A Structural Equation Model of Financial Literacy, Financial Inclusion and Financial Capability in the U.S

Background and Purpose

Financial capability, defined as “a consumer’s ability to apply financial knowledge and perform desirable financial behaviors to achieve financial well-being” (Xiao & O’Neill, 2014), is gaining attention in practice and public policy. As a result of recent global financial crisis, and worsening income and wealth inequality, there is growing recognition that people need stronger financial capability to avoid financial difficulties and poverty. Financial capability theory suggests that a focus on the combination of financial knowledge and skills, and access to appropriate financial products and services has demonstrated promise to result in financial behaviors that facilitate financial stability and security. The purpose of this study is to investigate the contribution that financial inclusion makes to financial capability in combination with financial knowledge for the general U.S. population.

Methods

This study investigated the association between financial literacy, financial inclusion, and financial capability using a nationally representative sample from the 2012 National Financial Capability Study (N=25,509). The latent variable of financial literacy was measured based on financial knowledge, knowledge of credit score, self-assessed financial knowledge and access to financial education.  The latent variable of financial inclusion was measured based on saving account ownership, homeownership, Alternative Financial Services use, investments, and credit card usage. The latent variable of financial capability was measured based on spending compared to expenses, whether pay bills monthly, whether overdraw checking, whether keep up with expenses, emergency savings, retirement plan, and emergency money. Confirmatory factor analysis was used to examine if 16 survey items were good indicators for financial capability, financial literacy and financial inclusion. Then structural equation modeling was used to examine if financial literacy was a significant predictor of financial capability. Last, financial inclusion was added to the previous model to examine if financial inclusion modified the relationship between financial literacy and financial capability. Model fit indices including RMSEA, CFI, and TLI were used to evaluate competing models. t-test was used to examine statistical significance of parameter estimates. Standardized parameter estimates were reported.

Results

The measurement model provided a good fit to the data according to the model-fit indices. All factor loadings were statistically significant. The structural equation modeling shows that financial literacy was significantly predictive of financial capability (β=0.75, p<0.05). When financial inclusion was added to the structured model, the regression coefficient for financial literacy was still significant, but diminished to 0.26, suggesting financial inclusion moderated the effect of financial literacy on financial capability. Financial inclusion was a strong predictor for financial capability (β=0.64,  p<0.05). The regression coefficient from financial literacy to financial inclusion was 0.79 (p<0.05). Findings suggest that financial literacy has an indirect effect (0.50) on financial capability through financial inclusion in addition to a direct effect.

Implications and Conclusion

Our data suggest that financial inclusion, in combination with financial literacy, has a unique and important contribution to financial capability. To help households build strong financial capability, a policy and practice focus on financial literacy should be paired with a focus on inclusion efforts.