How Do We Measure Financial Health?

The concept of financial health focuses attention on how well people are faring in their financial lives. As we saw in the previous blog post of this series, policymakers are increasingly interested in this concept, and some are looking for ways to apply it in national strategies. But, in order to make policy decisions or design financial products that support financial health, we must measure it. The question is: how?

Financial health is a multi-faceted concept, and standard measures of financial inclusion, such as bank account access or usage, fall short of capturing its essence.  They don’t tell us whether financial services are contributing to a person’s or household’s financial wellbeing, nor do they shed light on people’s ability to manage their financial obligations or have confidence in their financial future. Similarly, measures of employment status or income tend to skim over the difficulty many people have in managing high costs of living, income variability, financial shocks, or debt.

In contrast, financial health measurement begins to probe whether the economic and financial tools available to a person are working effectively in both the short and longer term. Specific measurement techniques are required, and policymakers and financial service providers are looking for technical guidance on how to use them well.

In our new report, the Financial Health Working Group (FHWG) – convened by H.M. Queen Máxima of the Netherlands, in her capacity as the United Nations Secretary-General’s Special Advocate for Inclusive Finance for Development (UNSGSA) – explains the technical concepts needed for financial health measurement, explores controversies, and introduces the various measurement approaches that have already emerged.

Measuring a hidden and multi-dimensional variable

Measures of financial health must grapple with the recognition that an individual’s current state of financial health cannot be simply and directly observed. The solution to this challenge is to identify a small group of questions that, taken together, form a strong proxy to the underlying condition.

How well does the following statement describe you? “I am just getting by financially.”

Sample question from the U.S. Consumer Financial Protection Bureau’s Financial Wellbeing Scale

Self-reported survey data has to date been the primary basis for financial health metrics. The short questionnaires used in such surveys have been derived using one of two approaches: either analytically, where the emphasis is on the statistical validity of the resulting metrics; or through expert judgment, where the emphasis is on developing a conceptually distinct yet coherent set of indicators that can support a call to action.

The analytical approach is very similar to methods used in psychometric questionnaires to estimate a person’s attitudes or personality traits, and often focuses on perceptions. A sample question of this type, from the U.S. Consumer Financial Protection Bureau’s Financial Wellbeing Scale, asks how well statements such as the following describe the respondent: “I am just getting by financially.”

Questions derived from an expert judgment approach tend to be more concrete, such as the Financial Health Network‘s question, “At your current level of spending, how long could you and your household afford to cover expenses, if you had to live on only the money you have readily available, without withdrawing money from retirement accounts or borrowing?” The issues surrounding the choice of questions can become complex, and our report attempts to sort them out for the non-specialist.

More recently, some researchers are using administrative data — such as account balances or transactions — either alone or as a supplement to survey data, to derive measures of financial health. Commonwealth Bank of Australia’s Observed Financial Wellbeing Scale, for example, uses data such as how often a person’s bank balance dips below their average weekly expenditure. Because such metrics are verifiable and recorded in real time, they can provide a better window into the dynamics of a rapidly changing situation (such as during the pandemic). However, each financial institution has an incomplete share of the customer’s transaction records and thus only a partial view of a customer’s financial life. In settings with large shares of adults excluded from the formal financial system, administrative data will also miss important segments of the population.

“At your current level of spending, how long could you and your household afford to cover expenses, if you had to live on only the money you have readily available, without withdrawing money from retirement accounts or borrowing?”

Sample question from the Financial Health Network

In all these examples, researchers selected a final set of questions from a longer set of candidates using statistical criteria and other practical or policy considerations. When these surveys are deployed, each individual’s responses are aggregated to produce a financial health “score” or “index” as a final metric for that person.

Choosing from many options and approaches

For policymakers interested in measuring financial health, the good news is that there is much experience, many examples to learn from and plenty of ongoing experimentation. The bad news is that there is no single, widely accepted method to set the standard. Metrics are in flux and may need to be adapted to specific country contexts. Nonetheless, policymakers should view the menu of options in measurement as an asset, in that it gives them the flexibility to select an approach that best fits with their specific needs, capabilities, and constraints.

What’s next for financial health measurement?

There is significant scope for the research community to support financial health measurement in low- and middle-income countries. Measurement efforts at the national level are underway in a growing number of countries, and the 2021 round of the Global Findex will provide a deeper look at several key financial health questions. As these initiatives publish their results in 2022, we will learn more about the financial health of much of the world’s population. These results may enable the development of a global financial health toolkit and serve as a valid basis for international comparisons.

With empirical measures of financial health, policymakers and product designers can develop policies and service models that advance financial health, assess progress, and evaluate what works.  We believe that local efforts, combined with a collaborative, multi-country process, will provide the data and knowledge resources that can guide decision-making and support people’s financial wellbeing.