Money Advice Association
Speech by Callum McCarthy
Institute of Money Advisers Conference, Leeds
7th July 2005
Today I want to talk about what is a fundamental problem affecting the provision of retail financial services, namely how do we establish a level of financial capability such that customers of the industry – actual or potential – are confident about the decisions they make; and have a confidence grounded on competence.
I want to discuss three subjects. First, I'll describe the present position, which is very far from the objective I've just defined of competent and confident customers. That part is essentially setting out the problem. Second, I'll describe the various initiatives which the FSA has taken and is taking to identify ways of tackling the problem. They are good initiatives, which have drawn in support from many in the financial industry, in the voluntary sector, among employers, and in government. They are a start – but only a start. Third, and most important of the three subjects, I want to discuss how we have to build upon these initiatives if we are to make the step change required if we are to solve rather than simply describe, the fundamental problem.
Let me start with the present position. It has always been important, in any society since money has been used as an instrument of exchange, to understand one's personal and family finances. It's central to anyone's well-being. It is particularly important in a society like modern Britain, because increasingly we are all being required, as individuals, to make decisions which previously were made for us: decisions on pensions, which used to be taken by employers, are more and more the responsibility of the individual; university education now requires decisions on taking on debts, where previously it was a question of receiving grants; many aspects of health treatment now require financial decisions which were previously not called for. This move to require the individual to take responsibility for his or her financial decisions places growing strain on the need for basic financial capability – the ability of individuals to identify their financial needs and, when they are customers of financial services firms, to make informed decisions between the many choices available to them. I should add that the range of choice has become wider. We no longer live in a world where a mortgage comes only from a building society, insurance from an insurance company, or loans from an overdraft. The breaking down of cartels which has led to this increased choice, and the fact of increased choice, are welcome developments. But they put all the more weight on the ability of the individual to make informed choices.
But against this increasing requirement for financial capability, the actual capability of those who need to make financial decisions is too often inadequate, in terms of basic literacy and numeracy, as well as in respect of specific financial knowledge. Among the adult population in the UK, 23 per cent, if presented with the Yellow Pages and asked to name a plumber, cannot do so. More than 20 per cent, if asked to choose between receiving £30 or 10 per cent of £350, choose the lower figure. Put in another way, more than one in five of adults would not have understood either of the last two sentences. Yet an understanding of percentages is an essential requirement for comprehending many savings products. On financial specifics, the position is comparably worrying: a study by the Institute of Financial Services showed that eight from ten people did not correctly identify the term APR as describing the interest rate and other costs of a loan; five from ten people admit to not understanding financial products such as mortgages or ISAs. A survey done for the FSA asked the question: "if the inflation rate is 5 per cent and the interest rate you get on your savings is 3 per cent, will your savings be worth as much in a year's time?" – one in five gave the wrong answer. The problem of financial capability is immense, in terms of both the basic requirements of literacy and numeracy which underpin financial capability; and in terms of specific financial knowledge.
This obviously matters to the individual, who will make bad decisions: not paying off debts, borrowing in expensive ways, incurring risks which he or she does not understand, or failing to recognise the realities they face (one survey showed that 46 per cent did not know what the minimum guaranteed pension is, but 31 per cent were confident it would be sufficient for a comfortable requirement). It also has a wider, and equally harmful, effect. For markets to operate efficiently, they require good information, responsible selling practices – and customers who make use of the information put to them. But in the absence of customers with the necessary skills, providers of goods and services will find it more difficult to compete on the basis of relevant information; the incentive to sell through other means grows; the temptation to mis sell becomes greater; and the need for more intrusive regulation grows. If we are to make the market for financial goods and services effective, we need to develop customers whose decisions are based on financial capability. It is in everyone's – customer, company and regulator – interest for financial capability to be improved.
So that is the problem: we now have a position where far too many who could, should or actually do use financial services are ill-equipped to make the decisions they are called on to make. A huge improvement in financial capability is needed.
Let me turn to my second subject; what we at the FSA have been doing to tackle the issue – working with many other institutions. We at the FSA have been much concerned to start the process of change so badly needed – insofar as we are able to do so. I make that caveat clear. The principal responsibility for a society with literate and numerate citizens clearly lies with government, and with the education system, not with the financial services regulator. The government's spend on primary and secondary education runs at some £32 billion annually. The FSA's total expenditure on all our responsibilities is some £260 million. But within that figure we are taking our responsibilities for financial capability seriously. Our annual plan for 2005-06 shows that our spend on financial capability this year will be approximately double that which we spent last year – which was in turn twice that which we spent in the previous year. For all that increase, this year's spend of £8 million is insignificant in comparison with the government's spend on education, or in comparison with the financial services industry's spend on marketing at £1.4 billion. The challenge for the FSA is to identify where our efforts can have most effect, and where our expenditure has most leverage.
We have been tackling these questions as a priority for the FSA for more than a year, in a group chaired by the FSA's Chief Executive John Tiner which brings together representatives of government, employers, providers of financial services, those who use financial services, those who comment in the media about them, and those from the voluntary sector who have such direct experience of the problem. Our aim is to co-ordinate the resources that exist on a much greater scale than in the FSA to tackle the problem of financial capability; to act as a catalyst for action by those who have substantial resources; and to identify and finance seed corn activities where others will perform the harvest. We have tackled the issues in what I believe to be an entirely practical way and have been able to apply resources from our many partners to help to find new ways to deal with the problem. For example, Lloyds TSB chair a working group which looks at how we can use the work place to encourage understanding of financial needs and opportunities, and we have encouraged better integration of financial issues in the curriculum for schools which we were pleased to see recognised by Government in the White Paper on 14-19 education earlier this year. Of the seven working groups, we chair only one ourselves which is looking at what is needed by way of generic advice, and what is the best way of achieving this. The success of the national strategy is an essential but necessarily long-term task if we are to obtain an effective and fair market for retail financial products.
Let me mention three of our initiatives in particular. The first is to establish the facts as to financial capability with greater objectivity and in greater detail than the impressionistic picture I started this talk by painting, by establishing a baseline survey. Last week, we published an interim report on our baseline survey into the current levels of financial capability. This report sets out, for the first time, our definition of what it means to be financially capable. We have grouped all the different aspects into four domains – Managing Money, Planning Ahead, Making Choices and Getting Help. The survey is behavioural in approach: it is not simply a test of the levels of understanding but probes, for example, how and why people made their most recent financial services purchases, or the degree to which people are aware of their bank balance at any given point in time. Over the summer 5,000 people will be interviewed. The final report, which we will publish early next year, will give us a full picture of current levels of financial capability and a good indication of where our collective efforts to resolve the problems caused by lack of capability might best be directed. This is a major research project. We will use it to measure progress over the years ahead. It will enable us and our partners to see how much we have actually achieved in changing the world.
The second initiative is designed to help with the need for generic financial advice on questions like how do I handle debt? Open a bank account? Make best use of a credit card? Manage my weekly budget? Save in a sensible way? Again last week, we, in conjunction with BBC Online, were pleased to launch the Financial Healthcheck. This is a simple online tool, developed as part of the work on generic advice, aimed at providing general advice for those who want to take more control of their finances, but are not sure where, or how, to start. The tool, which takes no more than a few minutes to complete, was launched on both the BBC News and FSA websites. It aims to help people understand their priorities and provides signposts to other sources of information and advice. We are very pleased that some 125,000 people completed the Healthcheck on the first day alone. The initial feedback is both that there considerable appetite for such help, and that it is indeed proving useful to those new to financial planning.
The third initiative recognises that it will take a wide range of tools and approaches to succeed. That's why last week I was happy to announce that the FSA has established a Financial Capability Innovation Fund, designed to provide the financing for experiments by those in the voluntary sector aimed at tackling financial capability issues. It is dedicated to new ideas aimed at improving financial capability; it is specially aimed to support practical, grass roots projects; we want to find what does, and does not, work in practice. We have set aside £100,000 in the first place. As we expect most of the experiments we will support to require funding of between £5,000 and £20,000, this should provide an opportunity to support a range of initiatives. Applications should be made by 15 September, and we will make the decision on which to finance by the end of this calendar year. Application packs are available at this conference. My colleague, Martin Coppack, is here to answer questions on the scheme.
I am delighted that the FSA's modest fund has been accompanied by a much larger one. The Department for Work and Pensions has already launched a £3 million fund, the Pensions Education Fund, aimed at financing projects from non-profit organisation to deliver new ways of giving employees and the self-employed the information they need to make decisions about pensions and retirement.
Both these funds are aimed at helping those such as yourselves in the advice sector (amongst others), with your practical knowledge of the problems as they occur day-to-day, to find solutions; and then to share best practice learnt in one place across the country.
These are good initiatives. But they are only starting points – which brings me to the third issue which I want to discuss today. It is the issue of what next? How do we move from the world of research (the FSA work to establish an objective measure of where we now are in terms of financial capability, so that we can assess and monitor progress) and of experiments, including the valuable practical testing of solutions, to the world of real, sustained and major improvement in financial capability? How do we make the change in society, in education and in behaviour, which will constitute a very large and important social change – a change much more fundamental than changes associated with different attitudes to drink-driving or smoking? For we are seeking to make people understand and feel comfortable with concepts of risk and reward, of the time-value of money, and of budgeting. Change on this scale goes far beyond the work on initiatives and on experiments which we are supporting. It is not a matter of seed corn, but the heavy work of harvesting.
To do this will require very substantial resources, both financial and organisational. It is important that we face up to what will be needed, since the demands will undoubtedly outstrip the resources which the FSA can devote to this particular statutory objective. The financial resources needed – for example if our partners and we set our sights on developing the pilot work currently being undertaken in workplaces to cover a substantial proportion of the employees in the UK over the next few years - will be very large: they will be measured in tens of millions sterling. There are some who have argued that we should use our legal power to impose a levy on those we regulate so as to raise the finance. This is something we will not do. The FSA Board has considered this, and rejected it. We believe it would be wrong for us to use what is essentially a power to tax an industry to raise very substantial funds for this purpose.
There is also a need to recognise that the nature of the task is changing. Until now, we have principally been engaged in exploration: in mapping the current levels of financial capability (such as they are) and in mounting particular expeditions into particular problem areas – the financial capability needs of single parent families, or of young people not in employment or training; or how to better use the workplace as a means of providing financial advice. We at the FSA have been able to support and coordinate these separate pieces of work. Going forward, the task will be very different – development rather then experimentation; implementation, rather than idea generation. The organisational requirements will be very different: substantial project management skills will be the essential requirement.
Therefore there needs to be a debate on how to meet the financial and managerial demands of making a step change in financial capability, building on the work that has been undertaken to date – a change from which both customers of the financial services industry and the industry itself would so clearly benefit. A structure needs to be developed and put in place that would bring together the work of firms in the industry, government and its agencies and of those in the voluntary sector. This structure will provide the two resources which the next stage will so clearly need: money and management. I hope that the industry will respond to this challenge, which is particularly in the hands of those most concerned with the retail market for financial services. I therefore look to the trade bodies – The Association of British Insurers, the British Bankers Association, the Investment Management Association and others with interests in the retail financial sector - to consider these financial and managerial demands, which will help us all to take the next large step in financial capability. Such a step would benefit their customers and advance what I believe is – certainly should be – their own ambition of providing clearly described goods and services to customers who are able, on the basis of comprehensible description of both reward and risk, to make informed decisions.
I have described both the need for a substantial change in financial capability and the steps we in the FSA have taken, with you and others, to start the process of change. But the most important question now is what next – and who will take this work to the next, essential, stage.
This speech was delivered on behalf of Callum McCarthy by a member of the FSA Financial Capability team.