on your hands. A problem that you may not see as your responsibility, but I assure you it will provide value if you take responsibility and address it. Every few years FINRA runs a financial literacy test for its National Financial Capability Study. The test measures consumers knowledge on basic financial concepts such as inflation, interest, stocks and bonds. Of the five questions asked only 34% of Americans were able to get four out of the five correct. This staggering percentage is trending downward and shows a clear financial literacy problem in our society. Some states are beginning to attack this issue and making financial education courses mandatory. This step, however, will not completely solve the problem for two reasons:
- Those uncomfortable with the topic of personal finance would most likely take the class due to a dearth of talent.
- This initiative is for the next generation of FS customers. It will not change anything for customers that cannot answer the five basic financial questions now.
As an industry, take ownership of this problem. Placing a priority on financial literacy will not only help solve an ongoing societal issue, but it will also provide great benefit to the FS firm. I’ve outlined below three benefits a firm will see with a financially literate client base.
- Account balances – Just over 2/3rds of Americans live paycheck to paycheck and lack any form of savings or emergency funds. This fact is not only a massive risk for the customer but also a negative for the bank. A financially literate customer who knows the importance of saving for retirement and a six-week emergency fund would improve a banks cash on hand. Imagine 75% of your customers who currently hold little savings and no emergency fund suddenly had both. It’s not that your customers don’t want these accounts. They lack the financial literacy to understand the importance of it and the confidence to get there.
- Higher credit scores – Due to the knowledge of how the credit system works and how to properly utilize credit. The financially literate tend to have a much higher credit score. The higher credit score would allow you to lend more money to these customers. When customers are financially literate and understand concepts such as opportunity cost and time value of money, they will be more willing to utilize/leverage debt in a positive way. This “good debt” allows the customer to enhance their financial lives and lenders to develop relationships with good debtors. (See this blog on new criteria for credit risk management.)
- Relationship primacy – Relationship primacy is a difficult task in 2022. Newer generation customers tend to have a best-in-breed approach to choosing providers and products. The original thought of the wallet share model is incorrect. However, through financial literacy you can have a significant impact on supporting your customer’s financial empowerment. Supporting financial empowerment has been shown to have a more significant impact on relationship primacy and taking positive action with the provider when compared to more standard gauging like NPS and CSAT.
Now, you may be thinking why you should listen to me. After all, the financial services industry makes a lot of money off financially illiterate people. Fees for overdrafts and repossessions/foreclosures due to bad debt can be a significant revenue source for the business. While this is all true, having a financially literate customer base will outweigh these revenue sources. During the financial crisis of 2008, the banking industry lost a substantial amount of trust from the public. The industry has fought hard to get that trust back, and you all have made wonderful progress, but there is more work to be done. As we head into these uneasy economic times, do not give your customers a chance to have that lack of trust creep back up. Instead, focus on financial literacy and show them that you are in their corner and there to support them in all aspects of their financial lives. Make this initiative a priority and put it on your shoulders to bridge this gap, not just on the shoulders of the education system.