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Measuring Financial Capability and its Determinants Using Survey Data

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Abstract

Financial capability, or people’s ability to manage and take control of their finances, is receiving increasing interest among policy makers as more people find themselves in difficult financial situations during the current economic downturn. We tackle the problem of how to measure financial capability—with a specific focus on making ends meet and money management—using data from a general household survey (the British Household Panel Survey), and then identify its key determinants using panel data models. This is important if appropriate policies and programmes are to be targeted at those most in need. We find the lowest financial capability among young unemployed single adults living in households with other unrelated non-working adults. In contrast, older men and women in full-time work with an employed spouse have the most financial capability.

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Notes

  1. We focus on variables available at all 16 waves of BHPS data, to enable us to construct a consistent measure of financial capability over time. Data is also available each year on the number of consumer durables to which individuals have access. However, we do not use this information because it proved to be only weakly correlated with the other relevant indicators of financial capability. This might be because such consumer durables reflect tastes and preferences as much as financial resources and management.

  2. We’ve standardised the correlations with the saving variable so that the positive correlations indicate that individuals in a difficult financial situation are less likely to save.

  3. Housing Benefit is a means tested social security benefit in the UK that is intended to help towards housing costs.

  4. We experimented with a number of different combinations of the housing payment problems variables, including creating a single variable measuring the scale of problems and including separate variables independently of the others. The current specification provides the most consistent measure.

  5. By construction the common factor is normalised to have mean zero and standard deviation of one. Here, however, we have excluded people in receipt of Housing Benefit in constructing the factor weights but not the principal factor, as such people may avoid housing payment problems because of Housing Benefit receipt. The fact that Housing Benefit recipients have below average values for the principal factor indicates that they have below average financial ability.

  6. To validate this measure, we examined its correlation with other measures of financial wellbeing collected intermittently over the BHPS sample period. The results are reassuring, indicating average correlations between 0.2 and 0.3 (see Taylor 2009 for further details).

  7. The drawback of using fixed effects models is that they do not allow the impact of time-invariant observable characteristics (e.g. ethnicity, gender etc.) to be identified.

  8. These are based on a person in good health, living in a couple with two dependent children, with one person in full-time employment (the man in man’s calculation and the woman in the woman’s calculation), the other in economic inactivity.

  9. The positive coefficients on the own outright variable are likely to be endogenous, in that those who have no housing costs are not at risk in some of the indicators contributing to our measure of financial capability. We include this as a control variable to correct for this (rather than omitting those with no housing costs completely from the analysis which would reduce the sample sizes considerably), but place no causal interpretation on this coefficient.

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Acknowledgments

This work stems from a project originally funded by the Financial Services Authority. Thanks to Mel Bartley, Stephen Jenkins and Amanda Sacker for helpful comments on earlier drafts.

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  1. Institute for Social and Economic Research, University of Essex, Colchester, CO4 3SQ, UK

    Mark Taylor

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Correspondence to Mark Taylor.

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Taylor, M. Measuring Financial Capability and its Determinants Using Survey Data. Soc Indic Res 102, 297–314 (2011). https://doi.org/10.1007/s11205-010-9681-9

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