Financial Literacy and Engagement in Banking

(ProQuest: . denotes formulae omitted.)INTRODUCTIONIt has been widely considered that access to finance is important especially to the deficit spending people (Karsidi et al., 2015). A well distributed access to finance is positively correlated with economic growth as the financing could be optimized for innovation and other productive activities (King and Levine, 1993; Rajan and Zingales, 2003). However, as we have seen, access to formal financial institution is quite imbalanced particularly for the poor. In Indonesia, the fourth most populous country, according to the 2013 national survey, only 59.7% of adult people have access to formal financial institutions (financial inclusion). Santoso et al. (2015) argue that the level of financial inclusion could be explained from the demand and supply side. On the demand side, the level of financial inclusion is mainly determined by economic security, while on the supply side, the reluctance of formal financial institutions to channel loans to poor people and micro, small and medium enterprises (MSMEs)1 contribute to determine the level of financial inclusion (Rosengard and Prasetyantoko, 2011). In this paper, we argue that engagement of poor people to the formal financial institutions, more specifically banks is mostly driven by how financially literate they are as it is generally considered that financially poor people are associated with lower level of financial literacy (Cameron et al., 2014). Financial literacy is defined as the "a combination of awareness, knowledge, skill, attitude and behavior necessary to make sound financial decisions and ultimately achieve individual financial wellbeing" (Atkinson and Messy, 2012). Some contend that financial literacy is important especially with regards to knowledge and accessibility to financial product (Cameron et al., 2014). Low level of financial literacy might not be sufficient to ensure that households make appropriate financial decisions (Calcagno and Monticone, 2015). Subsequently, financial literacy could improve the participation in the financial markets (Lusardi, 2008; Santoso et al., 2015). The Indonesian government, under the Indonesia financial supervisory agency (OJK), has also declared a national campaign program to accelerate the levelof financial literacy2.The present paper therefore investigates the impact of financial literacy on banking engagement. We study the financial literacy and its impact on engagement of poor people to formal financial institutions aggregately at the sub-district level3 instead of at the individual or household level. Arguably, the more financially literate the society, it would lead to more engagement in formal financial institutions.Engagement in the formal financial institutions could be considered as a part of financial inclusion program which has becomes a global initiative.RESEARCH METHODSTo study the link between financial literacy and engagement in banking, we use aggregate data of 78 sub-districts of 5 districts in a province in Indonesia (the Special Province of Yogyakarta). Information comes from primary and secondary data. The primary data which is the degree of financial literacy and banking engagement of poor people are gathered from the survey conducted by Bank Indonesia using in-depth interview to the head of households (Santoso et al., 2015). However, instead of working on household's level, our study focuses on the aggregate data at sub-district level. The secondary data such as the number of banks in the sub-district, number of cooperation in the sub-district, population of subdistrict, number of industry in sub-district and the degree of ruralness are collected from various sources mainly from the Statistics Central Bureau (BPS). As explained earlier, our dependent variable is the engagement in banking, while, financial literacy is main determinant variable. We include a number of variables to explain the variation in engagement in banking between sub-districts which are the ratio of population per bank, the number of bank, and the ratio of cooperation to control for the availability of the supply side. …