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Financial Capability and Asset Development$

Julie Birkenmaier, Jami Curley, and Margaret Sherraden

Print publication date: 2013

Print ISBN-13: 9780199755950

Published to Oxford Scholarship Online: May 2013

DOI: 10.1093/acprof:oso/9780199755950.001.0001

Building Blocks of Financial Capability

(p.3) 1 Building Blocks of Financial Capability
Financial Capability and Asset Development

Margaret Sherraden

Oxford University Press

Abstract and Keywords

Families lack financial knowledge and skills to make optimal financial decision in an increasingly complex financial landscape. Simultaneously, they lack access to appropriate and beneficial financial services that create conditions for financial stability, well-being, and confidence in the future. People need both financial knowledge and financial inclusion to build financially secure and hopeful lives. The concept of financial capability bridges the disciplines of economics, psychology, and sociology, taking into account how individual action and behavior, human psychology, and social structure influence household financial management and decision making. This chapter explores the idea of financial capability and calls for greater attention to research and professional training in building financial capability, especially in low-income and financially vulnerable households.

Keywords:   financial capability, financial literacy, financial inclusion

In an era of rising financial instability and growing inequality, many families face two major challenges. They lack financial knowledge and skills to make optimal financial decisions in an increasingly complex financial landscape. Simultaneously, they lack access to appropriate and beneficial financial services that create conditions for financial stability, well-being, and confidence in the future. People need both—financial knowledge and financial inclusion—to build financially secure and hopeful lives. When individuals have both, they become financially capable. This chapter explores the idea of financial capability and calls for greater attention to research and professional training in building financial capability, especially in low-income and financially vulnerable households.1

The concept of financial capability bridges the disciplines of economics, psychology, and sociology, taking into account how individual action and behavior, human psychology, and social structure influence household financial management and decision making.2 Although economists, psychologists, and sociologists view human behavior through different lenses, together they offer a promising way forward for improving financial functioning and well-being.

Financial capability

Financial capability is both an individual and a structural idea. It combines a person’s ability to act with their opportunity to act. In this way, people are able to “understand, assess, and act in their best financial interest” (Johnson & Sherraden, 2007, p. 124). The key distinction between financial literacy and financial capability, according to this definition, is that to be financially capable, people must be more than financially literate; they must also have access to financial products and services that allow them to act in their best financial interest. Together, ability and opportunity contribute to a person’s financial functioning in ways that lead to improved financial well-being and life chances. (p.4)

Capability has a particular meaning, derived from the seminal work of philosophers Amartya Sen and Martha Nussbaum. As Sen writes, “Capabilities … are notions of freedom in the positive sense: what real opportunities you have regarding the life you may lead” (Sen, 1987, p. 36, emphasis added). According to Nussbaum, who applies capability theory to human development and welfare, the idea of capability takes into account not only people’s internal capabilities (e.g., ability, knowledge, skills) but also the external conditions and array of opportunities available (e.g., access to products, services, and institutions), which together make up their combined capabilities (2000, p. 85). Nussbaum suggests that policies, laws, regulations, and practices should provide opportunities for all individuals to develop the full range of capabilities that lead to well-being.

While people must possess internal capabilities, certain external conditions also must exist in order for people to be capable.3 As Nussbaum notes, internal capabilities may exist even when external conditions do not: “a society might do quite well at producing internal capabilities but might cut off the avenues through which people actually have the opportunity to function in accordance with those capabilities” (2011, p. 21). Similarly, internal capabilities may be lacking; a society could do “well in creating contexts for choice in many areas” (combined capabilities) but not “educate its citizens or nourish the development of their powers of mind” (internal capabilities) (2011, p. 22). Both are needed in order for people to function. The key point is that they are interactive; internal capabilities are “developed, in most cases, in interaction with the social, economic, familial, and political environment” (Nussbaum, 2011, p. 21).

It is important to point out that this understanding of financial capability is different from that commonly used today. More typically, “financial capability” often is used synonymously with “financial literacy” or more broadly to refer to a set of individual qualities—including knowledge and skills, attitude, habit, motivation, confidence, self-efficacy, and behavior—that lie within the individual (Atkinson, McKay, Kempson, & Collard, 2006; Dixon, 2006; Lusardi, 2010; Transact, 2009).4 Although attitudes, motivation, confidence, and behavior suggest contextual variables (i.e., they are qualities that are not considered entirely innate), context is not integrated into most current conceptualizations of financial capability. Definitions sometimes include context, but looking closer, changing external conditions is rarely operationalized.5

By contrast, we suggest that financial capability does not reside solely within the individual. Instead, it captures a relationship between individuals and their social reality; financial capability depends on what is possible for people living in a particular society. In other words, people make financial decisions based on innate ability, knowledge, and skills, but also on what is within their “realm of possibility.” For example, when researchers hear financially vulnerable people say that mainstream financial products and services are not meant for them (Kempson & Finney, 2009), it suggests a chasm between the financial worlds of rich and poor. In this way, a feeling of confidence may not be so much an expression of individual ability and skill in making financial decisions, but an expression of the individual’s economic and social position and influence in relation to mainstream financial and economic institutions. Real options and opportunities in people’s (p.5) environment shape their assumptions and understanding about what is possible. It is this link between individual and structure that influences attitudes, motivation, confidence, self-efficacy, and behavior. In this way, the social, economic, and political context is internalized in people’s perceptions and expectations and is likely to influence behavior (Reynolds & Pemberton, 2001).6

Institutions play an important role in capability theory because they are the principal conduits for social, economic, and political realities in an individual’s life. Institutions give shape and meaning to human behavior; they do not “just constrain options: they establish the very criteria by which people discover their preferences” (Powell & DiMaggio, 1991, p. 11). Expanding financial capability, especially in populations that are underserved, requires more than offering better-designed products and services (although these can make a difference). It also requires changing the ways that financial institutions include (or exclude) low-income and financially vulnerable populations. For example, we know that institutional change, including public policy reform, is required to address deep and persistent inequalities in wealth by gender and race (Conley, 1999; Conley & Ryvicker, 2005; Gittleman & Wolff, 2004; Keister, 2000; Oliver & Shapiro, 1995; Schneider, 2011).

Despite the challenges of making significant change, institutional theory provides ways to think about how to increase access to opportunity for financially vulnerable households. For example, in their work on saving and asset building in low-income households, Michael Sherraden and colleagues identify a bundle of institutional constructs that shape saving in households (Beverly et al., 2008; M. Sherraden, 1991; M. Sherraden & Barr, 2005; M. Sherraden, Schreiner, & Beverly, 2003). These include access, information, incentives, facilitation, expectations, restrictions, and security. These constructs may also provide a way to examine and measure how well policy and financial institutions serve financially vulnerable households more generally.

Another strand of research that informs the way we can think about financial opportunity (and address constructs identified in institutional theory) comes from behavioral economics. Behavioral economics provides key insights into how people actually behave when confronted with financial decisions, pointing out that human psychology leads individuals to make nonrational and sometimes suboptimal (yet understandable) decisions, even when they are relatively well informed (Maital, 1982; Tversky & Kahneman, 1986; Wärneryd, 1999). At the same time, this body of work demonstrates that financial products and services can be designed in ways that make good financial choices more likely (Thaler & Sunstein, 2008). As Richard Thaler and Cass Sunstein suggest in their book Nudge, “choice architecture” can channel financial behaviors toward positive results (2008). Some financial products take into account these very human ways that people behave, for example, in providing simple choices and automatic features.

A final theoretical point about capability has implications for voice and influence in institutional change. Sen points out in Development as Freedom that public policies can enhance people’s lives through expanded opportunity and that people can influence the direction of public policy “by the effective use of participatory capabilities by the public” (1999, p. 18). In fact, Sen writes, “The two-way (p.6) relationship is central” (1999, p. 18, emphasis in original). In societies that enhance capabilities, people are engaged in defining capabilities and may be more likely to challenge injustices through individual and collective action. For example, using extensive empirical evidence that famines are less likely to occur in democracies, Sen (1981) demonstrates that ordinary people must have the ability to be heard and influence policy decisions. In this way, capability theory includes the idea that ordinary people gain “voice” (Hirschman, 1970). In financial capability, we would expect that ordinary people would have greater voice, and play a greater role, in shaping their financial world and economic well-being.

In sum, improving financial functioning in financially vulnerable families is not simply a matter of changing individual behavior, but also a matter of changing institutions. But how can it be accomplished? The remainder of the chapter examines what we know about the building blocks of financial capability. The first part defines and discusses how people develop knowledge and skills for managing their financial lives. The second part focuses on financial inclusion of financially vulnerable groups in the United States, components of inclusion, and innovations in expanding participation. The third part brings these discussions together in an examination of how combining the two leads to financial capability. The concluding section addresses the role of social work and other applied scholarship in research and practice in building financial capability in low-income and financially vulnerable households.

The first building block: financial literacy

A financially literate person has the knowledge, ability, skills, and confidence to make good financial decisions (Huston, 2010). As the current chair of the board of governors of the Federal Reserve System, Ben Bernanke, explained in 2006 testimony before the US Senate Committee on Banking, Housing, and Urban Affairs, financial literacy improves financial decisions and economic outcomes:

Clearly, to choose wisely from the variety of products and providers available, consumers must have the financial knowledge to navigate today’s increasingly complex financial services marketplace. Consumers with the necessary skills to make informed financial decisions about purchasing a home, financing an education or their retirement, or starting a business will almost certainly be economically better off than those lacking those vital skills.

Today, in the face of growing evidence that many Americans lack sufficient financial knowledge and skills, a vocal chorus has joined Bernanke in calling for financial education. The US government has developed a National Strategy for Financial Literacy with four goals: (1) to increase awareness of and access to effective financial education; (2) to determine and integrate core financial competencies;7 (3) to improve financial education infrastructure; and (4) to identify, enhance, and share effective practices (US Department of Treasury, 2011b).

Overall, studies suggest that people have low levels of financial literacy (Bernheim, 1998; Hilgert, Hogarth, & Beverly, 2003; Lusardi, Mitchell, & Curto, 2010; (p.7) NCEE, 2005; OECD, 2005). A recent national study with a sample of 1,500 US adults, found that people think they know more than they really do as measured by simple questions about interest, inflation, and risk/diversification. For instance, among those who gave themselves the highest score in math, 52% were unable to do two simple calculations involving interest rates and inflation (FINRA, 2009b). Further, 64% of respondents with credit cards and checking accounts who agreed with the statement “I am good at dealing with day-to-day financial matters,” engage in behaviors that generated fees or high costs (FINRA, 2009b, p. 35). Five waves of financial literacy assessments with high school students (1997 to 2006) by the Jump$tart Coalition for Personal Financial Literacy suggest low levels of financial knowledge (Mandell, 2008). Half of adults over 40 in a national survey lack knowledge of their pensions, health coverage, and other key financial facts (Nelson, 2007). Two-thirds of adults could not answer a range of personal finance questions correctly in a nationally representative study, falling short especially on credit management and investment questions (Hilgert, Hogarth, & Beverly, 2003). Similarly, a national study finds levels of understanding about debt are also low (Lusardi & Tufano, 2009).

Young people, minorities, and those with less income and education perform at lower levels in surveys and tests (Anderson, Zhan, & Scott, 2004; Applied Research and Consulting, 2009; Mandell, 2008). Although these tests may not address many financial survival skills of low-income families “that are relevant to [their] personal and economic circumstances” (Kempson & Atkinson, 2009, p. 16), low levels of financial knowledge and skills can take a financial toll on any household. This may be especially true in low-income households where the margin for error is small and poor financial choices can have profound consequences. When a low-income family does not grasp the full meaning of credit card interest rates and debit card fees, for example, the results can be more damaging than in a wealthier household where there is a financial cushion. To illustrate, a woman we interviewed as part of a study on savings in low-income households reported that she used her credit card to pay for everything. Assuming she had to pay only the monthly minimum payment, she did not realize that interest was accumulating.8 “I didn’t know that it worked like that,” she explained, “I didn’t read the fine print on some of them. So we wound up ruining the credit that we had” (M. S. Sherraden & McBride, 2010, p. 109). Since credit ratings determine the likelihood and cost of future borrowing, as well as influence other important aspects of people’s lives, lack of understanding about credit cards placed her in a difficult financial situation. It took her years to pay off the credit card balance and rebuild a decent credit rating. Affluent households also misuse credit cards, but, in contrast to poor households, they are more likely to have a financial cushion, so even when they fail to pay in full each month, they may be less likely to default, and thus avoid severe damage to their credit rating.

Financial knowledge and skills are a key building block of financial capability. How do people learn about financial matters and what is known about how to generate higher levels of capability especially in financially vulnerable households?9 First, financial socialization provides a foundation of attitudes, knowledge, and (p.8) skills as children observe and learn from their families and others as they grow up, a process that continues into adulthood. Second, financial education also contributes to people’s knowledge and skills. Finally, people seek financial information and guidance from counselors and others, especially when faced with difficult financial decisions.

Financial Socialization across the Life Course

Cognitive, behavioral, and environmental influences shape people’s financial socialization, or the “values, attitudes, standards, norms, knowledge, and behaviors” that guide financial understanding and approaches to financial decisions (Schuchardt et al., 2009, p. 86; see also Ward, 1974). Understanding the economic world and one’s place in it begins in early childhood and continues through life (Furnham, 1999; John, 1999).10 Some people are better financial decision makers than others because they are able to delay gratification to benefit their overall financial well-being. For example, self-control learned in childhood can affect financial well-being later in life (Moffitt et al., 2011).

People absorb from their environment what they have the opportunity to observe and experience, beginning with parents who model financial behavior, including use of products and services (Hira, 1997; Mandell, 2008; Marshall & Magruder, 1960).11 Parents are “an important channel” through which young adults acquire financial knowledge (Clarke, Heaton, Israelsen, & Eggett, 2005; Lusardi, Mitchell, & Curto, 2010, p. 374). Parenting style, in particular, may have important financial socialization effects (Otto, forthcoming). People are more likely to invest in stocks if their family does, even among minorities (Chitegi & Stafford, 1999). Likewise, low-income children who receive encouragement and hands-on support by parents are more likely to save (Kempson, Atkinson, & Collard, 2006). People who had a savings account as adolescents are more likely to have accounts as adults (Friedline, Elliott, & Nam, 2011). Another study shows a small but significant relationship between parent financial behavior and orientation and their children’s financial behavior in childhood and adulthood (Webley & Nyhus, 2006).

Opportunities for social learning vary, as do exposure and access to financial opportunities, depending on a person’s place in society and opportunity to learn and practice, and these have important implications for how people think about, and behave regarding, financial matters (Gutter, Garrison, & Copur, 2010). Some studies suggest that many parents do not share important financial teaching with their children (Bowman, 2011; Zelizer, 1994). Some children grow up learning about financial markets around the dinner table, while others do not. Wealthier families, for example, are likely to have information and experience with mainstream financial services and are better prepared to guide their children (Stacey, 1987). The financial lessons that low-income parents can share with their children often are not cheerful ones; they try to shield young ones from financial distress (M. S. Sherraden & McBride, 2010).

(p.9) Family is also only the first of many agents of socialization that also include peers and media (Beutler & Dickson, 2008; Furnham & Argyle, 1998; John, 1999; McNeal, 1987; Moschis, 1985). People continue to absorb financial lessons, attitudes, and values through life. The individual’s stage of development, as well as the social, cultural, political, and economic context in which they live, shapes socialization across the life course (Elder & Giele, 2009). In studies of financial socialization, relatively few focus on adults, especially studies that examine cohort differences across historical periods, such as financial socialization among those who grew up during the Great Depression compared to those who grew up in the more affluent 1960s.

Financial Education

The limits of what people learn from financial socialization, combined with growing financial complexity of people’s lives and financial products and services, have prompted many to call for more financial education (US Department of Treasury, 2006). Policymakers, practitioners, and financial institutions have responded with a proliferation of financial education programs. In 2009, 36 states required personal finance content standards and 13 required courses or parts of courses dedicated to personal finance (Council for Economic Education, 2011). Some financial education programs aim to reach broad and diverse audiences, such as students or the public at large, while others target special groups. Some have a wide focus, covering topics such as basic numeracy, spending, planning, budgeting, earning, credit, debt, bill paying, saving, managing financial risk, investing, or taxes (Godsted & McCormick, 2007; Hogarth, 2006). Other financial education programs concentrate on specialized knowledge and skills for particular financial moments in time, such as buying a car or a home, or taking out a student loan. Methods for teaching also differ widely, ranging from public service announcements to curricular approaches to intensive experiential education.

Overall, the impact of financial education is positive, although somewhat mixed.12 One study, for example, finds that adults who grew up in states that mandated a personal finance course in high school had higher savings rates than those who grew up in states that lacked such a mandate (Bernheim, Garrett, & Maki, 2001), although another study finds that mandates for financial education have no significant effect (Cole & Shastry, 2009). A pre-post assessment of a nationwide high school personal finance curriculum showed that students retained financial knowledge over a three-month period and reported increased confidence in financial management (Danes, 2004). A study with very low-income families in subsidized housing who participated in mandatory financial education showed improvements in self-reported financial knowledge, financial behavior, savings, and credit scores compared to a control group (Collins, 2010). A large quasi-experimental study finds positive impact of financial education on financial knowledge among high school students in the period after instruction, although it is unknown if they retain knowledge over time (Walstad, Rebeck, & MacDonald, 2010). In contrast, Mandell, who followed Jump$tart Coalition surveys of high (p.10) school students for over a decade, concluded that there is no apparent relationship between financial education in school and financial literacy scores (2008). However, others note, the Jump$tart test does not control for what was taught, the quality or amount of instruction, or baseline knowledge (Walstad, Rebeck, & MacDonald, 2010).

The lack of consistent results is due in part to the wide range of objectives, audiences, activities, and timing and design of studies of financial education (Braunstein & Welch, 2002; Hathaway & Khatiwada, 2007; Hogarth, 2006). Some have suggested that financial education helps people make better decisions when they focus on “specialized knowledge about financial issues, markets, and products” (Altman, 2011, p. 38). For example, a study of “Get Checking”—a program that provides financial education about account management after the individual has been reported to ChexSystems for bank account abuse or mismanagement—finds that participants began recording transactions and communicating more with financial institutions (Haynes-Bordas, Kiss, & Yilmazer, 2008). Meta-analyses may be helpful in consolidating findings across multiple studies. In the meantime, several questions remain unclear, including the optimal age to initiate financial education, necessary content, the best teaching methods, and how these factors might vary across target groups (Burhouse, Gambrell, & Harris, 2004). More research is required on the effects of financial education on low-income and minority households and other financially vulnerable households (Hathaway & Khatiwada, 2007; Lutheran Immigration and Refugee Services, 2008; Lyons, Chang, & Scherpf, 2006; Schuchardt et al., 2009). Finally, impact studies using experimental and quasi-experimental methods will help ascertain the contributions of financial education to financial functioning and well-being (Holden, Kalish, Scheinholtz, Dietrich, & Novak, 2009; Lyons, Palmer, Jayaratne, & Scherpf, 2006; Martin, 2007; McCormick, 2008).

Financial Advice and Guidance

Sometimes people need financial advice (Murray, 2011). They may need guidance in assessing advantages and disadvantages of different financial products and services. They may need help dealing with financial problems brought on or exacerbated by job loss, divorce, health and mental health problems, home foreclosure, problem debt, severe poverty, and disability. Interventions vary by substantive focus, method and intensity, and type of provider. The substantive focus of financial advice and guidance may include a range of issues, such as obtaining public benefits, credit, debt modification, foreclosure prevention services, bankruptcy, insurance—or planning for saving, education, home buying, taxes, investment, or retirement.

Like financial education, advice and guidance differ by goal, method, and length and intensity. Goals may focus on near- or long-term financial decisions, planning, or problem solving. Interventions may be in person, by telephone, or online, and individual- or group-based. Guidance comes in several forms, including planning and advice, counseling, coaching, and mentoring. In practice, however, definitions (p.11) remain unclear and often overlap, perhaps reflecting professional boundaries more than real differences in approach.13 Financial planning and advice dispensed by professional financial planners is largely fee-based and aimed at the nonpoor. Growing numbers of colleges and universities, human service organizations, and online services offer free or low-fee planning and advice services. The growing field of financial counseling (and financial therapy) is problem- or crisis-focused and therapeutic in nature but maintains a focus on financial issues (Collins & Murrell, 2010). Financial coaching is different from financial counseling because it helps clients identify and achieve financial goals through a client-directed process aimed at behavior change (Collins & Murrell, 2007; Mangan, 2010). Financial coaches may be trained and certified or volunteers (Collins & Murrell, 2007).14 Financial mentoring provides ongoing role models for positive financial behavior for children and adults. Mentors are more likely to be peers or volunteers rather than professionals.

Today, despite the great need for help, people in financial trouble face a confusing and uneven patchwork of public, private, and nonprofit financial counseling agencies. People worry that advice they receive might cost money or that the IRS may learn about their finances. Online advice is easy to find if an individual has computer access, but it is often difficult to apply or to know if the advice is appropriate and legitimate. Advisors, planners, counselors, coaches, and mentors represent a variety of disciplines, including peer counselors, consumer and family economists, housing counselors, credit counselors, financial planners, lawyers, and social workers. For people in financial difficulty, it is hard to know where to get quality advice and guidance. In response, a number of organizations have or are developing professional certification that makes it easier for consumers to identify qualified sources of guidance, although even these are often unregulated (Collins & Birkenmaier, chapter 14, this volume).15

Studies that examine effectiveness of financial advisors and counselors suggest positive results, but as yet there are relatively few studies and outcomes are challenging to compare because of the diversity of programs and approaches and the lack of quality data (Caskey, 2006; Hornburg, 2004). Impact research with appropriate research designs can generate testable propositions, better measures, and valid and reliable results (Collins, Baker, & Gorey, 2007; Collins & O’Rourke, 2009; Hornburg, 2004; Mallach, 2001).

In her blog Financial Literacy and Ignorance, Annamaria Lusardi, director of the Financial Literacy Center,16 contends that financial illiteracy “concentrated among particular population subgroups—those with low-income and low education, minorities, and women … is often the result of personal choice, of parents’ education, and of an individual’s access and exposure to financial education” (2007). While financial socialization, financial education, and financial advice and guidance are undoubtedly important, it is doubtful that by themselves they will make people financially capable. People also need access to quality financial products and services. The next section addresses the extent to which low-income and financially vulnerable groups have access to these resources to become financially capable. It also highlights features of quality products and services and offers examples of promising financial services innovations.

(p.12) The second building block: financial inclusion

Even the most educated have difficulty keeping pace with the growing complexity of modern financial life. As Lauren Willis observes, “The gulf between the literacy levels of most Americans and that required to assess the plethora of credit, insurance, and investment products sold today—and the new products as they are invented tomorrow—cannot realistically be bridged” (2008, p. 3). Willis and others argue that a focus on financial education blames the victim and “provides a convenient excuse for society to refrain from assisting consumers who are experiencing poor financial outcomes” (2008, p. 45; see also Gross, 2005; Williams, 2007).

For low-income individuals and families, financial inclusion means, at a minimum, having access to a safe place to deposit money, a place to store precautionary savings, a means to generate savings and investment, reasonably priced small dollar credit, and simple insurance products (Caskey, 1994, 2005; Kempson, Whyley, Caskey, & Collard, 2000; E. Seidman, 2008; M. Sherraden, 1991).

Underserved Households

Unfortunately, this array of basic and beneficial financial products and services is out of reach for many households (Barr, 2004; Bucks, Kennickell, Mach, & Moore, 2009; Carr & Schuetz, 2001; Hogarth, Anguelov, & Lee, 2005). According to the Survey of Consumer Finances, 1 in 12 households are unbanked, that is, they “lack any kind of deposit account at an insured depository institution” (FDIC, 2012, p. 4). Nearly 1 in 4 low-income households are estimated to be unbanked (Bucks et al., 2009).17 Minority groups, unmarried heads of household, the young,18 and people with less formal education, lower income, and fewer financial assets are overrepresented among the unbanked (Abt Associates, 2006; Caskey, 2005; FDIC, 2009; FINRA, 2009b; Stegman, Lobenhofer, & Quinterno, 2003). There are many reasons why people are unbanked, such as poor credit history, past account management problems, cultural and language barriers, geographic location, and lack of knowledge and familiarity. For example, branch bank closings in the wake of the economic crisis have disproportionately affected poorer communities (Schwartz, 2011). Job status and payment method also influences whether people have a financial account (Pew Health Group, 2010). Among those who are unbanked, 72% say they do not have enough money to warrant an account, 35% do not want to share personal information, 35% do not like dealing with banks, 23% say hours or location are inconvenient, and 22% say the banks would not open an account, according to another nationally representative study (FINRA, 2009b). Other studies find that managing and worrying about overdrafts, bouncing checks, fees, and generally keeping up with the account weigh on people’s minds (Barr, Dokko, & Feit, 2011).

When people lack access to appropriate banking products and services, they turn to other financial products and services, which often increase costs over time (Caplovitz, 1967).19 For example, a nationally representative study finds that 71% of the unbanked sometimes used money orders to pay bills, and 47% used check (p.13) cashing stores to cash checks (FINRA, 2009b). Alternative, or “fringe,” financial services include financial services operating outside of federally insured banks and thrifts (Barr, 2004; Berry, 2005; Caskey, 1994; FDIC, 2009; Karger, 2005). These include check cashing outlets, pawnshops, payday loans, rent-to-own, tax refund lenders, car title loans, pyramid schemes, and loan sharks (FDIC, 2009). Alternatives also include informal savings instruments such as rotating savings and credit associations (ROSCAs), and savings clubs. While some may offer convenient and appropriate alternatives, such as low-cost check cashing and prepaid cards, many are predatory and engage in unfair, deceptive, or fraudulent practices (Squires & Kubrin, 2006).

The line between the mainstream and alternatives is increasingly blurred; both sectors provide check cashing, mobile banking, and online person-to-person lending (FDIC, 2009). Unbanked immigrants may avoid bank accounts, using remittances as a money management tool (Pew Health Group, 2010). Moreover, as the recent subprime lending crisis revealed, products and services that exploit vulnerable and unsophisticated consumers are found in both alternative and mainstream financial services sectors. Further, many people use mainstream and alternative financial services simultaneously. These so-called underbanked are unable to meet their financial services needs within the mainstream financial services sector (Pew Health Group, 2010).20

Although alternatives often provide greater access, they lack consumer protections, can be expensive and time consuming, and may lead to problem debt (C. Choi, 2010; Fellowes & Mabanta, 2008). Costs associated with check cashing, tax refund anticipation loans, and payday loans illustrate the high cost of using these services. According to one estimate, a family earning $18,000 a year can spend up to $500 on basic payment products at check cashing facilities (Caskey, 2005, p. 153; see also Fellowes, 2006). In addition to these high costs, homeowners with subprime mortgages pay substantially more than those with prime mortgages (AECF, 2005). The First Nations Development Institute reports that refund anticipation loans (RALs), which offer quick access to tax refunds, charge between 50% and 500% annual interest in Native communities in the United States, among the poorest communities in the country (First Nations Development Institute, 2008). Overall, working poor families who receive the earned income tax credit (EITC) spent an estimated $600 million on RAL fees in 2006 (Wu & Fox, 2008). Another alternative product, payday loans, helps people make ends meet, but in the process, may lead to problem debt and an array of other negative outcomes (Fox, 2009).

Ultimately, however, neither mainstream nor alternative financial products are meeting the needs of low-income households. As Michael Barr, former Assistant Secretary for Financial Institutions in the US Treasury, writes,

The financial services mismatch between the needs of [low- and moderate-income] households and the products and services offered to them largely forces these households to choose among the high-fee, ill-structured products offered by both banking and [alternative financial services] institutions. (2009, p. 67)


As a result, many households rely instead on cash transactions and cash saved at home, a risky approach to cash management (FDIC, 2009; Pew Health Group, 2010). In a recent study on savings in low-income households, one respondent stored emergency money in “little stashes here and little stashes there.” Unfortunately, she reported that the money tended to disappear quickly. “Something always come up, though, and I ended up spending it. And then I’d get started back over again and then something always come up and I ended up spending it” (M. S. Sherraden & McBride, 2010, p. 143). Regrettably, keeping large amounts of cash on hand is unsafe not only because of the threat of spending it but also because it cannot accrue interest and is at risk for theft (Beverly, McBride, & Schreiner, 2003; Mullainathan & Shafir, 2009).

Key Features of Inclusive Financial Products and Services

Emerging evidence in fields of behavioral economics, and economic psychology, anthropology, sociology, and social work suggests features that may extend the reach of financial products and services into financially vulnerable households. Appropriate financial products and services that are accessible, affordable, financially attractive, easy to use, flexible, secure, and reliable will enable them to participate fully in social and economic life (Collins et al., 2009; M. Sherraden, Schreiner, & Beverly, 2003; Thaler & Sunstein, 2008).21 These features are discussed below and illustrated in the next section with innovations aimed at building financial capability.22


Financial services are appropriate when they meet the diverse needs of vulnerable populations. Determining the most appropriate financial services involves taking into account age, gender, education, cultural background, and financial situation on forms and types of financial services. To illustrate, financial services that take into account increasing rates of physical, cognitive, and social network limitations in older years may be appropriate (Wells, 2011). Likewise, immigrants and refugees may prefer cross-national access that allows them and their relatives in the country of origin to access accounts and facilitate sending remittances across international borders (Vexler, Rocchio, Salem, & Vélez, 2008).


This refers to the ability and right to approach, enter, use, and communicate with a financial institution (Beverly et al., 2008). Factors, small and large, pose access barriers to low-income households. Barriers are not limited to location (Fellowes & Mabanta, 2008).23 They also include psychological discomfort, language barriers, and inconvenient hours (Berry, 2005; Caskey, 1994, 2005; FDIC, 2009). Particular groups, such as immigrants who do not speak English or are unfamiliar with US banking, may feel out of place in mainstream financial institutions (Lutheran Immigration and Refugee Services, 2008; Osili & Paulson, 2006). (p.15) Low-income households are often ineligible for checking accounts because of poor credit records and prior problems with managing an account.24 Some bank products, such as direct deposit, do not accommodate irregular income streams.

In recognition of the importance of accessibility, some small banks have transformed the way they reach out to lower-income customers. For example, Union Bank in California created “Cash & Save” outlets, seeking to draw clientele away from check cashing outlets, after they learned customers “didn’t want marble lobbies, comfy chairs, free coffee, and regular business hours.” “For them, Formica countertops were perfectly fine, so long as they could access their money when and where they needed it” (Beaudin, 2006, p. 69; Stegman, 2001).


Financial products and services must be affordable. However, the underserved report that financial products are too expensive given the small scale of their financial transactions (Bucks et al., 2009; Caskey, 2005; FDIC, 2009).25 Among the top five reasons cited by the previously banked for why they are now unbanked, 34% said they do not have enough money to warrant an account, 26% do not want or see the value in an account, and 12% said service charges are too high (FDIC, 2009). A survey of unbanked households finds that a top concern about bank accounts is high fees (29%), followed by confusing fees and high minimum balances (14%) (Barr, 2009, p. 76). For example, a young mother with three children reported paying $240 in bank fees—$20 for each of 12 bounced checks—because her husband’s paycheck arrived late at the bank: “I was just devastated.… We paid hundreds of dollars in check charges that just killed me. And I thought, ‘No more!’” They closed their checking account and joined the ranks of the unbanked (M. S. Sherraden & McBride, 2010, p. 98). For these reasons, programs are developing simple “plain vanilla” accounts that have low threshold requirements (i.e., are relatively easy for low-income people to qualify for and maintain).

Financially Attractive

At the same time, financial services can be financially attractive by offering high returns, low fees, matches, bonuses, prizes, and other benefits. These features are available to bank customers who make large deposits or maintain high account balances. Unfortunately, they are largely out of reach of the poor.26 In fact, low-income people often are subject to high costs for falling below minimum balance requirements (Berry, 2005; Caskey, 1994). Innovations in savings products are providing evidence on how to offer financial benefits, such as savings matches and benchmarks, to households with low incomes (see e.g., NYC Department of Consumer Affairs, 2009; Pender, 2012). Numerous studies suggest that savings matches and bonuses, in particular, attract people to open accounts and encourage saving, although for some segments, the rate of return may also be an effective incentive (M. Sherraden, 1991; Kempson & Finney, 2009; Schreiner & Sherraden, 2007; M. S. Sherraden & McBride, 2010).

(p.16) Easy to Use (with Automatic Features)

The wide array of available financial products and services is confusing, and products are often difficult to use. Especially for those with little experience, low numeracy skills, and lack of financial knowledge, choosing and using financial products and services can be daunting (Berry, 2005; Lusardi & Mitchell, 2007). This suggests that products should be simple and transparent, and information should be clear and readily understandable to all, including non-English speakers, and people with low literacy or disabilities (Kempson & Finney, 2009).

But these features are not enough. Behavioral economics, a field that analyzes how psychology affects economic decisions, provides insights about why. Since it is human nature to avoid making difficult or unpleasant financial decisions, people tend to procrastinate and take the “path of least resistance,” (J. J. Choi, Laibson, Madrian, & Metrick, 2002). To illustrate, people are more likely to save for retirement (important, but unpleasant because it is more enjoyable to spend money now than to save it for the future) when they are part of an “opt-out” savings plan that automatically transfers money to a retirement account. There are several reasons for this. An “opt out” plan yields more participants than an “opt in” plan because most people stay with the default (path of least resistance). Most people save for retirement by precommitting to transfer some wages to a retirement account. In this way, a “saver” does not have to decide to save each month; it happens automatically. Further, it keeps cash out of pockets and checking accounts where it is far easier to spend. Moreover, people tend to think about or “frame” their retirement account differently, further inhibiting its use (e.g., “it’s for my retirement—not for spending”) (Tversky & Kahneman, 1986). In other words, direct deposit into a retirement account (or other savings account) reduces the willpower required to save, making it easier because it happens automatically.

Thus, the design of financial products and services can pad “the path of least resistance,” and “nudge” people toward better financial choices (Thaler & Sunstein, 2008, p. 83). Unfortunately, features that make financial products easier and more effective are often unavailable and unfamiliar to people with low incomes. Their employers often do not offer direct deposit into checking accounts, and typically do not offer or contribute to employee retirement accounts. Reaching low-income households with easy-to-use financial products and services, including asset-building opportunities, requires special designs.

Many savings innovations build on behavioral economics principles, usually by making saving easier through automatic features, providing social support, or making saving more financially attractive through the use of incentives (M. Sherraden, 1991; Tufano & Schneider, 2010). Among the best known is Save More Tomorrowtm, which increases retirement saving through default enrollment and incentives (Thaler & Benartzi, 2004). Other examples include “Keep the Change,” a bank-led program that rounds up debit card withdrawals to the nearest dollar and transfers the difference to a savings account (McGeer, 2007). The bank matches these small savings 1:1 for three months and 5% after that, up to an annual maximum of $250. In a year and a half, 4.3 million customers saved $400 million ($93 on average).27 “Keep the Change” is a simple, customer recruiting and loyalty (p.17) program that encourages bank customers to use a debit card and simultaneously build small savings (Mierzwa, 2007; Tufano, 2009; Tufano & Schneider, 2009).

Some studies suggest that introducing an element of excitement or thrill through savings account prizes or lotteries might attract interest (Kempson & Finney, 2009; Tufano & Schneider, 2010). In “Save to Win,” which uses “thrill” as a savings incentive (Tufano & Schneider, 2009), credit unions entered everyone who made a $25 deposit into their savings accounts into a lottery to win $100,000 and small monthly prizes. More than 11,000 people saved $8.6 million in 2009, including a large proportion of people with low incomes who had not saved regularly in the past (Stuhldreher, 2010). “Save to Win” capitalizes on the excitement of lotteries as well as the common belief that winning the lottery is the most likely method for obtaining a large sum of money (Tufano & Schneider, 2009, 2010).28 However, approaches such as “Save to Win” may encourage people to think that lotteries (even gambling) are a good bet.


Flexibility also is a necessary feature of financial services for low-income families (Collins, Morduch, Rutherford, & Ruthven, 2009; Kempson & Finney, 2009). Income streams are often irregular and unpredictable (M. S. Sherraden & McBride, 2010). Expenses are similarly irregular, some predictable (such as school supplies or a wedding) and some unpredictable (such as a health emergency). At the same time, the margin for error is slim; large or small unexpected expenses, such as a car repair, a theft, or school field trip money, can strain or cause havoc. Lacking emergency savings, low-income families may have to borrow in a hurry, sometimes incurring high fees (Lusardi, Mitchell, & Curto, 2010).

Although not all low-income families need and want the same financial products, some flexible features may be welcome. This might include accounts that allow people to “transact in any sum, no matter how small, at any time” (Collins et al., 2009, pp. 181–182). In savings and insurance, deposits might be more adaptable, permitting small and intermittent payments (perhaps lapsing altogether during hard times) and allowing flexibility to use savings for unexpected events (Kempson & Finney, 2009). Similarly, there is evidence of demand for savings products that allow withdrawals, as well as commitment products that discourage withdrawals (Kempson & Finney, 2009; M. S. Sherraden & McBride, 2010). Similarly, loan payments might take into account financial instability, permitting borrowers to pay larger sums when money is more plentiful and smaller sums when it is scarce.

Secure and Reliable

Finally, financial products and services should be secure and reliable. A legacy of exploitation and discrimination, including the recent wave of subprime lending that led to the economic crisis, has further fueled widespread skepticism of financial institutions in low-income and minority communities (Carr & Schuetz, 2001). A study of unbanked households in Detroit, for example, suggests that account security is a key barrier for customers who otherwise would want an (p.18) account (Barr, 2009), and a national survey finds that 7% of the previously banked report they “do not trust banks” (FDIC, 2009).

Regulation can help. Although the Federal Deposit Insurance Corporation (FDIC) protects accumulations up to $250,000 in bank accounts,29 the recent financial crisis has made clear that more consumer protections and regulations are needed to shelter low-income consumers from unsafe products and services (Barr, 2004; Campbell, Jackson, Madrian, & Tufano, 2011; Tufano, 2009; Warren & Bar-Gill, 2008). Regulation has not caught up with new financial products, such as prepaid cards and mobile banking, which raise significant reliability and security risks (Barr, 2009). Recent legislation may begin to protect consumers from excesses that brought on the Great Recession of 2008 (Boshara et al., 2010). The Credit Card Accountability Responsibility and Disclosure Act of 2009 expands credit card protections,30 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 increases federal banking and securities regulation on financial enterprises.31 The latter also created the Bureau of Consumer Financial Protection, which may increase transparency and reduce fragmentation and inefficiencies in regulation (Tennyson, 2009).32

However, regulation is not enough. Financial institutions have a legacy of discrimination to overcome if they hope to attract impoverished and minority communities as future customers. This requires products and services that meet other criteria, such as affordability and accessibility.

Financial Inclusion Innovations

For illustrative purposes, this section highlights two types of innovations that use these principles to expand financial inclusion in the United States.33 “Bank On,” begun by a coalition of banks, credit unions, nonprofits, and local government to reach the unbanked and underbanked in San Francisco, offers low-threshold products to low-income clients. The initiative aims to reduce an estimated $40 million a year spent at check cashers and payday lenders.34 Within 5 years, an estimated 71,000 starter bank accounts were open and active (Phillips & Stuhldreher, 2011, p. 1).35 The “Bank On” model is being piloted or planned in about 70 cities and 6 states, with mixed results (Phillips & Stuhldreher, 2011). Cities for Financial Empowerment builds on Bank On and the New York City financial empowerment model (NYC Department of Consumer Affairs, 2011) aimed to build financial stability in lower income households across the nation.36

The fastest growing, and perhaps most promising alternative to traditional banking, is so-called branchless banking (Boyd, Jacob, & Tescher, 2007; Busette & Gencer, 2010; Center for Financial Inclusion, 2008). Many see a very different future for banking services in low-income communities because of the high cost of offering low-balance accounts (Caskey, 2005; Barr, 2004). Especially with increased regulation, branchless banking offers a low-cost alternative.

Branchless banking uses cards or codes to access financial services through ATMs, direct deposit, mobile phones, prepaid cards, debit cards, online banking, and electronic check conversion.37 Mobile banking is revolutionizing banking, (p.19) especially in developing countries, as it leverages mobile technology to allow budgeting, payments, depositing, and withdrawals through the use of cell phones (Mas & Mayer, 2011). As Maria Otero (2011), a pioneer in microfinance and currently in the US State Department recently observed: “After spending most of my career in pursuit of financial inclusion, I can’t tell you how delighted I am that the answer is finally at our fingertips. And not just our fingertips … but in the hands of poor, non-banked individuals around the world.”

Branchless banking can link benefits and social assistance that are already delivered electronically to savings and other financial instruments (Barr, 2007; Stegman, 1999; Stegman, Lobenhofer, & Quinterno, 2003).38 Furthermore, unbanked individuals report they would use low-cost, low-risk options such as debit cards, prepaid debit cards, and payroll cards that allow them to withdraw funds through an ATM (Barr, Bachelder, & Dokko, 2006; Fellowes & Mabanta, 2008; Hogarth, Anguelov, & Lee, 2005; Romich, Gordon, & Waithaka, 2009).39

Payment cards, the fastest growing segment of branchless banking in the United States, include debit, prepaid debit, and payroll cards (not gift cards) that permit users to receive income, make purchases, pay bills, and withdraw cash electronically (Barr et al., 2011).40 Depending on the type, payment cards may be loaded by an individual, government-benefit program, employer, reward program, or health benefit program (CFSI, 2010). Payment cards, for example, permit saving through a linked bank account that is separate from the account for the card (Barr et al., 2011). Generally, payment cards are safer than carrying cash, protected against fraud and theft, less expensive than cashing checks at a check casher or using money orders, and promising as a large-scale alternative to mainstream banking.

Challenges to Building Financial Capability through Financial Inclusion

Notwithstanding the growth of promising innovations for financial inclusion, several major challenges remain. First, the types of innovations discussed above still cover only a small proportion of low-income households in the United States. Compared to many other countries, the United States lags in offering branchless banking through mobile phones, while online banking has limited applicability in many low-income households due to lack of secure Internet access. Innovations should inform policy development that can reach millions of low-income families with appropriate financial services (M. Sherraden, 2011). Related to this, we still have a great deal to learn about needs for financial products and services in poor communities.41

Second, many innovative products raise questions for how to safeguard the financial lives of low-income families (Barr, 2009, p. 69; Block, 2011; Busette & Gencer, 2010). For example, while branchless banking holds promise, questions remain about security and privacy, regulatory issues, pricing, and accessibility (Boyd, Jacob, & Tescher, 2007).42 Neither a public nor a private payment card program “offers a broadly available payment card product that is affordable, transparent, and reflects the preferences” of low- and moderate-income households (Barr et al., 2011, pp. 4–5). Fees are often high and confusing, and users may not (p.20) know if their card is federally insured or if it will help build their credit score (Barr et al., 2011; CFSI, 2010; C. Choi, 2010), especially in the fast growing area of branchless banking that lies outside of existing consumer protections.43 Increasing fragmentation of financial services, along with their growing complexity, suggests a need for financial education, guidance, and alternative ways of linking financial products (Stone & Sledge, 2011).

Despite the challenges, these and other innovations suggest that it is possible to design beneficial products and services and extend financial inclusion to ordinary households. They illustrate how features—such as accessibility, affordability, financial attractiveness, ease of use, security, and reliability—can shape quality financial products and services and build long-term financial stability and opportunities for development.

But by themselves, financial services innovations cannot ensure financial capability. People also must know how to manage their household financial decisions and when and how to use financial services. Combining financial education and guidance and appropriate financial services will build financial capability.

Financial capability: linking financial literacy and financial inclusion

The argument for financial literacy is that people who are knowledgeable and skilled money managers will be able to make informed financial decisions and improve financial behavior (Figure 1.1). The argument for financial inclusion is that access to appropriate and quality financial services will increase financial opportunities (Figure 1.2).

Figure 1.3 brings these ideas together into a schematic depiction of financial capability. The combined influence of financial knowledge and skills with financial inclusion generates financial capability, which results in both the ability to act and the opportunity to act.44 Financially capable people are able to behave and

                      Building Blocks of Financial Capability

Figure 1.1 Financial Literacy

                      Building Blocks of Financial Capability

Figure 1.2 Financial Inclusion

                      Building Blocks of Financial Capability

Figure 1.3 Financial Capability

act in their best financial interests. Individual behavior is not always required; some things happen (action) without individual behavior. For example, an employer-based retirement plan requires a signature when the employee signs up, but thereafter, accumulation of retirement savings requires no special behavior from the individual (other than going to work). Financial capability, in turn, contributes to greater financially stability, well-being, and opportunities for future development.

To illustrate, we turn to an example. Let’s say that Jewell, a 16-year-old youth,45 begins her first job at a fast food restaurant. Simultaneously, she enrolls in a high school financial education course, where she learns how to open and manage a secured checking account, and how to sign up for direct deposit of her paycheck. When she goes to the bank to open the checking account, she also learns about a special no-fee youth savings account that requires only a small initial deposit, and bonuses for reaching savings targets.46 Because, eventually, Jewell wants to buy a house, she opens the savings account and arranges to send $20 a month automatically from checking to her savings account. In school, she also learns about higher yield savings vehicles. When she finishes high school and enters community college, she moves into a slightly better paying job. After several years, during which she participates in a free homebuyer course, she reaches her savings goal, transfers her money to a higher yield savings instrument and continues saving. Although she has to borrow occasionally from her savings, after 12 years of saving, when she is 28 years old, she has saved enough for a down payment on a house and some repairs, with a little left over for emergencies.

In this example, a young person actively engages in her financial life, learning and doing at the same time. This interaction between financial knowledge and skills and financial inclusion is central to the idea of financial capability. Using knowledge she gained from school, she developed an early and positive relationship with a financial institution, gained a sense of mastery in money management, and felt more secure because her money was safer and she was accumulating savings (financial well-being). She also avoided exploitative alternative financial services, ubiquitous in the community where she lived. Eventually she had enough money to invest in a house (financial development). Moreover, she felt more in control of her life, which may have helped build her personal resilience. We have little empirical evidence on financial control and well-being, although there is some evidence that desirable financial behavior contributes to overall well-being (p.22) (Kim, Garman, & Sorhaindo, 2003), and evidence of a correlation between debt and psychological ill-health, although causal direction is not clear.

Over time, feedback effects may generate even more learning (higher financial knowledge and skills) and lead to the use of more beneficial financial products and services (more financial inclusion), and greater financial capability. As Nussbaum writes, internal capabilities (in this case, financial ability, knowledge, and skills) and external conditions (access to beneficial financial products and services) are each important, but interact in ways that make the combination more potent than the sum of each of its parts (2000).

According to this schema, however, when financial education and access to quality financial products are not available simultaneously, the impact may be less effective—in some cases even harmful. Suppose that instead Jewell arranges with her employer to deposit $20 a month of her wages to a regular savings account,47 but the bank does not offer a special youth savings account. She occasionally withdraws some savings using the bank ATM.48 She has trouble tracking the withdrawals, and the bank begins to assess fees because of her low balance. When she realizes what is happening, she becomes scared and discouraged. She withdraws her remaining savings and closes the account. Saving seems futile and the bank unfair. Instead, she saves her money at home, where it is more likely to be spent, lent, or stolen. When she needs emergency money, she turns to a payday lender who charges such high rates of interest that she must take out another loan to pay the first. This leads to problem debt and a poor credit rating, which affects her ability to secure good interest rates and may even affect her ability to get a job or an apartment. What may be worse, these experiences leave Jewell with a negative view of financial institutions, leaving her with diminished capability to act in her best financial interests in the future.

Today, unfortunately, the second scenario is more likely than the first. Even when young people take a financial education class in high school, their employers are unlikely to offer direct deposit, and youth are unlikely to have access to an incentivized youth savings account. Parents, who often use alternative financial products, may not be in a position to help their children navigate mainstream financial products and services. Moreover, youth may not be thinking about long-term saving in part because their parents may have no experience in long-term financial investing.

The consequences of low financial capability can be even more serious. In recent years, easy credit, low incomes, and poor money management, among other factors, have contributed to severe financial problems among low- and moderate-income families (Introduction, this volume). For example, many low-income families, in pursuit of the American Dream of homeownership, purchased houses with subprime loans, and subsequently lost them to foreclosure, or are “under water” on their mortgages (AECF, 2005). Even financially literate borrowers eligible for prime loans utilized subprime loans because of heavy marketing and targeting in low-income communities. In one year alone (2009), almost three-quarters of a million subprime loans were in foreclosure (Mortgage Bankers Association, 2010). (p.23)

These examples suggest that failing to connect internal capability (financial knowledge and skills) and external conditions (financial products and services) could produce what Amartya Sen calls an “unfreedom” that limits a person’s capabilities (1999, p. 86). In practical terms, these examples represent the loss of hope and sense of a future, as well as widespread and tragic loss of household net worth. Financial instability and loss have associated negative psychological costs that have important implications for well-being (Taylor, Jenkins, & Sacker, 2009).

Fortunately, there have been advances in promoting financial capability in low-income households. First, innovations in savings combine a financial product with financial education to build financial capability in families who have been largely excluded from asset-building policies in the past (Howard 1999; L. S. Seidman, 2001; M. Sherraden, 1991; Woo, Rademacher, & Meier, 2010). Individual Development Accounts (IDAs) and Children’s Development Accounts (CDAs) use incentives (often a 1:1 or 2:1 match) to attract savings and help people build assets for investment purposes (M. Sherraden, 1991). Some form of financial education usually accompanies IDAs. Research finds that low-income people can and do save for longer-term goals, and they respond to incentives (Schreiner & Sherraden, 2007).

A second example is a promising approach from New York City, which integrates financial counseling into service delivery systems (Bloomberg & Mintz, 2011), and has generated a number of banking products and services including streamlined bank accounts, savings accounts, along with financial education and counseling in low-income neighborhoods. The bank account, SafeStart Bank Accounts, is a savings account with a starting balance of $25, an ATM card, and no overdraft or monthly fees (Fernholz, 2010; NYC Department of Consumer Affairs, 2009, 2010a). The savings account, SaveNYC (which has now expanded nationally and is called SaveUSA), is an incentivized matched savings program designed to encourage short-term savings among low- to middle-income tax filers (Bloomberg, 2012). Twenty-five financial empowerment centers reach nearly half of the unbanked households in New York (NYC Department of Consumer Affairs, 2010b; NYC Department of Consumer Affairs, 2011; Santos, 2011).

Empirical Evidence on Financial Capability

Empirical evidence on financial capability is promising but nascent (Baker & Dylla, 2007). Studies show an association between financial knowledge and positive financial practices, although causality is unclear (Courchane & Zorn, 2005; Hilgert, Hogarth, & Beverly, 2003; Monticone, 2010). In other words, most studies examine a “bundle” of services—such as an account, financial education, and support—without isolating their independent effects. However, there is some evidence on financial capability. In one study, for example, experience with financial products (bank account and investing) explains more variance in investment knowledge than a high school financial education course (Peng, Bartholomae, Fox, & Cravener, 2007). A comparison of financial education-only and financial education-plus-IDA finds that participants in the latter tested significantly higher (p.24) on financial knowledge on average, although the two groups, both low-income, differed in important ways (Anderson, Zhan, & Scott, 2004). Two large randomized control trials in India and Indonesia find that people who received small subsidies for opening a bank account had much higher account opening rates and use of the account, than those who received only financial education (Cole, Sampson, & Zia, 2011). Another study finds some higher financial management skills among soldiers who owned a savings account in high school (Bell, Gorin, & Hogarth, 2009). In the Small Dollar Loan program piloted by FDIC, default rates appear to be lower in products accompanied by savings and financial education; however, limited sample size and program variation temper these results (Miller, Burhouse, Reynolds, & Sampson, 2010).

Leading with Financial Product

Some programs “lead” with offers of a financial product but also include financial education. The financial product draws interest, and the addition of education aims to improve understanding and product management. For example, Individual and Child Development Accounts, college savings plans, homebuyer programs, income tax preparation, public benefits, jobs, emergency aid, and saving clubs focus on product outreach but sometimes also offer financial education. There is some evidence that outcomes improve with the addition of financial education. For example, there is independent contribution of financial education (up to 10 hours) on opening an account and saving performance in IDAs (Schreiner & Sherraden, 2007). But another randomized study of IDAs in Canada called Learn$ave finds that the group that received 15 hours of financial management training and case management services did not save more than the group with the saving match only, although qualitative findings suggest the educational content may have been inadequate (Leckie, Shek-Wai Hui, Tattrie, Robson, & Voyer, 2010). Another study that encouraged low-income participants to open bank accounts finds that those who did not plan to open an account had good financial reasons, suggesting the importance of providing financial education and financial services at the same time (Lyons & Scherpf, 2004). A large-scale matched savings program in the UK, Saving Gateway, found a low take-up rate for financial training and advice (8% to 18% in different phases), and in qualitative interviews, participants expressed lack of enthusiasm (Kempson & Finney, 2009, p. 46).

Programs that lead with financial services find that offers of financial education are not an enticement to participate. After discovering that “getting a bank account is not an incentive to go to a [financial education] class” in Bank On San Francisco, the program decoupled financial education requirements from account opening (Phillips & Stuhldreher, 2011, p. 13). An evaluation of the federal government’s First Accounts program, which aimed to bring low-income households into the financial mainstream, finds that few participants took up the free education services (Abt Associates, 2006). A study assessing the effects of offering online banking along with financial and computer literacy to low-income participants finds that participants were drawn by the technology, although implementation challenges diminished effectiveness overall (Servon & Kaestner, 2008).

(p.25) Leading with Financial Education

Other programs lead with financial education but also offer a financial product or service. This type of experiential education may increase motivation, attention, focus, and absorption of information (Johnson & M. S. Sherraden, 2007; O’Neill, 2006). Some research suggests that even an imagined product may make financial education more effective (McCormick, 2008; Russell, Brooks & Nair 2006). For example, financial education using a stock market game has better outcomes than didactic approaches (Mandell, 2008). Unbanked participants in a financial education program in Chicago were encouraged to open a bank account. When offered a bank account by a bank representative who attended the financial education workshop, the take-up rate (and use of other complementary bank products) was significantly higher than among unbanked participants who attended a workshop without a bank representative present (Bertrand, Mullainathan, & Shafir, 2006). A survey of financial education programs in San Francisco reported increased participation in financial education programs that also offered incentives with tangible benefits (L. Choi, 2009). For example, homebuyer education programs offering a tangible benefit (such as down payment assistance) may draw more low-income participants and incentivize participation in financial education or coaching.

Some studies question combining financial education and products. For example, Lewis Mandell’s research finds that individual motivation, more than owning stocks or credit cards, leads to better performance on a financial literacy assessment (Mandell, 2004; Mandell & Klein, 2009). A qualitative study of a youth savings account and financial education program finds that participants attribute increased financial knowledge to financial education workshops but not to holding assets, but youth also express dislike for financial education sessions (Scanlon & Adams, 2009).

Future applied research should focus on understanding the discrete and summative contributions of financial education, guidance, and financial products and services. Research should also explore if effectiveness differs by approaches to financial education and across variations in financial products. Offering financial education and a savings account with automatic deposit features, for example, may have stronger effects on savings than offering financial education and a matched savings account. More work is needed to identify the key indicators of financial knowledge and skills and financial inclusion, as well as financial stability, well-being, and financial development. Research should also examine what works for diverse groups of financially vulnerable people (e.g., different stages of life, gender, cultural backgrounds, and perceptions of risk). What works for different population groups? Greater clarity across these questions will generate more effective policy and practice.

Next steps in building financial capability

Financial capability leads to greater financial stability and a brighter financial future. Researchers and practitioners are beginning to understand how to build (p.26) financial capability in low-income and financially vulnerable households. Families also need access to quality financial products and services appropriate to their circumstances. For many financial matters, getting the services right is just as important. For example, a person with a steady income, a retirement account (with an employer contribution), and access to free banking and safe and inexpensive insurance is a long way toward being financially capable. One such professional recently underscored the impact of the benefits he receives as part of his employment: “My [financial] illiteracy is undetected and irrelevant. It is my option-rich environment that—regardless of my personal financial literacy—provides me with financial services, accessibility, and inclusion.” Nonetheless, theoretical and empirical evidence suggests that understanding financial basics and how to manage money and make optimal financial decisions is also essential, but impact will be limited if financial education and counseling is done in isolation from improving access to quality financial services.



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(1.) Recently, financial vulnerability has been operationalized by Lusardi, Schneider, and Tufano (2011) as the estimated one-half of Americans unable to access $2,000 in 30 days in the event of an emergency. However, we use the term along the lines of others, such as Chambers (1989), who suggests a broader definition: Financial vulnerability refers not only to having a low income but more generally to “defencelessness, insecurity, and exposure to risk, shocks, and stress,” including loss of assets (p. 1).

(2.) For detailed discussion of these perspectives, especially as it concerns saving in low-income households, see Beverly and Sherraden (1999), Beverly et al. (2008), and M. S. Sherraden and McBride, 2010.

(3.) The principle of “person-in-environment” in social work bears some similarities (Kondrat, 2002).

(4.) As described by a 2009 financial capability survey: “financial capability encompasses multiple aspects of behavior relating to how individuals manage their resources and how they make financial decisions (including the factors they consider and the skill sets they use). It is a multi-dimensional concept that requires looking at individual behavior from various angles” (FINRA, 2009a, p. 4).

(5.) An exception is the President’s Advisory Council on Financial Capability, which defines financial capability as financial education and financial access, although some of its work appears to equate financial capability with education, as is evident in this statement concerning youth: “Financial capability starts with financial education” (US Department of Treasury, 2011a, p. 1).

(6.) We distinguish between an individual’s expectations (what an individual expects to actually occur given existing constraints) and aspirations (what an individual would like to occur given the best circumstances) and suggest that expectations are a stronger predictor of behavior.

(7.) The core competencies mentioned refer to the ability of consumers to make informed decisions about their personal finances and include: earning, spending, saving, borrowing, and financial protection (US Department of Treasury, 2010).

(8.) Fortunately, recent regulatory changes are already beginning to prevent this type of situation, although more protections are needed, according to the Consumer (p.27) Federation of America, The Center for Responsible Lending, and other consumer research and protection groups. (http://www.federalreserve.gov/consumerinfo/wyntk_creditcardrules.htm)

(9.) There are other streams of inquiry, reviewed in Xiao, Collins, Ford, and colleagues (2010).

(10.) There are cognitive developmental limits (Berti & Bombi, 1988).

(11.) Scholars note a high correlation between financial literacy and parent education and level of financial investment (Lusardi, Clark, Fox, Grable, & Taylor, 2010; Mandell, 2008).

(12.) The number of financial education and effectiveness studies is too numerous to cover in detail here. (Detailed reviews of the research include: Agarwal, Amromin, Ben-David, Chomsisengphet, & Evanoff, 2011; Atkinson, 2008; Braunstein & Welch, 2002; Buckland, 2011; Caskey, 2006; Courchane & Zorn, 2005; Fox, Bartholomae, & Lee, 2005; Hathaway & Khatiwada, 2007; Hogarth, 2006; Lusardi et al., 2010; Lyons, 2005; Lyons, Palmer, Jayaratne, & Scherpf, 2006; Martin, 2007; Schuchardt et al., 2009.)

(13.) Financial guidance also may include financial case management and financial tutoring, but these terms are ill-defined.

(14.) For example, the Community Services Society of New York City has organized a volunteer Financial Coaching Corps (http://www.cssny.org/programs/entry/financial-coaching-corps).

(15.) In the United Kingdom, which has made strides in designing a universally accessible system of financial advice, policy makers are examining a national accreditation system for personal advisors to ensure quality services (Ben-Galim & Lanning, 2010).

(16.) The Financial Literacy Center is a joint project of The Rand Corporation, Dartmouth College, and the Wharton School of Business at the University of Pennsylvania. (http://www.rand.org/labor/centers/financial-literacy.html)

(17.) The “unbanked,” according to the FDIC, include all those who answer “no” to the question: “Do you or does anyone in your household currently have a checking or savings account?” (Bachelder et al., 2008).

(18.) Although the preretirement (ages 45–64) group, especially minority and low-income, has high rates of unbanked (16.5 million), suggesting challenges for saving for retirement (Jackson et al., 2010).

(19.) People also turn to credit. In New York City, residents are less likely than the national average to be unbanked, yet in nine of the ten poorest neighborhoods they are more likely to have a credit card than a bank account (NYC Department of Consumer Affairs, 2011).

(20.) According to the FDIC estimates that 21% are underbanked, defined as households that “hold a bank account, but also rely on alternative financial services providers” (Burhouse & Osaki, 2012, p. 4).

(21.) There are many definitions of financial inclusion and exclusion. This one draws from Stein, Randhawa, and Bilandzic (2010); and the Center for Financial Inclusion, which also calls for a “full suite of quality financial services” and “with dignity for the clients” as key features (http://www.centerforfinancialinclusion.org/Page.aspx?pid=1941).

(22.) There are other important areas for consideration, including other ways that people transfer funds, manage risk and credit, and invest. However, we limit the discussion to checking and savings accounts because they are basic for financial management. (p.28)

(23.) Fellowes and Mabanta (2008) report that 56% of lower-income neighborhoods have bank and credit union branches, compared to nonbanks, which are located in 31% of such neighborhoods.

(24.) Insufficient funds in an account can lead to fees for overdrafts and bounced checks, refusal by banks to issue a checking account, and reports to the ChexSystem®, which, similar to a credit report, follows a patron and may prevent the individual from opening accounts in other banks for a period of up to five years.

(25.) For their part, banks also argue that offering low-balance accounts is expensive (Barr, 2004).

(26.) As David Caplovitz (1967) pointed out several decades ago, the poor “pay more,” including for financial services (AECF, 2005; Fellowes, 2006).

(27.) The bank has benefited from the 1.8 million new savings accounts and 1.3 million new checking accounts over 19 months (Mierzwa, 2007).

(28.) In 2007, lottery revenues in the United States almost reached $24 billion (American Gaming Association, 2010), and sales are up during the economic crisis (Matheny, 2011).

(32.) Officially, the law’s (H. R. 4173—605) purpose is “to implement and, where applicable, enforce Federal consumer financial law consistently for the purpose of ensuring that all consumers have access to markets for consumer financial products and services and that markets for consumer financial products and services are fair, transparent, and competitive” (http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf).

(33.) In an effort to reach scale, some innovations piggyback on other institutions. For example, the US Treasury is piloting a refund program in 2011 that has features of a checking account. In the planned pilot, 600,000 people will receive offers for a debit card for tax refunds that has free bill paying, free ATM withdrawals at select machines, and spending without added fees (Reddy, 2011). Evaluation will measure take-up, comparing different approaches in charges and messaging (Reddy, 2011). Other examples include an automatic savings option associated with the Earned Income Tax Credit (Wagner, chapter 10, this volume), bank-at-school initiatives (Cruce 2002; Rhine, Reeves, Castro, Wides, & Williams, 2009), and automatic savings deposits at birth (Clancy, Lassar, & Taake, 2010).

(37.) http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre14.pdf. Internationally, governments and financial institutions are linking branchless banking and government-to-people (G2P) programs that use electronic banking to transfer social assistance payments, pay wages, and send pension payments to households (Mas, 2008; Pickens, Porteous, & Rotman, 2009).

(38.) Electronic benefit transfer (EBT) is used widely by federal and state governments (see http://fms.treas.gov/eta/background.html).

(39.) Other innovations provide low-cost/small dollar credit alternatives to pawnshop, payday, and auto title loans (Sanders & Forman, 2010). These may include small (p.29) dollar loans or salary advances from banks and credit unions, salary advances by employers, creditor payment plans, emergency assistance programs, and military loans (Center for Responsible Lending, 2010). For example, FDIC guidelines allow banks to offer loans up to $2,500 (with no/low origination fees and a maximum 36% annual percentage rate, or APR), and credit unions offer loans to members at even lower rates (FDIC Small Dollar Loan Program, http://www.fdic.gov/smalldollarloans/; Miller, Burhouse, Reynolds, & Sampson, 2010).

(40.) See Barr et al. (2011) and Flores (2011) for description and analyses of prepaid cards. One type, reloadable prepaid cards, with an estimated value of $120 billion in 2009, can be used where the card brand is accepted (CFSI, 2010; Flores, 2011).

(41.) Studies underscore the difficulty in recruiting low-income and unbanked individuals into IDA programs, with implications for demand (Sherraden & McBride, 2010).

(42.) Interestingly, research in Kenya, for example, which has a high penetration of mobile banking among the poor, finds that people do not lose money at higher rates using this technology compared to traditional banking or savings groups, and furthermore, they resolved problems more quickly (Zollman & Collins, 2010).

(43.) People may not understand fees and may also be liable for losses. For example, losses may result if they do not report errors promptly, or if they lose their cards (http://www.fms.treas.gov/eft/regulations.html). Although the FTC advises card owners to notify their financial institution by certified letter with return receipt requested (keeping a copy for their own records), this advice is likely to go unheeded in many households. Moreover, there is little recourse after 60 days. http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre14.pdf

(44.) We intentionally use opportunity to “act” instead of “behave.” Improvements to financial well-being may occur without individual behavior. For example, retirement savings plans often require only one “behavior” (sign-up for an employer-based retirement plan), but accumulations happen automatically without any further behavior (automatic transfers and employer matches).

(45.) Jewell is a composite sketch from qualitative interviews with low-income savers conducted by the author and colleagues (Sherraden, Johnson, Guo, & Elliott, 2010; Sherraden & McBride, 2010).

(46.) Some Children’s Development Account (CDA) programs offer these kinds of incentives.

(47.) Even this service may not be available. Many low-wage employees have no access to direct deposit.

(48.) Some banks now offer ATM withdrawal protection so that customers cannot overwithdraw from their accounts; nonetheless, many charge fees for low balances.