Note: As part of the Central Bank of the Future research project, we asked a few people to help us think big in reimagining the Central Bank of 2070. What underlying assumptions would have to change to foster economic inclusion? This post is the first article in our "What If...?" blog series.
What if central banks were governed by an understanding that ensuring the financial health of the citizenry was as important a goal as maintaining the health of the economy?
There is a clear connection between macroeconomic health and microeconomic health. Consumer financial challenges are often the canary in the coal mine that signal the broader economy is headed for trouble. As an example, consider the subprime mortgage meltdown that triggered the 2008 financial crisis. Yet central banks and the broader academy tend to consider macro- and microeconomics in isolation from each other, as separate disciplines. If the macroeconomy is the balance sheet and the microeconomy is the P&L, then what we’re missing is the cash flow statement that connects them. Financial health accounting may provide the linkage between the two, providing central banks with a new set of indicators by which to monitor the health of the economy.
While some central banks already have a mandate around financial inclusion, financial health is different. Financial health comes about when people have day-to-day systems that enable them to build resilience and seize opportunities. It’s about being able to spend, save, borrow, and plan in ways that enable people to manage life’s ups and downs. While inclusion is primarily about getting people into the formal financial system, as measured by account ownership, financial health is the desired outcome.
At the rate we’re going, we are on track to solve the pure inclusion problem.
According to the Findex survey, in the last eight years, the share of adults around the world who own an account through a financial institution or a mobile money service has increased 18 points, from 51% to 69%. Owning an account can be helpful, but it is just the first step. Case in point: In India, the government facilitated the opening of accounts for everyone. About half of these accounts are now dormant. Likewise, in the United States, 89% have a checking account, but 30% aren't able to pay all their bills on time, and 39% wouldn't be able to pay an emergency $400 expense with cash or a cash equivalent. Moreover, owning an account can have negative consequences. Look no further than overdraft fees in the United States, which generate at least 30% of service charge income for seven of the largest banks. Or consider how lenders gain power over borrowers by having access to collect payments via direct access to a customer’s bank account.
We have made great strides in ensuring consumers are financially literate, protected, and banked, but those outcomes are just the baseline. We now need to raise the bar. What we should care about - and what central banks should ultimately be focused on - is ensuring that citizens are financially healthy.
How do we know if someone is financially healthy? Multiple measurement frameworks have emerged over the last six years. Some are subjective measures, while others are objective. Most gather data from consumer surveys, while some have developed proxy measures from transaction and product usage data. They all have one thing in common: a recognition that financial health is about both stability and opportunity, today and over the long term.
My organization developed one of the first measurement frameworks, along with a financial health score. We use this framework as the basis of an annual survey on the state of financial health in the United States. As of 2019, data from the U.S. Financial Health Pulse finds that only 29% are healthy, 54% are coping, and 17% are vulnerable. In addition, dozens of financial services companies are using our methodology to measure the financial health of their customers, design products and strategies, and understand what works to improve it.
We also worked with the Center for Financial Inclusion at Accion and the Gates Foundation to understand whether our framework was relevant in a developing country context. In partnership with the Dalberg consulting firm, we spoke to people in Kenya and India. We asked how they think about their financial lives and conducted surveys to test a variety of indicators. We found that while people use similar words to define financial health in those countries as they do in the U.S., the indicators need to take into account absolute income level, the strength of one’s social network, the role one plays in the household, and the even more dramatic levels of income volatility experienced in developing countries.
What would it mean for central banks to regularly measure the financial health of the citizenry? For one, it might provide a new set of leading indicators by which to monitor the health of the macroeconomy. It might also change the culture of central banks, as what gets measured gets managed. When the Federal Reserve Bank of the United States lowers interest rates to spur economic growth, for instance, what may be a boon for corporations can be harmful for individual savers who will find it harder to build up the kind of buffer helpful in managing through financial shocks.
Economic growth and individual resilience are both important policy goals. Balancing them is critical to designing policies that can improve overall economic health without sacrificing Main Street for Wall Street, or vice versa. For that to happen, financial inclusion, and ultimately financial health, must be more than a stand-alone mandate or function. It needs to be integrated into the broader role of central banks. It needs to be baked into the purpose of the Central Bank of the Future.
Jennifer Tescher is the President & CEO of Financial Health Network, a national non-profit organization whose mission is to improve financial health for all. Learn more at https://finhealthnetwork.org/ (link is external).