4 Chapter 4 Assessing Financial Structure and Financial Development 4.1 Overview 4.1.1 Motivation for Assessing Financial Structure and Financial Development Extensive evidence confirms that creating the conditions for a de pand efficient financial system can contribute robustly to sustained economic growth and lower poverty (e.g.,see Beck,Levine,and Loayza 2000,Honohan 2004a,and World Bank 2001a).Moreover,in all levels of development,continued efficient and effective provision of financial services requires that financial policies and financial system structures be adjusted as needed in response to financial innovations and shifts in the broader macroeconomic and institu- tional environment. 4.1.2 Scope of Analysis The goals of financial structure analysis and development assessment for a country are to (a)assess the vision of fin es.（b)ama the factors behind miss the obstacles to the ffic of a broad range The dimensions the range,scale (depth ong which and reach (breadth or penetration),and the cost and quality of financial services provided to the economy.At a high level of abstraction,those services are usually classified as including the following: ·Making payments ·Mobilizing savings
69 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 4.1 Overview 4.1.1 Motivation for Assessing Financial Structure and Financial Development Extensive evidence confirms that creating the conditions for a deep and efficient financial system can contribute robustly to sustained economic growth and lower poverty (e.g., see Beck, Levine, and Loayza 2000, Honohan 2004a, and World Bank 2001a). Moreover, in all levels of development, continued efficient and effective provision of financial services requires that financial policies and financial system structures be adjusted as needed in response to financial innovations and shifts in the broader macroeconomic and institutional environment. 4.1.2 Scope of Analysis The goals of financial structure analysis and development assessment for a country are to (a) assess the current provision of financial services, (b) analyze the factors behind missing or underdeveloped services and markets, and (c) identify the obstacles to the efficient and effective provision of a broad range of financial services. The dimensions along which service provision must be assessed include the range, scale (depth) and reach (breadth or penetration), and the cost and quality of financial services provided to the economy. At a high level of abstraction, those services are usually classified as including the following: • Making payments • Mobilizing savings Chapter 4 Assessing Financial Structure and Financial Development
Financial Sector Assessment A handhook .Allocating capital funds s of funds Thus,the ideal financial system will provide,for example,reliable and ine expensive money transfer within the country,reaching remote areas and poor households.There will be remunerative deposit facilities and other investment opportunities offering liquid- 4 ity and a reasonable risk-return tradeoff.Entrepreneurs will have access to a range of sources for funds for their working-and fixed-capital formation;affordable mortgage and consumer finance will be available to households.The credit renewal decisions of banks and the market signals coming from organized markets in traded securities will help ensure that goodse 1。 stable funds.Ins the porfoli offered by liquid mise and eintem urities marke pooling and the shifting of risk at a reasonable price to entities that are able and willing to absorb it. The scope of financial structure analysis and of development assessment is fairly extensive-as illustrated in the above list-and those structural issues cannot be simply broken into self-contained segments corresponding to existing institutional arrangements. Structural and development issues arise across the entire spectrum of financial markets and intermediaries.including banking.insurance.securities markets.and nonbank otermediation.They often demand co nsideration of facto rs for which well-adapted and eadily available.Therefore,the challenge is to tra ging and somewha stract concepts into a concrete and practica asse The suggested approach begins with a fact-finding dimension that seeks to benchmark the existing financial services provided in (and available to)the national economy-in terms of range.scale and reach.cost,and qualitw-against international practice.Such benchmarking should help pinpoint areas of systemic underperformance,which can then be further analyzed to diagnose the causes of the underperformance against realistic tar- get.o some extent,the benchmarking can be quantified,but in pracrice quantificarion supplemented by in-depth qulitat ive info ation The eve 9 antity is deficie t,then what has dhgaskdn Deficiencies will often be traced toa wide range of structural,institutional,and policy factors. First,there may be gaps or needed changes in the financial infrastructure,both in the soft infrastructures of legal,information,and regulatory systems and in the harder transactional technology infrastructures that include payments and settle- ments systems and communications more generally. Second,there may be flaws or needed adaptations in regulatory or tax policy (including competition policy)whose inadeq acies or unintended side effects dis the fu of the polic tioning of the financ an extent not warranted by the ng eeper,there may be broad governance issues at th national level for example,where existing institutional structures impede good policy making (especially favoring incumbents over newcomers)
70 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 • Allocating capital funds • Monitoring users of funds • Transforming risk Thus, the ideal financial system will provide, for example, reliable and inexpensive money transfer within the country, reaching remote areas and poor households. There will be remunerative deposit facilities and other investment opportunities offering liquidity and a reasonable risk-return tradeoff. Entrepreneurs will have access to a range of sources for funds for their working- and fixed-capital formation; affordable mortgage and consumer finance will be available to households. The credit renewal decisions of banks and the market signals coming from organized markets in traded securities will help ensure that good use continues to be made of investable funds. Insurance intermediaries and the portfolio possibilities offered by liquid securities markets will help maximize the risk pooling and the shifting of risk at a reasonable price to entities that are able and willing to absorb it. The scope of financial structure analysis and of development assessment is fairly extensive—as illustrated in the above list—and those structural issues cannot be simply broken into self-contained segments corresponding to existing institutional arrangements. Structural and development issues arise across the entire spectrum of financial markets and intermediaries, including banking, insurance, securities markets, and nonbank intermediation. They often demand consideration of factors for which well-adapted and standardized quantification is not readily available. Therefore, the challenge is to translate those wide-ranging and somewhat abstract concepts into a concrete and practical assessment methodology. The suggested approach begins with a fact-finding dimension that seeks to benchmark the existing financial services provided in (and available to) the national economy—in terms of range, scale and reach, cost, and quality—against international practice. Such benchmarking should help pinpoint areas of systemic underperformance, which can then be further analyzed to diagnose the causes of the underperformance against realistic targets. To some extent, the benchmarking can be quantified, but, in practice, quantification must be supplemented by in-depth qualitative information. The question being asked in every case is, if quality or quantity is deficient, then what has caused this deficiency? Deficiencies will often be traced to a wide range of structural, institutional, and policy factors. • First, there may be gaps or needed changes in the financial infrastructure, both in the soft infrastructures of legal, information, and regulatory systems and in the harder transactional technology infrastructures that include payments and settlements systems and communications more generally. • Second, there may be flaws or needed adaptations in regulatory or tax policy (including competition policy) whose inadequacies or unintended side effects distort or suppress the functioning of the financial system to an extent not warranted by the goals of the policy. • Third, digging deeper, there may be broad governance issues at the national level, for example, where existing institutional structures impede good policy making (especially favoring incumbents over newcomers)
Chapter 4:Assessing Financial and Financial Development Fourth,financial sector deficiencies may also be traced toproblems in the counry's wider economic infrastructures,including the education,transportation,and com munications systems.Furthermore,many developing countries are faced with the difficulty that effective finance requires a scale of activity that may be beyond the reach of small economies,populated as they are by a small number of small clients small intermedaries and small organized markets (see Bossone,Honohan,and ong 2002).An effective financial m while rib ting to wider growth and developmen is also somewhat dep nt on the wider economic 4 environment-not least the macroeconomic and fiscal environment The most distinctive feature of financial structure analysis and development assess ment is the focus on the users of financial services and on the efficiency and effectiveness of the system in meeting user needs.Policy reforms that benefit users and that promote financial development are generally favored in such analysis and assessments.The pro t framew ork is also guided by the p ption,which is based on a sizable iricale dence,that an effectiv ve and effic ent finan ial system is best provided by market-driven financial service providers,with the main role of goverment bei serve as regulator and provider of robust financial infrastructure.Therefore,the establish ment of a government-sponsored financial service provider is not seen as likely to be the first-best solution to deficiencies.Instead,the role and effectiveness of financial service providers are assessed regardless of whether they are government owned.Assessment has wo phases:information gathering and analytical reporting. Phase 1:Infommation-Gathering Phase To reflect this focus on users and the services they require,the overall assessment needs to adopt a functional pproach and not to b to a perspective that is be ased on existing institutional dividing lines b fferent groups of providers Nevertheless much of the information gathering will inevitably reflect those institutional divisions,not the least because national regulatory structures are typically organized along those lines (notwithstanding the trend to integrated supervisory agencies in several countries). In addition,the adequacy of the legal,information,and payments infrastructures and of other ts of the rall polic the develop nent:each ance cutting acr any single sec Yet rma bou the effectiveness of the infrastructures and ab eff of the policy environment is often obtained only by learning how each sector works Likewise,the competitive structure,efficiency,and product mix of the various sectors can be explained only on the basis of an understanding of the design and performance of the infrastructures.So the information-gathering phase of the assessment needs to have a sectoral,as well as an infrastructural,dimension.Cross-utting policy issues such as taxa tion also need to be kept in mind.Finally, user perspect be helpful,es dentifying gaps in providing markets and services,as well as in discovering deficiencies in quality and cost that might not be revealed from analysis of the suppliers. The information-gathering phase of the assessment is multidimensional.Typical com- ponents of the information-gathering phase may include the following: 71
71 Chapter 4: Assessing Financial Structure and Financial Development 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 • Fourth, financial sector deficiencies may also be traced to problems in the country’s wider economic infrastructures, including the education, transportation, and communications systems. Furthermore, many developing countries are faced with the difficulty that effective finance requires a scale of activity that may be beyond the reach of small economies, populated as they are by a small number of small clients, small intermediaries, and small organized markets (see Bossone, Honohan, and Long 2002). An effective financial system, while contributing to wider economic growth and development, is also somewhat dependent on the wider economic environment—not least the macroeconomic and fiscal environment. The most distinctive feature of financial structure analysis and development assessment is the focus on the users of financial services and on the efficiency and effectiveness of the system in meeting user needs. Policy reforms that benefit users and that promote financial development are generally favored in such analysis and assessments.1 The proposed assessment framework is also guided by the presumption, which is based on a sizable body of empirical evidence, that an effective and efficient financial system is best provided by market-driven financial service providers, with the main role of government being to serve as regulator and provider of robust financial infrastructure. Therefore, the establishment of a government-sponsored financial service provider is not seen as likely to be the first-best solution to deficiencies. Instead, the role and effectiveness of financial service providers are assessed regardless of whether they are government owned. Assessment has two phases: information gathering and analytical reporting. Phase 1: Information-Gathering Phase To reflect this focus on users and the services they require, the overall assessment needs to adopt a functional approach and not to be confined to a perspective that is based on existing institutional dividing lines between different groups of providers.2 Nevertheless, much of the information gathering will inevitably reflect those institutional divisions, not the least because national regulatory structures are typically organized along those lines (notwithstanding the trend to integrated supervisory agencies in several countries). In addition, the adequacy of the legal, information, and payments infrastructures and of other aspects of the overall policy environment are central to the development assessment: each has relevance cutting across any single sector. Yet, information about the effectiveness of the infrastructures and about the unintended and hidden side effects of the policy environment is often obtained only by learning how each sector works. Likewise, the competitive structure, efficiency, and product mix of the various sectors can be explained only on the basis of an understanding of the design and performance of the infrastructures. So the information-gathering phase of the assessment needs to have a sectoral, as well as an infrastructural, dimension. Cross-cutting policy issues such as taxation also need to be kept in mind. Finally, user perspective can be helpful, especially in identifying gaps in providing markets and services, as well as in discovering deficiencies in quality and cost that might not be revealed from analysis of the suppliers. The information-gathering phase of the assessment is multidimensional. Typical components of the information-gathering phase may include the following:
Financial Sector Assessment A handhook Quantitative benchmarking of the size,depth,cost and price efficiency,and the h)of finar ial intermediaries and markets,using intemation (section 4 .2) Review of legal,informational,and transaction technology infrastructures (sec. tion 4.3) .Sectoral development reviews,providing a more in-depth assessment of service provision,structure,and regulation (Sectors covered will normally include com- 4 mercial banking and nearbanking,insurance,and securities sectors and may also include some or all of the collective savings institutions and of the financial aspects of public pension funds,specialized development intermediaries,mortgage finance. and micr finance.Thos refer to the fund ctioning b ooth of the e regulatory apparatus sectio 4.41) .Demand-side reviews of access to,and use of,financial services by households nterprises,small and medium enterprises (SMEs),and large enterprises (sec. tion 4.5) .Reviews of selected additional cross-cutting aspects of the policy environment (for example,distorting taxation and subsidization of financial intermediation)and of implications for competition of cross-sectoral ownership structures(Those reviews also may mention missing product issues,thus focusing on whether key financial -such as leasing,factoring,and venture capital-are available and iden- tifying the reasons for their absenc e [see section 4.6].) Phase 2:Analytical and Reporting Phases The relative imp ts of the infor scope of thei to c ngin scope of information presents a challenge to ass o must,in th analy tical ane reporting phases,synthesize the information to identify th major axes of needed polic reform and of infrastructural strengthening for stability and development.Segments of the financial system that are already active,but for which the benchmarking exercise suggests shortcomings,will deserve more-detailed attention.For segments that are missing or are not very developed,the discussion of needed policies can be confined to the level of broad strategy.How those components can be integrated into a policy framework is discussed in section 4.7. 4.1.3 Stability and Development:Complementarities Despite the Different Perspective Financial structure analysis and develop ment assessment inevitably overlaps extensively with the stability a nt.Even if ade equate fr rom a stability perspe the e supervisory practices may nee reform fror he e develop ment perspective.Certain areas not norm ly considered n stability-orien assessments such as microfinance and development banking,warrant attention from the development perspective.Moreover,every sector that is relevant to stability can have an important
72 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 • Quantitative benchmarking of the size, depth, cost and price efficiency, and the penetration (breadth) of financial intermediaries and markets, using internationally comparable data (section 4.2) • Reviews of legal, informational, and transaction technology infrastructures (section 4.3) • Sectoral development reviews, providing a more in-depth assessment of service provision, structure, and regulation (Sectors covered will normally include commercial banking and nearbanking, insurance, and securities sectors and may also include some or all of the collective savings institutions and of the financial aspects of public pension funds, specialized development intermediaries, mortgage finance, and microfinance. Those sectors need to refer to the functioning both of the industry [financial services providers] itself and of the regulatory apparatus [section 4.4].) • Demand-side reviews of access to, and use of, financial services by households, microenterprises, small and medium enterprises (SMEs), and large enterprises (section 4.5) • Reviews of selected additional cross-cutting aspects of the policy environment (for example, distorting taxation and subsidization of financial intermediation) and of implications for competition of cross-sectoral ownership structures (Those reviews also may mention missing product issues, thus focusing on whether key financial products—such as leasing, factoring, and venture capital—are available and identifying the reasons for their absence [see section 4.6].) Phase 2: Analytical and Reporting Phases The relative importance of the components of the information-gathering phase and the scope of their analysis will vary according to country circumstances. This wide-ranging scope of information presents a challenge to assessors who must, in the analytical and reporting phases, synthesize the information to identify the major axes of needed policy reform and of infrastructural strengthening for stability and development. Segments of the financial system that are already active, but for which the benchmarking exercise suggests shortcomings, will deserve more-detailed attention. For segments that are missing or are not very developed, the discussion of needed policies can be confined to the level of broad strategy. How those components can be integrated into a policy framework is discussed in section 4.7. 4.1.3 Stability and Development: Complementarities Despite the Different Perspective Financial structure analysis and development assessment inevitably overlaps extensively with the stability assessment. Even if adequate from a stability perspective, the existing regulatory framework and the supervisory practices may need reform from the development perspective. Certain areas not normally considered in stability-oriented assessments, such as microfinance and development banking, warrant attention from the development perspective. Moreover, every sector that is relevant to stability can have an important
Chapter 4:Assessing Financial and Financial Development development dimension.Notwithstanding the overlap of themes,the focus of the sectora and infrastructural development reviews is different from,and complementary to,that of the stability assessment.For each sector,the development review is designed to consider whether policy or legislative changes are needed to enhance the ability and incentive of market participants to deliver financial services. The types of question asked in analyzing financial structure and development are often differ ent from those that take center stage in the stability assessment.For example are regulato n hank e conduct (includir g intere 4 ch ing and automate chi nduly and do they act as barriers to competition and to the extension of financia services to underserved segments?Is the regulation of insurance company investments hampering their contribution to long-term funding of enterprises!Is there an adequate enabling lega framework for the emergence of widely accessed credit registries?Are judicial practice funding,and skills supportive of speedy and low-cost debt recovery?Does the regulatory framework for payments systems support an efficient and low-cost network of retail pay ments throughout the country? rlap betweer stability and develo ment raises both ractical and conce toral reviews the e is the need ina ormation gatheri here i the need to ensure that the recommendations mesh well together.In practice,the two perspectives- stability and development,reinforce each other in terms of recommenda- tions more often than they create a tension or tradeoff.For example,legal procedures for enhancing creditor rights tend both to reduce the risk of loan losses undermining the soundness of the banking system and to increase the willingness of intermediaries to extend credit.Yet there can be some apparent tension,for example,when entry of rowned banks though improv quality and price of services to the rest e econom y nts (a s Apparent cor mus sidered an esolved from der perspective of ensuring ong-term,stable financial development in the interest of the economy at large.One issu in this context is whether the system is sufficiently robust(stability analysis)to withstand the potential shocks associated with liberalization that will eventually be needed for development reasons.In this sense,the stability analysis can provide some guidance to the timing and sequencing of development-oriented reforms.A detailed analysis of sequenc. ing issues is presented in chapter 12. 4.2 Quantitative Benchmarking If we are to obtain an overall picture of where the financial sector is,or is not,perform ing well,then th inancial intermediaries and mark ets scope of a can b fullyhnof compro National authorities are likely to be interested in countries in the same region,as well as those of a similar size and a similar level or higher levels of per capita income.The type of indicators that would be appropriate is discussed in chapter 2 and summarized in box 4.1
73 Chapter 4: Assessing Financial Structure and Financial Development 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 development dimension. Notwithstanding the overlap of themes, the focus of the sectoral and infrastructural development reviews is different from, and complementary to, that of the stability assessment. For each sector, the development review is designed to consider whether policy or legislative changes are needed to enhance the ability and incentive of market participants to deliver financial services. The types of question asked in analyzing financial structure and development are often different from those that take center stage in the stability assessment. For example, are regulatory restrictions on bank entry and conduct (including interest rate ceilings, ownership, branching, and automated teller machines [ATMs]) unduly constraining, and do they act as barriers to competition and to the extension of financial services to underserved segments? Is the regulation of insurance company investments hampering their contribution to long-term funding of enterprises? Is there an adequate enabling legal framework for the emergence of widely accessed credit registries? Are judicial practice, funding, and skills supportive of speedy and low-cost debt recovery? Does the regulatory framework for payments systems support an efficient and low-cost network of retail payments throughout the country? The overlap between stability and development raises both practical and conceptual issues for the sectoral reviews: At the practical level, there is the need to coordinate information gathering to avoid duplication of effort. At the conceptual level, there is the need to ensure that the recommendations mesh well together. In practice, the two perspectives—stability and development, reinforce each other in terms of recommendations more often than they create a tension or tradeoff. For example, legal procedures for enhancing creditor rights tend both to reduce the risk of loan losses undermining the soundness of the banking system and to increase the willingness of intermediaries to extend credit. Yet there can be some apparent tension, for example, when entry of foreign-owned banks—although improving the quality and price of services to the rest of the economy—is seen as a threat to the profitability of incumbents (a stability issue). Apparent conflicts must be considered and resolved from a wider perspective of ensuring long-term, stable financial development in the interest of the economy at large. One issue in this context is whether the system is sufficiently robust (stability analysis) to withstand the potential shocks associated with liberalization that will eventually be needed for development reasons. In this sense, the stability analysis can provide some guidance to the timing and sequencing of development-oriented reforms. A detailed analysis of sequencing issues is presented in chapter 12. 4.2 Quantitative Benchmarking If we are to obtain an overall picture of where the financial sector is, or is not, performing well, then the performance of financial intermediaries and markets—in terms of total assets, scope of activity, depth, efficiency, and penetration—can be compared to a carefully chosen set of comparator countries. National authorities are likely to be interested in countries in the same region, as well as those of a similar size and a similar level or higher levels of per capita income.3 The type of indicators that would be appropriate is discussed in chapter 2 and summarized in box 4.1
Financial Sector Assessment:A Handbook Box 4.1 Quantitative Indicators for Financial Structure and Development Assessment The meas penetration indicat y with d and s 4 (M2)for lude some more detailed analysis ontract ento of the a ourt systems such as the dof judicial co tion),spee ctiveness of it and loan sie distribution,as well as rights,presence of a credit registry,and fimm entry -c an be drawn from e World Bank nents from the World Business Environment number of banks, ally th ment-owned banks are also relevant.Eficienc overhead costs c off by relevant s mmary economic and the informal cco nomy.illit arate total popul services include cash-to-GDP ratio lags in check c h can be World Bank. umber and more de able for aa oof countries,thus allow sources.is contained in chapter 2. Ideally,given data availability,it may be possible to use the results of research studies that have identified causal factors for cross-country differences in depth,efficiency,and other dimensions of financial development.For example,several studies have attempted in average bank margins-key indicators of the price effici banking in terms of policy,institutional,and macroeconomic variables.Those variable include the bank's size,a measure of property rights protection,and other bank-and country-level characteristics.such as bank concentration.output gap,and interest rate level Ifthose policy and for the tion,the results of the studies can be used to throw light on potential improvements that could be achieved through better policies and better institutions.The residual between the expected value of average bank margins in the country predicted by the study and the actual margins,if positive,will point to the need for closer analysis of idiosyncratic ures in the country-fearures that may be contributing to the gap.(For an illustratior of this technique in practice in Kenya,see appendix E.)A similar approach can be used
74 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 Ideally, given data availability, it may be possible to use the results of research studies that have identified causal factors for cross-country differences in depth, efficiency, and other dimensions of financial development. For example, several studies have attempted to explain differences in average bank margins—key indicators of the price efficiency of banking in terms of policy, institutional, and macroeconomic variables. Those variables include the bank’s size, a measure of property rights protection, and other bank- and country-level characteristics, such as bank concentration, output gap, and interest rate level.4 If those policy and institutional variables are available for the country in question, the results of the studies can be used to throw light on potential improvements that could be achieved through better policies and better institutions. The residual between the expected value of average bank margins in the country predicted by the study and the actual margins, if positive, will point to the need for closer analysis of idiosyncratic features in the country—features that may be contributing to the gap. (For an illustration of this technique in practice in Kenya, see appendix E.) A similar approach can be used Box 4.1 Quantitative Indicators for Financial Structure and Development Assessment The measures chosen as quantitative indicators for financial structure and development assessment will naturally include basic indicators of financial depth expressed as a percentage of gross domestic product (GDP). The indicators are proxies for the size of the different components of the financial sector and could include credit to the private sector and broad money (M2) for banking; number of listed equities and bond issues, market capitalization, and value traded of financial markets for financial markets; and insurance premium income and asset size for insurance. Data on breadth and penetration—which are proxies for the population’s access to different segments of the financial sector and, thus, for outreach—of financial markets include bank branch and outlet intensity and deposit and loan size distribution, as well as number of clients in the banking, nearbanking, and insurance sectors. The data gauge the share of the population with access to financial services. Data on market structure—number of banks, concentration in banking, and share of foreign-owned and government-owned banks—are also relevant. Efficiency measures include interest margins, overhead costs or asset indicators, and turnover ratios for capital markets. Indicators of efficiency and quality of payment services include cash-to-GDP ratio, lags in check or payment order clearing, volume and value of checks or payment orders processed in retail and large value payment systems, and number and density of ATMs. Indicators for size, depth, and efficiency are available for a large cross-section of countries, thus allowing comparison; however, the assembly of breadth and penetration indicators on a cross-country basis is in the beginning stages. There is a clear ranking of cross-country data availability among different sectors, with data on banking, insurance, and stock markets more readily available than on bond markets and microfinance. Quantitative benchmarking may also include some comparisons over time within countries where feasible and should serve as basis for more detailed analysis. Infrastructural quality measures—contract enforcement (including measures of the effectiveness of the court systems such as the speed of judicial conflict resolution), speed and effectiveness of insolvency procedures, creditor and minority shareholder rights, presence of a credit registry, and firm entry regulations—can be drawn from the World Bank’s Doing Business Database. Also informative are user assessments from the World Business Environment Survey. Finally, the quantitative indicators for financial structure and development assessment can be rounded off by relevant summary economic and social indicators such as GDP per capita, share of the informal economy, illiteracy rate, total population size, and so forth, which can be selected from the World Development Indicators published by the World Bank. A more detailed presentation of financial structure indicators, including definitional issues and data sources, is contained in chapter 2
Chapter 4:Assessing Financial and Financial Development for banking depth where macrovariables,such as inflation and the level of gross domestic product(GDP)per capita,are key determinants along with institutional variables,such as shareholder and creditor rights (e.g.,see Beck,Demirguc-Kunt,and Levine 2003). There are also some cross-country studies of other dimensions.including insurance penetration,stock market capitalization,and turnover,although those studies may not yet be sufficiently well established for heavy reliance to be placed on them for bench marking purpos es.Along with other dimensions,including ess to fina cial se not yet sufficieny developed o t this ki 4 ing.In those cases,simple cross-cou comparisons against peers can,nevertheless,be informative and can point to areas of deficiency. 4.3 Review of Legal,Informational and Transactional Technology Infrastructures for Access and Development The major cross-cutting infrastructures can be grouped under the three headings of legal informational,and transactional technology.The robustness of legal infrastructures is universally acknowledged as crucial to a healthy financial system.Creditor protection entral,as is bankruptey law and its impleme ation.In e areas,re rm of the co rt system is often att art c ance law and e can also b hiomataalinfiaicesne&indeacontingandadingTiesandpacice,phsth see as co legal and organizational requirements for public or private credit registries and property registries.Other aspects,such as the ratings industry,may be relevant in more-advanced middle-income countries.Internationally recognized accounting and auditing standards exist,and assessments of their observance,when available,can be useful for both stability and development assessments.The nost important transactional technology infrastruc relat g holesale pay and nay already be mpo nt Payment Syste s (CPS (See S) e chapte s of CPSI nt purp is the functioning of the retail payments system:although it is not vulnerable to sudder failure on a large scale,it is not considered"systemically important"in the sense of the CPSIPS.The efficiency with which the legal.information.and transactional technol. ogy infrastructures support financial intermediation in the country plays a critical role ir access and development.Detailed assessments of those areas are described in chapters 9, 10,and 11 of this handbook,and they provide information on the quality of the infra ed below 4.3.1 Legal Infrastructure 1997,1998,and Levine Although discussed in more detail in chapter 9 of this handbook,the following discus sion highlights the aspects of the legal system that are important for development assess- ment. 75
75 Chapter 4: Assessing Financial Structure and Financial Development 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 for banking depth where macro-variables, such as inflation and the level of gross domestic product (GDP) per capita, are key determinants along with institutional variables, such as shareholder and creditor rights (e.g., see Beck, Demirgüç-Kunt, and Levine 2003). There are also some cross-country studies of other dimensions, including insurance penetration, stock market capitalization, and turnover, although those studies may not yet be sufficiently well established for heavy reliance to be placed on them for benchmarking purposes. Along with other dimensions, including access to financial services, cross-country research is not yet sufficiently developed to support this kind of benchmarking. In those cases, simple cross-country comparisons against peers can, nevertheless, be informative and can point to areas of deficiency. 4.3 Review of Legal, Informational, and Transactional Technology Infrastructures for Access and Development The major cross-cutting infrastructures can be grouped under the three headings of legal, informational, and transactional technology.5 The robustness of legal infrastructures is universally acknowledged as crucial to a healthy financial system. Creditor protection in principle and in practice is central, as is bankruptcy law and its implementation. In both of those areas, reform of the court system is often at the heart of needed reforms. Corporate governance law and practice can also be seen as coming under this heading. Informational infrastructures include accounting and auditing rules and practice, plus the legal and organizational requirements for public or private credit registries and property registries. Other aspects, such as the ratings industry, may be relevant in more-advanced, middle-income countries. Internationally recognized accounting and auditing standards exist, and assessments of their observance, when available, can be useful for both stability and development assessments. The most important transactional technology infrastructures—relating to wholesale payments and settlements—may already be assessed using the Core Principles of Systemically Important Payment Systems (CPSIPS). (See chapter 11 for details of CPSIPS.) The additional dimension required for development purposes is the functioning of the retail payments system: although it is not vulnerable to sudden failure on a large scale, it is not considered “systemically important” in the sense of the CPSIPS. The efficiency with which the legal, information, and transactional technology infrastructures support financial intermediation in the country plays a critical role in access and development. Detailed assessments of those areas are described in chapters 9, 10, and 11 of this handbook, and they provide information on the quality of the infrastructure elements, which are discussed below. 4.3.1 Legal Infrastructure The efficient functioning of the legal system is indispensable for effective financial intermediation (e.g., see La Porta et al. 1997, 1998, and Levine, Loayza, and Beck 2000). Although discussed in more detail in chapter 9 of this handbook, the following discussion highlights the aspects of the legal system that are important for development assessment
Financial Sector Assessment A Handbook In addition to the cro country quantitative evidence mentioned in box 41,underly exerci Systems (World Bank 2001b)and from interviews with banks,enterprises,academics,and other market participants. The effective creation,perfection,and enforcement of collateral is a cross-cutting issue for financial intermediation and requires assessing the appropriate legislation,the 4 property registries (including stamp duties and notary fees),the court system,and the out-of-court enforcement mechanisms.If collateral taking is limited to certain assets or if high collateral-to-debt ratios are equired.this limitation or size gr effectiver sof collateral pr cess can ms of lending,such as interest rates,along with the competitiveness of the lending market. The effectiveness of debt enforcement and insolvency procedures in terms of cost and time it takes,both through and outside the court system,is important for effective and efficient intermediation.Expedited enforcement systems that use private negotiation and out-of-court settlement can be very helpful,if available.The possibility of flexible ways of achieving corporate financial restructuring,albeit without undermining creditors' Position,s A deficient insolvenc restrict the of the c system overalla and can lead to sub ptimal out-of-court settlements or even restrictions or the a sto,and the re ns of,lending The functioning of the court system is crucial.The evaluatior n here could include an assessment of the legal profession along several dimensions,such as education,skills funding,fees,and ethical behavior.The effectiveness of specialized courts in local cir- cumstances can be examined if we bear in mind that those courts can help in situations where complex commercial issues arise and even in situations with less-complex issues. such as loan recovery.The courts may work faster and more consistently than regulat courts-though experience here is mixed,and it may be better in the long run to vork ard an nt in the functioning of the cou The state of corporateg vemance,includi among managemen majority owners,and outside investors,can ct on the ease wi which outi invetor providefnancend the price tro o theuand he practice of corporate governance need to be considered;if a formal corporate governance assessment has been carried out,its findings can be drawn upon here. 4.3.2 Information Infrastructures Asymmetric information between borrowers and lenders and,thus,the transaction costs can be reduced if there is readily available information on the financial condition of bor- rowers and especially on their history of credit performance.In particular,two areas of the information infras should not be glected:(a)tr ency in bo financial sta ents enables lender rs to ss bo reditw h: pas t financial an opera ional performance,and (b readily available cr on borrowers e ables lenders to assess borrowers'creditworthiness according to their past performance within the financial system
76 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 In addition to the cross-country quantitative evidence mentioned in box 4.1, underlying factual information for this exercise can come both from any completed assessments of formal codes such as the Principles and Guidelines for Effective Insolvency and Creditor Rights Systems (World Bank 2001b) and from interviews with banks, enterprises, academics, and other market participants.6 The effective creation, perfection, and enforcement of collateral is a cross-cutting issue for financial intermediation and requires assessing the appropriate legislation, the property registries (including stamp duties and notary fees), the court system, and the out-of-court enforcement mechanisms. If collateral taking is limited to certain assets or if high collateral-to-debt ratios are required, this limitation can ration credit to certain sectors or size groups of borrowers. The effectiveness of the collateral process can also affect the terms of lending, such as interest rates, along with the competitiveness of the lending market. The effectiveness of debt enforcement and insolvency procedures in terms of cost and time it takes, both through and outside the court system, is important for effective and efficient intermediation. Expedited enforcement systems that use private negotiation and out-of-court settlement can be very helpful, if available. The possibility of flexible ways of achieving corporate financial restructuring, albeit without undermining creditors’ position, is important. A deficient insolvency framework can restrict the use of the court system overall and can lead to suboptimal out-of-court settlements or even restrictions on the access to, and the terms of, lending. The functioning of the court system is crucial. The evaluation here could include an assessment of the legal profession along several dimensions, such as education, skills funding, fees, and ethical behavior. The effectiveness of specialized courts in local circumstances can be examined if we bear in mind that those courts can help in situations where complex commercial issues arise and even in situations with less-complex issues, such as loan recovery. The courts may work faster and more consistently than regular courts—though experience here is mixed, and it may be better in the long run to work toward an overall improvement in the functioning of the court system. The state of corporate governance, including the relationships among management, majority owners, and outside investors, can have an important effect on the ease with which outside investors provide finance and the price thereof. Both the rules and the practice of corporate governance need to be considered; if a formal corporate governance assessment has been carried out, its findings can be drawn upon here.7 4.3.2 Information Infrastructures Asymmetric information between borrowers and lenders and, thus, the transaction costs can be reduced if there is readily available information on the financial condition of borrowers and especially on their history of credit performance. In particular, two areas of the information infrastructure should not be neglected: (a) transparency in borrowers’ financial statements enables lenders to assess borrowers’ creditworthiness on present and past financial and operational performance, and (b) readily available credit information on borrowers enables lenders to assess borrowers’ creditworthiness according to their past performance within the financial system.8
Chapter 4:Assessing Financial and Financial Development Credit registries,if they exist,vary widely in the information that is being collece and that is available to financial institutions;hence,they vary in their effectiveness in improving access.The effect on access is influenced by characteristics such as(a)which financial and nonfinancial institutions provide data and have access to the data(the more the better);(b)whether only negative information (i.e.,on defaults and delinquencies) also po ositive information, tion improves the potentia use of the registry for credit appraisal);(c)for what kind of loans is the information collected;and (d)for how long 4 is information kept.While there are reasons to expect privately owned registries to out. perform those operated by public agencies,there are instances of effective publicly owned registries.Local conditions can influence the choice here.Existing credit registries should evaluared not only on their design features,but also on how they have performed in practice.The legal and regularory environment is important fo stence and effective ness of credit registries and other financial information vendors.While protection of con- sumer privacy is important,unduly restrictive rules here can hamper information sharing on borrowers to the detriment of their access to credit. Credit registries may be complemented by other providers of financial information on nmercial infon on endors,such as Bloombergor Reuters,trade associa ts of c ating ag cies,might contrib eto transpar ency in the financial market.Finally,there might be private information-sharing agree ments between financial institutions outside the formal structure of a credit registry. Accounting and auditing standards and practices are important elements of the infor. mation environment in that they govern companies'disclosure of financial information to the public.A full assessment of the accounting and auditing standards (see chapter 10 for further details on these standards)in this a rea n sbe practicable,bu the standards,neverthele ss,represent the overall goa that should be aspired and ca e used as a reference for identifying information-based barriers to enhanced financing for the corporate sector. 4.3.3 Transactional Technology Infrastructures The effective transfer of money between customers of the same and of different institu- tions is one of the main functions of the financial systems.While the stability assessment of the paym nent system is mostly inte ment focuses more on the cost or a nd access to re velopment assessment includes evaluating the effectiveness of the check and money transfer system in terms of time and cost.It also entails assessing the access to those services,either directly through banks or indirectly through other financial institutions that use banks as agents.Indicators to assess the effectiveness of the payment system include the cost and to nsfer money.As alter studies have su the small nu tive indicators mbers of the popula ation an nd of subgrou who ha ve a tr sactions bank account,debit card,or credit card,as well as the distribution of travel time to the nearest ATM or money transmission point.Unfortunately,as yet,there is no cross-country dataset for such access indicators
77 Chapter 4: Assessing Financial Structure and Financial Development 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 Credit registries, if they exist, vary widely in the information that is being collected and that is available to financial institutions; hence, they vary in their effectiveness in improving access. The effect on access is influenced by characteristics such as (a) which financial and nonfinancial institutions provide data and have access to the data (the more the better); (b) whether only negative information (i.e., on defaults and delinquencies) or also positive information, including interest rate, maturity, and collateral, is collected and provided (positive information improves the potential use of the registry for credit appraisal); (c) for what kind of loans is the information collected; and (d) for how long is information kept. While there are reasons to expect privately owned registries to outperform those operated by public agencies, there are instances of effective publicly owned registries. Local conditions can influence the choice here. Existing credit registries should be evaluated not only on their design features, but also on how they have performed in practice. The legal and regulatory environment is important for existence and effectiveness of credit registries and other financial information vendors. While protection of consumer privacy is important, unduly restrictive rules here can hamper information sharing on borrowers to the detriment of their access to credit. Credit registries may be complemented by other providers of financial information on borrowers. Commercial information vendors, such as Bloomberg or Reuters, trade associations, chambers of commerce, or credit-rating agencies, might also contribute to transparency in the financial market. Finally, there might be private information-sharing agreements between financial institutions outside the formal structure of a credit registry. Accounting and auditing standards and practices are important elements of the information environment in that they govern companies’ disclosure of financial information to the public. A full assessment of the accounting and auditing standards (see chapter 10 for further details on these standards) in this area might not always be practicable, but the standards, nevertheless, represent the overall goals that should be aspired to and can be used as a reference for identifying information-based barriers to enhanced financing for the corporate sector. 4.3.3 Transactional Technology Infrastructures The effective transfer of money between customers of the same and of different institutions is one of the main functions of the financial systems. While the stability assessment of the payment system is mostly interested in wholesale systems, the development assessment focuses more on the cost of and access to retail payment services. Development assessment includes evaluating the effectiveness of the check and money transfer system in terms of time and cost. It also entails assessing the access to those services, either directly through banks or indirectly through other financial institutions that use banks as agents. Indicators to assess the effectiveness of the payment system include the cost and time to transfer money. As alternative indicators of access, some studies have surveyed the small numbers of the population and of subgroups who have a transactions banking account, debit card, or credit card, as well as the distribution of travel time to the nearest ATM or money transmission point. Unfortunately, as yet, there is no cross-country dataset for such access indicators
Financial Sector Assessment a Handbook 4.4 Sectoral Development Reviews Sectoral developmental reviews complement the assessments of regulatory standards Over the past several decades,extensive institutional change and experimentation in advanced economies have led to the emergence of elaborate regimes of regulation and supervision of the banking,insurance,and securities markets.Those regimes are designed 4 to ensure integrity of the functioning within the sectors and to avoid behavior that is likely to contribute to failure.They have evolved largely in response to the rapid develop men of the financial sector in adva nomies r r tha as a m the development of the sco hou gh,in several cases,regulatory liberaliz been influenced by a perceived risk to the competitiveness of domestic financial markets in an increasingly global financial system. The standards and codes used for those sectors essentially codify what has emerged as the common core of what remains a somewhat diverse set of regulatory institutions. While the standards and codes represent a fairly firm and widely agreed framework for essment on the prudential side,the mechanics of over oming ba ers to development unsophisticatedfin ncial systems in low hich a dmiddle-income coun ds an d codes ei presenc of much of what is sought in the goal of developing the financial system and at the same time contain (to some extent)principles that guide institutional development and good practices in financial institutions.Promoting institutional development,however,raises issues of sequencing and absorptive capacity in implementing policy reforms.Because of those considerations,conducting the develop cal,more subjective,ar arguably more assessing the rele ant stan ds ar For most low.and mi ddle ncome countries,a b rief and selective review of deve opment issues provides the information that is needed on the preconditions for a full standards and codes assessment.Where standards and codes for a sector are not being fully assessed,the review of development issues can be accompanied by a less detailed. stability-oriented,regulatory assessment.The assessor should highlight deficiencies in provided and shoul attemp f that have ed to those e deficie well a s any policy policy-that hav contributed to the deficiencies. Although some of the nee data are covered in cro country databases(as mentioned in chapter 2),for many other dimensions in each of the sectors,only noncomparable national sources are currently available,Those dimensions would include aspects such as the stock market free-float,reliance by large firms on inter- national depositary receipts.transactions costs for securities markets.prices of insurance oducts,and maturity structure of intermediary p ortfolios s must use their j ent in evaluating wh ate ation is vailable o such matters Because competitiveness issues have a pervasive influence on sectoral performance the issues need to be analyzed in all sectors.The competitive structure of the industry
78 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 4.4 Sectoral Development Reviews Sectoral developmental reviews complement the assessments of regulatory standards. Over the past several decades, extensive institutional change and experimentation in advanced economies have led to the emergence of elaborate regimes of regulation and supervision of the banking, insurance, and securities markets. Those regimes are designed to ensure integrity of the functioning within the sectors and to avoid behavior that is likely to contribute to failure. They have evolved largely in response to the rapid development of the financial sector in advanced economies rather than as a means of promoting the development of the sector—though, in several cases, regulatory liberalization has been influenced by a perceived risk to the competitiveness of domestic financial markets in an increasingly global financial system. The standards and codes used for those sectors essentially codify what has emerged as the common core of what remains a somewhat diverse set of regulatory institutions. While the standards and codes represent a fairly firm and widely agreed framework for assessment on the prudential side, the mechanics of overcoming barriers to development of what are still unsophisticated financial systems in low- and middle-income countries are not something for which a comprehensive template can be distilled from current practice. Indeed, the standards and codes either explicitly or implicitly assume the presence of much of what is sought in the goal of developing the financial system and at the same time contain (to some extent) principles that guide institutional development and good practices in financial institutions. Promoting institutional development, however, raises issues of sequencing and absorptive capacity in implementing policy reforms. Because of those considerations, conducting the development assessment for any given subsector is necessarily less categorical, more subjective, and arguably more difficult than assessing the relevant standards and codes. For most low- and middle-income countries, a brief and selective review of development issues provides the information that is needed on the preconditions for a full standards and codes assessment. Where standards and codes for a sector are not being fully assessed, the review of development issues can be accompanied by a less detailed, stability-oriented, regulatory assessment. The assessor should highlight deficiencies in quantity (scale and reach), quality, and price of the services provided and should attempt to identify the infrastructural weaknesses that have contributed to those deficiencies, as well as any policy flaws—including flaws in competition and tax policy—that have likely contributed to the deficiencies. Although some of the needed data are covered in crosscountry databases (as mentioned in chapter 2), for many other dimensions in each of the sectors, only noncomparable national sources are currently available. Those dimensions would include aspects such as the stock market free-float, reliance by large firms on international depositary receipts, transactions costs for securities markets, prices of insurance and efficiency of insurance products, and maturity structure of intermediary portfolios. The assessors must use their judgment in evaluating whatever information is available on such matters. Because competitiveness issues have a pervasive influence on sectoral performance, the issues need to be analyzed in all sectors. The competitive structure of the industry