ISLAMIC FINANCIAL LITERACY: CONSTRUCT PROCESS AND VALIDITY.

Author:Setiawati, Rike
Position:Report
 
FREE EXCERPT

INTRODUCTION

Financial literacy is a salient aspect required both in the economic, financial and social environment to make proper financial decisions. Bhushan and Medury (2013) described that financial literacy has become increasingly complex over the past few years with the introduction of many new financial products. Furthermore, Nidar and Bestari (2012) explained that the national economy will not lead to the global financial crisis provided that people understand the financial system. Miller et al. (2009) provided a number of reasons regarding the importance of financial literacy, especially on how to evaluate today's increasingly complex financial services and products and sound decision making, help deal with financial difficulties (such as accumulated savings, asset diversification and insurance purchases), also improve financial behaviour (punctual payment of bill, manage appropriate loans) and help improve the efficiency and quality of financial services.

The efforts to improve community's financial literacy have been widely carried out in the last decade and become an important agenda of various countries characterized by programs launched by their government and researches pertaining to the measurement of financial literacy. However, it is still relatively rare to find a research which discusses the measurement of financial literacy among Muslims. This aspect is considered important since some measures used in determining the existing financial literacy have not been appropriately adapted for Muslims regarding its distinction in financial principles.

Abdullah and Chong (2014) stated the 'financial crisis has also caused the world's new focus on Islamic finance ". Thus, the Islamic finance industry has been inundated with wide ranges of financial instruments and assets choices for not only Muslim but also non-Muslim investors. Furthermore, Kayed (2008) in his article questioned the research community's efforts to investigate the level of Islamic financial literacy among Muslims and highlighted the importance of dissemination of Islamic finance knowledge through the education system.

The need for researches on Islamic financial literacy is not only encouraged by the internal factor of the Muslim community itself as the obligation to obey the rules of Islam, but also due to external factors, such as the availability (supply) of complex financial instruments that raise awareness among the Muslim community to respond through financial decision making based on Islamic financial literacy.

The purpose of this study is to determine the construction of Islamic financial literacy along with its dimensions and indicators through qualitative methods and testing the validity of the instrument constructs empirically. The establishment of Islamic financial literacy constructs with its dimensions and indicators is required as a parameter to measure the level of financial literacy of the community at various groups. It is expected that this finding can be a reference for the government in policies making and other interested parties in order to realize the financial inclusion program.

LITERATURE REVIEW

The Development of Concepts and Definitions of Financial Literacy

Since the 1950s, financial literacy has been recognized in many countries around the world. The definition of financial literacy has also been broadly acclaimed by financial experts and researchers as it is available in a number of literatures, yet none of which presents similar definitions. In general, the frequently used definition of financial literacy as proposed by Hung et al. (2009) is about knowledge and skills in financial management, while others put emphasis to the aspects of financial concepts, information assessment and decision making (Lusardi and Mitchell, 2007); ability to evaluate and make valuation of financial instrument information (Mandell, 2008); interpreted as debt literacy (Lusardi and Tufano, 2009).

More specifically, as it is stated by Atkinson and Messy (2012), financial literacy is defined as a combination of financial knowledge, attitude and behaviour. Financial knowledge is the understanding on financial terms and concepts necessary for everyday use in social life (Bowen, 2002). Meanwhile, financial attitudes are the application of financial principles for creating and maintaining value through the best decision-making and resource management (Rajna et al., 2011). Furthermore, financial behaviour refers to human behaviour in relation to money management (Xiao, 2008).

The blueprint of financial literacy launched by the Financial Services Authority (FSA) in Indonesia dated November 19, 2013, defines that financial literacy is a series of processes or activities to improve knowledge, confidence and skill of consumers and the wider community in order that they can better manage their finances.

So far there have been some researches related to Islamic financial literacy, but researchers who discuss Islamic financial literacy do not explicitly define it. Some of them refer to the definition of conventional financial literacy tailored to the system and the obligations which must be met in Islamic finance. Salehudin (2010) used the term "halal literacy " and defined it as the ability to distinguish halal and haram on the basis of sharia (Islamic Law). Meanwhile, Razak and Abdullah (2015) defined "Islamic financial literacy in a broader aspect consisting of financial or basic wealth (income, consumption and savings) management, financial planning (takaful, pension schemes and sharia-based investment), zakat, inheritance law (faraid) and wasiyyah, charitable donations (waqf and alms) ". The researcher underlied the obligations that he thought it should be implemented in Islamic finance such as zakat, sharia and investment transactions, endowments, the implementation of wills, orphan property management and property management in accordance with the principles outlined in Islamic teachings. Similarly, Antara et al. (2016) defined "halal literacy as a person's ability by combining a set of knowledge, awareness and skills to distinguish between halal and haram on products and services based on sharia law ".

Approach to Financial Literacy Measurement

There are two approaches in measuring financial literacy namely self-assessment approach and objective measures approach (Kharchenko, 2011). Self-assessments approach is used to assess literacy ability to provide information about attitudes of respondents to financial decisions, financial knowledge and financial information. Jappelli (2010) used this approach by comparing literacy rates within 55 countries based on indicators of financial literacy. On the other hand, the objective measures approach employs the objective test to assess the knowledge of financial terms, financial concepts and financial capabilities numerically. According to OECD institutions (2005), the objective test approach is regarded to be better than self-assessment method in analysing the financial knowledge of respondents. Lusardi and Mitchell (2005) used this objective test approach to examine the understanding of respondents by using compound interest variables, inflation, risk diversification, important concepts for savings and investment activities.

Meanwhile, the research on financial literacy measurement based on division used by Atkinson and Messy (2012) in the form of financial knowledge consists of two groups. The first group of respondents' research answered questions related to general financial knowledge in personal financial recognition as in the last decade conducted by Avard et al. (2005); Jones and Stine (2005). The second group used financial knowledge as a proxy for financial literacy (Warwick and Mansfield, 2000; Joo et al., 2003; Atkinson and Messy, 2012). Atkinson and Messy (2012) used 8 core questions designed to measure knowledge, namely: division, time value of money, interest paid on a loan, calculation of interest plus principle, compound interest, risk and return, definition of inflation and diversification.

Researches which divide financial attitudes can be taken into consideration as psychological tendency expressed when evaluating recommended financial management with levels of agreement and disagreement (Parrotta and Johnson, 1998). On the other hand, Rajna et al. (2011) who studied financial attitudes of Malaysian people found that as a whole, medical practitioners in Malaysia have a positive financial attitude, yet they still do not have financial practice.

Researches focused on the division of financial behaviour are an essential and most important element of financial literacy. Atkinson and Messy (2012) described four questions which enable people to provide more information and statements about the frequency of behaviour, including statements associated with purchase considerations, paying their obligations on time, analysis on financial records and long-term plans. Furthermore, Lusardi and Tufano (2009) developed an instrument to focus specifically on debt literacy.

Islamic Financial Review

Islamic financial activities are based on the underlying principle that money is not regarded as a productive asset of commodities/tradable goods. Instead, money benefits can be obtained once it is functioned either as a medium of exchange or through investment with taking into account the inherent risks. Khaled (2011) stated that the basic principles of Islamic finance refers to financial services performed according to Islamic law which can be summarized as follows: 1) prohibition of interest (riba); 2) risk sharing; 3) money as potential capital; 4) prohibition of speculative behaviour; 5) sanctity contract; 6) approved sharia activities; and 7) short-selling prohibition.

Interest in conventional loans or savings which earns fixed returns without any risk sharing is considered unfair and therefore prohibited in Islam. Meanwhile, with the prohibition of interest, the fund...

To continue reading

FREE SIGN UP