Financial fragility and financial stress during the COVID-19 crisis: evidence from.
| Autor | Cardona-Montoya, Raul Armando |
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Introduction
The successive and continuous economic crises and the volatility of the international financial markets have had negative impacts on production, employment and income that may in turn have affected the finances of individuals. The global COVID-19 pandemic negatively affected the financial well-being of millions of households around the world, specifically their capacity to have control over day-to-day finances (Consumer Financial Protection Bureau, 2017).
Referring to Garman and Joo (1998), Fadzli Sabri and Falahati (2013) state that financial wellness is a comprehensive concept that comprises financial satisfaction, financial objectivity, financial perception and financial behaviour that all cannot be assessed through one measure. Hence, the construct of "financial literacy" became a matter of public relevance after the sub-prime financial crisis of 2008 because of its potential role in the stability of the economy (Consumer Financial Protection Bureau, 2015; Lusardi, 2015; Cordero and Pedraja, 2018; Lusardi et al, 2020).
Financial literacy has become a main concern among financial educators in recent decades in such a way that the Consumer Financial Protection Bureau (2015) stated the following: "the ultimate goal of financial literacy is sustained financial well-being for individuals and families". But attaining this goal is far from easy, as Chieffe and Rakes (1999) have observed, unplanned financial events are a problem that affects people with low incomes, but they can also affect those who have middle or high incomes. In other words, the lack of financial literacy may lead to financial fragility that makes households more vulnerable to negative external shocks and leads to a negative outlook on their finances.
Although Lusardi and Mitchell (2011) have identified that nearly half of Americans are financially fragile, Fisch et al. (2019) have shown that the financial crisis may have helped people to become less financially fragile. For instance, they identified that the percentage of working-age Americans considered as financially fragile decreased from 40% in 2012 to 36% in 2015. Later, Lusardi et al (2020) found that 27% of respondents were financially fragile and had low confidence because so many families were under financial distress after losing their pay cheques and without a buffer stock of savings or access to funds, many Americans had a difficult time in the COVID-19 crisis.
Unsurprisingly, the situation is even worse in emerging countries. Ali et al. (2020) show that one-fifth of urban Malaysian households would not be able to survive for at least three months after their income was cut off, and 68.2% of Pakistani households have suffered financial distress (Caner and Wolff, 2004). Valerio and Villamonte Blas (2022) explain the impact of financial stress on economic activity and financial stability using a panel of advanced and emerging economies.
In Colombia, due to the effects of the pandemic, thousands of businesses went bankrupt or entered into financial restructuring agreements through the protection of the Bankruptcy Law. This liquidity crisis occurred as the country's GDP showed negative growth of 6.8% (DANE, 2021). The foregoing produced the destruction of 5.5 million jobs in the first month after social isolation was decreed during the pandemic. This degree led to an unemployment rate in 13 main cities of 11-21.5% and was at 15.9% at the end of 2020 (DANE, 2021).
Furthermore, the government could make worse the negative effect of the crisis by generating households' financial stress. According to the Interamerican Development Bank (2020), the pandemic has exerted high fiscal pressure on the economies of all countries worldwide and has had a negative effect that has generated liquidity and debt problems that have affected households, which are not financially prepared to deal with it.
Many studies have related financial literacy with financial fragility, but very few have addressed the relationship between the previous two constructs with financial preparedness and financial stress. Financial preparedness allows people to make the best consumption, savings, investment and financing decisions, and these in turn put them in better shape to manage financial stress during an exogenous crisis. Although some studies have addressed these issues, such as the ones of Lusardi and Mitchell (2011), OECD (Organisation for Economic Co-operation and Development) (2014) and Lusardi (2015), it is important to design specific questions to measure financial preparedness and financial stress.
Thus, we aim to measure four constructs (financial literacy, financial fragility, financial preparedness and financial stress) and determine their relationship to a sample of Colombian households. Our contribution lies in the creation of the construct of financial stress and its relationship with the previous three constructs in an emerging country such as Colombia. To establish a relationship between the four constructs, we use two different methods: a linear regression model and a structural equation model.
We find a positive relationship between financial literacy and financial preparedness pre-COVID and between financial fragility and financial stress. We also find a negative relationship between financial preparedness and financial stress during the COVID crisis and between financial preparedness and financial fragility in Colombian households. We verify our results using a structural equation model and found that there is no significant relationship between financial literacy and financial fragility, nor between financial literacy and financial stress, so a better financial education will not lower financial fragility and stress unless it is being applied by households through better financial preparedness.
In the next section, we present our literature review, followed by our methods and the empirical results. In the final section, we conclude the article.
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Literature review
The OECD (2014,2016) recommends principles and good practices for financial education to help governments, financial entities and educational institutions implement it. The Jump Start Coalition for Personal Financial Literacy defines financial literacy as follows: "The ability to use knowledge and skills to manage one's financial resources effectively for a lifetime of financial security" (rijumpstart.org).
The Programme for International Student Assessment (PISA) test for Colombia produced unfortunate results after evaluating the financial knowledge of 15-year-olds and ninth graders in 2015; in the test, Columbia ranked last among 18 countries from different continents (OECD, 2014). This low performance is consistent with other studies which explained that financial education covered less than 1% of the country's educated population in 2011 (Garcia, 2012).
Furthermore, in 2012, a document of the World Bank carried out the first Survey of Financial Capabilities in Colombia by applying a survey questionnaire to 1,526 adults with terrible results. Of the participants, 66% showed poor knowledge and great weakness in the making of financial decisions. Further, only 11% reported to have recently received information through a financial literacy programme, and of these, parents were the most common source of information (Reddy et al, 2013).
At the national level, Garcia Bohorquez and Castro (2010) have studied the financial capacities of Colombian children and youth, and the financial education in the central banks of Latin America and have found low financial capacities and less education. Studies have shown the importance of financial education in developing personal factors to strengthen their financial capacities (Lusardi etal, 2017; Cordero and Pedraja, 2018; White et al., 2019).
Cao Alvira et al. (2020) have identified important linkages between financial literacy and the indebtedness and wealth accumulation of households in Bogota (Colombia).
They also have found that households with good money management reduce the probability of acquiring debt, but if they have numerical skills, they can increase the probability of using debt sources. Gine et al. (2017) have found that customers with financial literacy do not easily accept the lending cost of their financial products. Some authors find a positive and significant correlation between knowledge and innovative performance (Leiva and Brenes-Sanchez, 2018). Also, Rasool and Ullah (2020) find that financial literacy is very important to make financial decisions.
Given the above, our first hypothesis is the following:
H1. We expect a positive relationship between financial literacy and financial preparedness.
Research on households' financial fragility has normally been directed to variables such as education levels, income size, debt level, income, consumption, savings and sources of financing in the event of contingencies.
Poh Lee and Fadzli Sabri Lee(2017) have established the core definition of financial fragility as the personal feeling of being in a financially unstable situation; this feeling is one of the early indicators of financial stress for households. For this reason, they advise that households must always be concerned with an alert to their financial status and immediately take some corrective action...
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