Financial Sector Assessment

Scope and Coverage of Financial Services

The financial system provides five key services: (a) savings facilities, (b) credit alloca­tion and monitoring of borrowers, (c) payments, (d) risk mitigation, and (e) liquidity services.

Savings mobilization can be assessed by examining the effectiveness with which the financial system provides saving facilities and mobilizes financial resources from house­holds and firms. The extent of financial savings could be ascertained by examining the level and trends in the ratio of broad money to GDP. As mentioned earlier, this indicator may overstate the true picture if currency constitutes a high proportion of broad money. Other more specific indicators of access to savings facilities include the ratio of bank deposits to GDP and the proportion of the population with bank accounts.

Information on the outreach of the financial system can help interpret developments in financial savings. Hence, indicators such as the total number of bank branches, the population per bank branch, and the distribution of branches and other outlets (e. g., rural or urban) could provide valuable information on the access of the population to saving facilities. Further, it is important to assess the range of saving vehicles that are available

because, in many countries, traditional bank deposits are the most common form of finan­cial savings. Saving through non-bank forms of financial intermediation are, therefore, crucial to financial diversity, and development indicators for non-bank intermediaries such as insurance, pensions, and capital markets could be useful in gauging the degree to which the population uses non-bank forms of financial savings. Hence, household and corporate holdings of non-bank financial assets (e. g., bonds) could provide extra informa­tion on the degree of access to financial savings.

The ratio of private sector bank credit to GDP is a common measure of the provision of credit to the economy, as well as of banking depth. Often, this indicator is supple­mented by information on the ratio of loans to total bank deposits. Where available, the volume of finance raised through the issuance of bonds and money market instruments should supplement information on bank credit. Analyzing trends in those indicators should reveal the overall degree to which the banking sector provides credit to firms and households. It is also useful to assess the sectoral distribution of private sector credit to gauge the alignment of bank credit with the distribution of domestic output. Therefore, the relative proportion of total credit going to agriculture, manufacturing, and services would be relevant information in evaluating the adequacy of the level of credit provided to the economy.

A key function of financial systems in market economies is to offer fast and secure means of transferring funds and making payments for goods and services. The state of development of the payment system is of interest here, especially the focus on the various instruments for making payments, including cash, checks, payment orders, wire transfers, and debit and credit cards. The proportion of payments (volume and value) made with different payment instruments can reveal the developmental status of the payment sys­tem, with cash-based economies at the lower end of the spectrum. Some indicators such as the number of days for clearing checks, the number and distribution of clearing centers, and the volume and value of checks cleared could provide general information on the effectiveness of existing money transfer mechanisms. In addition, it is relevant to examine the various risks associated with the payments system, through indicators such as access to settlement credit, size of settlement balances, and so forth, thereby complementing the qualitative information from assessments of Core Principles for Systemically Important Payment Systems.8

The major risk mitigation services offered by the financial system include insur­ance (life and non-life) and derivative markets. The ratio of gross premiums to GDP is a popular indicator of development in the insurance industry, and this indicator could be supplemented with a breakdown of premiums between life and non-life insurance. A deep and well-functioning insurance industry would offer a wide range of products in both the life and non-life business, including motor vehicle, marine, fire, homeowners, mortgage, workers’ compensation, and fidelity insurance and life insurance, as well as disability, annuities, medical, and health insurance. In addition, coverage of derivative markets—options, futures, swaps, and structured finance products—where relevant in terms of available instruments, liquidity, and transaction costs, would be important, owing to their role in managing risk and in facilitating price discovery in spot markets.

Liquidity service provided by financial systems is reflected in maturity transforma­tion and secondary market arrangements, which facilitate investment in high-yielding

projects. Most high-return projects require a long-term commitment of capital; however, savers are often reluctant to give up their savings for long periods of time.9 The role of the financial system is to transform liquid, short-term savings into relatively illiquid, long-term investments, thus promoting capital accumulation. The availability of liquid­ity, therefore, allows savers to hold assets that they can sell easily if they need to redeem their savings.

Against this background, it is important to examine the degree of access that specified target groups (e. g., farmers, the poor, small and medium enterprises, or different geograph­ic regions) have to those financial services. Access is defined as the availability and cost of financial services and could be measured in a variety of ways.10 First, relevant measures of the supply of financial services includes the numbers of different types of financial institu­tions, the number of branches and other service outlets, the number of clients served, and the population per outlet. The volume of services (deposits, credit, money transmission, etc.) provided is another useful measure, especially if it is broken down by clientele and size (i. e., in a breakdown by socioeconomic groups or broad sectors or by size distribution). Second, it is also relevant to consider demand-side measures of access. However, demand - side indicators are not easy to construct and often require surveys to collect relevant data. Those surveys have often focused on collecting relevant information such as the savings and credit needs of households and enterprises, the needs relative to the supply, and the ease or difficulty of meeting those needs.11 Finally, it is important to examine the costs of financial services, usually by examining the level and trends in spreads between the borrowing and lending rates, the general interest rate structure, and the prices of other financial services (e. g., fees and minimum balances for deposits, as well as cost and time of payment services).

In addition, indicators of the functioning of various elements of financial system infrastructure—the insolvency and creditor rights regime, the systemic liquidity arrange­ments (other than those of payment systems, which have already been covered as a core financial system function), and the information and governance arrangements (e. g., credit reporting, disclosure rules)—can provide useful insights into costs and efficiency of financial transactions. Appendix B (Illustrative Data Questionnaires for Comprehensive Financial Sector Assessment) contains examples of those types of indicators.