Lubis, Arief Wibisono (2017). 'Is financial literacy a relevant conversion factor?: Exploring the value of financial literacy within the capability approach framework' Paper presented at the annual conference of the HDCA, Cape Town 2017.


Introduction and purpose: Empirical studies on conversion factors have not been widely conducted in the capability literature (see among limited studies: Chiappero-Martinetti and Salardi, 2007; Binder and Broekel, 2011). This is a significant potential area of research considering the role of conversion factors in human development evaluation is one important building block (Sen, 1985). Meanwhile, financial literacy has received an increasing amount of attention in the academic literature, with its role in improving financial behaviour as one popular case to be examined. Although most of the studies show limited evidence on the impact of financial literacy on financial behaviour, we can still find debates on this (see among others: Lusardi and Mitchell, 2006; Fernandes et al., 2014). However, financial literacy should be evaluated beyond the financial behaviour spectrum, since the policymakers envision financial literacy to be useful in helping people to achieve higher level of well-being. This study employs the capability approach in analysing the importance of financial literacy by answering the question: is financial literacy a relevant conversion factor? Another problem with financial literacy is that it has been criticised as being too narrow in explaining the dynamics of financial exchanges, especially with regards to the context of developing countries where economic and social exchanges are closely intertwined and people still rely heavily on informal financial sector (i.e. loans and grants from friends, family, etc). Conducting this research in a developing country like Indonesia will help to strengthen or negate this claim. Since non-cognitive trait such as self-confidence and trust has been proven by previous studies to impact financial behaviour (Gathergood, 2012; Guiso et al., 2014), another question that worth to ask is: what is the role of money attitude in conversion factors? Does it play a more significant role compared to financial literacy?

Research Methodology: I conducted a survey among more than 2,100 microfinance institutions’ clients in three provinces in Indonesia: DI Yogyakarta, West Nusatenggara, and South Sulawesi. There is hardly any study concerning financial capability in the Indonesian context, especially the one focusing on conversion factors. The choice of these provinces is based on cost and representativeness consideration. I adopt the approach by Deprins et al. (2014) that has been applied by Binder and Broekel (2011) in developing the conversion rate measure, in which output-oriented order-m non parametric efficiency calculation was employed. The logic behind this approach is to find the relative efficiency (conversion rate) of each decision making units (DMUs, or respondents in our research) compared to their peers. Since the focus is on microfinance institutions’ clients, it is interesting to see how these clients convert business profit into quality of life output, hence we use profit as the sole input for efficiency calculation. I use three dimensions of quality of life as has been used by Binder and Broekel (2011): health, housing, and nourishment. Financial literacy itself is measured by 5 questions that examine respondents’ knowledge on inflation and rate of return, the concept of diversification, and national social security system (Lusardi and Mitchell, 2006; Fernandes et al., 2014; Bernham et al., 2012), while money attitude comprise questions on confidence about investment decision making (Fernandes et al., 2014). Ordinary Least Square (OLS) with robust standard error is employed in examining the relationships among the variables.

Preliminary findings: The result confirms the initial hypothesis on the positive influence of financial literacy on conversion rates, suggesting that financial literacy is a relevant conversion factor among microfinance institutions’ clients in Indonesia. When the sample is divided into several sub-groups according to gender, age, place of living, and monthly profits, one can see that the significant role of financial literacy only holds among certain groups, including women, those living in DI Yogyakarta and South Sulawesi, older age group, and those with lower profits. The results can be used to target certain groups in which financial literacy has been proven to improve their conversion rates. Another important finding, given the inclusion of several socio-demographic indicators as control variables, is that conversion rates discrepancies among different sub-groups are real. Conversion rate inequality among people living in different provinces complement the data that show inequality of traditional economics measures such as regional gross domestic products and other quality of life indicators. Descriptive statistics also suggest that certain groups in the society should be the focus of financial literacy enhancement programmes, since their levels of financial literacy are overall low. Women is an example of sub-groups in our sample in which the level of financial literacy in general is poorer. This supports previous findings that highlight low level of financial literacy among women (OECD/INFE, 2013). Paradoxically, the result of this study’s regression analysis shows that financial literacy is important among women. Increasing women’s financial literacy thus is one way to improve their conversion efficiency. Following this this result, although poverty and conversion rates do not necessarily related, microfinance institutions should pay attention at financial literacy of their clients if these institutions are serious in improving the lives of their clients, since microfinance has been advanced as one solution for poverty reduction.

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