Financial Sector Assessment

Financial Soundness Indicators

Financial soundness indicators (FSIs) are indicators of the current financial health and soundness of the financial institutions in a country, as well as of their corporate and household counterparts, and FSIs play a crucial role in financial stability assessments. FSIs include both aggregated individual institution data and indicators that are representative of the markets in which the financial institutions operate. FSIs are calculated and dissemi­nated for use in macroprudential surveillance, which is the assessment and monitoring of the strengths and vulnerabilities of financial systems.

FSIs are a relatively new body of economic statistics that reflect a mixture of influ­ences. Some of the concepts are drawn from prudential and commercial measurement frameworks, which have been developed to monitor individual entities. Other concepts

are drawn from macroeconomic measurement frameworks, which have been developed to monitor aggregate activity in the economy. A list of FSIs, grouped into a core set and an encouraged set, is presented in tables 2.3 and 2.4 and will be discussed in this chapter. Detailed exposition and guidance on those FSIs can be obtained from the Compilation Guide on Financial Soundness Indicators (IMF 2004). It contains a discussion of the distinc­tion between a “core set” for which data are generally available and are found to be highly relevant for analytic purposes in almost all countries and an “encouraged set” for which data are not as readily available and whose relevance could vary across countries.12

The list of FSIs discussed herein consists mainly of aggregate balance sheet measures. This type of aggregation of individual institution-level indicators (microprudential indicators) into financial soundness indicators (macroprudential indicators) necessarily involves a loss of information because the distribution of prudential indicators of indi­vidual institutions is also a crucial dimension of financial stability. Although aggregation is required for facilitating macroprudential analysis and international comparison, the assessments could be strengthened by allowing some disaggregation through peer groups or through the monitoring of the distributional characteristics of various indicators. In addition, FSIs themselves are either backward-looking or contemporaneous indicators of financial soundness, available often with a lag or low frequency. Therefore, proper interpretation and use of FSIs requires a range of analytical tools (discussed in chapter 3), which includes conducting stress tests of individual institutions and monitoring the

Table 2.4. The Encouraged Set of Financial Soundness Indicators
Indicator	Indicates	Comment
Provides an indication of credit risk because a highly leveraged corporate sector is more vulnerable to shocks Indicates the extent to which earnings are available to cover losses Indicates the extent to which earnings available to cover losses are reduced by interest and principal payments Reveals corporate sector vulnerability to exchange rate movements Broad measure of capital adequacy, which is a buffer for losses Identifies credit exposure concentrations to particular countries by the banking system Provides a crude indicator of exposure to derivatives Provides a crude indicator of exposure to derivatives Identifies credit exposure to large borrowers Indicates the dependence on trading income Indicates the extent to which high noninterest expenses reduces earnings Indicates level of competition in the banking sector and the dependence of earnings on the interest rate spread Market indicator of counterparty risks in the interbank market Assesses the vulnerability to loss of access to customer deposits Measures risk to loan portfolios from foreign exchange movements Measures extent of dollarization Measures exposure to equity price movements Indicates liquidity in the securities market Indicates liquidity in the securities market Indicates size and significance within the financial sector Indicates size and significance within the financial sector Provides an indication of credit risk because a highly leveraged household sector is more vulnerable to shocks Indicates a household's ability to cover its debt payments Measures trends in the real estate market Measures banks' exposure to the residential real estate sector Measures banks' exposure to the commercial real estate sector
a. See Compilation Guide for Financial Soundness Indicators (IMF 2004) for a detailed definition and exposition of encouraged indicators. b. These may be grouped in different categories based on ownership, business lines, or group structure. c. May be in notional amounts or market value. The latter provides a better measure of exposure but may be more difficult to obtain. d. Or in other markets that are most relevant to bank liquidity, such as foreign exchange markets. e. Other indicators such as additional balance sheet data (e. g., maturity mismatches in foreign currency), data on the life insurance sector, or information on the corporate and household sector may be added.

distribution of stress tests results, as well as examining the determinants of FSIs and fore­casting their future course.

In addition, FSIs can be complemented by various market-based indicators, which are forward-looking indicators of soundness and are available with higher frequency. The various categories of FSIs are discussed in the following sections.