Financial Capability among Microfinance Clients in Indonesia

Lubis, Arief Wibisono; Comim, Flavio (2016). 'Financial Capability among Microfinance Clients in Indonesia' Paper presented at the annual conference of the HDCA, Tokyo 2016.

A number of studies have shown that financial development leads to a higher level of economic growth and lower inequality (Levine, 1997; Galor and Zeira, 1993; Banarjee and Newman, 1993). The fact that there is still limited financial development in some countries drives many attempts to identify the factors. One argument is that lack of financial development is caused by limited access to finance, or commonly referred as financial exclusion (Demirguc-Kunt and Klapper, 2012; Atkinson and Messy, 2013). Among the demand factors that leads to financial exclusion, financial literacy and financial capability have been receiving much attention from policymakers. However, there are few academic research on these two topics, especially financial capability, and a majority of them were conducted in developed economies (Atkinson, McKay, Collard, and Kempson, 2007; Lusardi, 2008; Alessie, Van Rooij, and Lusardi, 2011; Taylor, Jenkins, and Sacker, 2011). With regards to these topics, there are some issues remain unanswered within the context of developing countries. Given the strong informal sectors’ role in these countries (Collins et al., 2009), does the issue of financial literacy as envisioned by the mainstream literature matter for development? Sen (2000) addresses the importance of the ability of transforming resources, which financial literacy to some extent fits this ability, but is it the one that we should focus on?
There has been a move from the narrower concept of financial literacy to the broader financial capability. However, the literature shows disagreements in the concept and what it should comprised of. How can we align financial capability with the capability approach by Sen (1985a, 1985b)? Aside from Johnson and Sherraden (2006), Huang et al. (2014), and Storchi and Johnson (2016), an explicit link between financial capability and the capability approach has been overlooked. From these studies, two main values can be taken from the general idea of capability approach to financial capability: expansion of financial opportunity and the importance of social, economic, and cultural context that result different conception of financial capability. A follow up question then: how should we conceptualise financial capability, especially in the context of developing countries such as Indonesia? This question has not been widely explored, except by a number of limited studies such as Zollmann and Collins (2010) and World Bank (2013). The impact of financial capability on different aspects of life is another topic that deserves more attention, considering only a limited number of studies discuss it (see among others: Taylor, Jenkins, and Sacker, 2011 for the influence of financial capability on psychological well-being).
Our study tries to examine the issues of financial capability in the context of microfinance clients in Indonesia. From indicators published by the World Bank, compared to some peer countries, Indonesia is still lack behind in terms of financial development (ratio of credit to GDP, financial inclusion index, etc). By focusing in microfinance clients, we strive to contribute to the literature that examines the role of microfinance in development. In order to capture Indonesia’s diverse socio-demographic characteristics, the study is conducted in three cities in Indonesia: Makassar, Mataram, and Yogyakarta. In response to the questions listed at the end of the previous paragraph, this study has several more specific objectives. Firstly, it attempts to identify how people conceptualise financial capability. It also aims to see what factors can predict financial literacy and capability, by focusing on those identified in behavioural economics literature, and how the two variables contribute further to human development, as seen from the multidimensional quality of life. We expect that the result will contribute to policymakers in Indonesia, considering the country is currently in the initial phase of implementing the national strategy of financial inclusion.
We employ a combination of qualitative and quantitative methodologies as defined by Kanbur (2001). The qualitative aspect involves a participatory approach, in which the stakeholders play an important and active role in defining financial capability to follow Sen (2009)’s idea of public reasoning. Data collection began with a series of interviews and FGDs with various stakeholders (i.e. microfinance institutions’ clients, microfinance institutions’ management, and policymakers) in order to understand how financial capability should be conceptualised. Some of the results of this qualitative work is used to develop a questionnaire as the main measurement’s tool. We then distributed the questionnaires to more than 2,600 microfinance clients in three cities in Indonesia. Relationships between the variables are examined using regression techniques.
The result of the first phase of data collection, which consists of the results from interviews and FGDs, shows that people mainly define financial capability as the ability of daily financial management. This is the top-of-the-mind concepts that came out from the participants when asked about what constitutes people with financial capability. Other aspects such as the ability to plan and ask advice about financial issues, and financial literacy, are less frequently appeared, although after some probing questions the participants acknowledge the importance of some of these aspects. From the interviews and FGDs it appears that social networks play an important role in expanding people’s capability.
A measure of financial capability was then built, and we tried to examine the main predictors of this measure using the quantitative data from the second phase of data collection. Using OLS and WLS regressions, we found that financial capability varies with socio-demographic factors such as gender, age, education, and expenditure. Departing from the literature of behaviour economics, we also see whether psychological factors, both cognitive and non-cognitive traits, possess a contribution value in explaining variation in financial capability. The result confirms that controlled for the social-demographic indicators, cognitive factor is indeed a significant predictor, while trust as one component of general non-cognitive traits does not significantly explain financial capability. We also investigate whether higher financial capability is associated with the multi-dimensional quality of life, and the regression result shows the positive association.

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