Financial Sector Assessment A handhook Table 2.2.Indicators of Financial System Performance Sub-sector Indicator 2 Competition and concentration Total number of institu :lhterotratesproadsandprice5offinancialsorvice Efficiency :lheretnopeee e(as percentage of total assets Liquidity :Aeegekspeamrtaapaaion bid-ask spreads.Because bid-ask spread also reflects market liquidity,as discussed below. arket and of volatility of pric itioalnatoteecsCcoehadnnesca ity are sometimes used to substitute for market efficiency,although short-run changes in volatility may reflect shifts in the amount of liquidity in that market. Two important dimensions of market liquidity should be considered:market depth and market tightness.Market depth refers to the ability of the market to absorb large trade volumes without significant impact on market prices.This dimension is usually measured by the ratio of value traded to market capitalization (tu ratio),with higher ra indicating more liquid markets.Another dimension of liquidity marke t tightne ity to ch supply and demand t low cost that s measured y the average bid-as these indicators can be found in section 2.2.4. Table 2.2 summarizes the indicators of financial system performance that have been discussed in this section. 2.1.4 Scope and Coverage of Financial Services The financial system provides five key services:(a)savings facilities,(b)credit alloca- tion and monitoring of borrowers,(c)payments,(d)risk mitigation,and (e)liquidity serv ices ed by e examining the effec tiveness with which the hond m The exrent of fnanc inern xnth system provides saving facilities and mobil sfinancial resources from hou 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 ou ach of the fina ial s m can help inter in financial saving nche on per bank br and th distribution of nd other ou tlets (e.g.rura or uban)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
20 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 bid–ask spreads. Because bid–ask spread also reflects market liquidity, as discussed below, additional analysis of the extent of competition in the market and of volatility of price movements would be needed to assess efficiency. In addition, measures of price volatility are sometimes used to substitute for market efficiency, although short-run changes in volatility may reflect shifts in the amount of liquidity in that market. Two important dimensions of market liquidity should be considered: market depth and market tightness. Market depth refers to the ability of the market to absorb large trade volumes without significant impact on market prices.7 This dimension is usually measured by the ratio of value traded to market capitalization (turnover ratio), with higher ratios indicating more liquid markets. Another dimension of liquidity is market tightness—ability to match supply and demand at low cost that is measured by the average bid–ask spread. More liquid markets usually have narrower bid–ask spreads. Further discussion of these indicators can be found in section 2.2.4. Table 2.2 summarizes the indicators of financial system performance that have been discussed in this section. 2.1.4 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 Table 2.2. Indicators of Financial System Performance Sub-sector Indicator Competition and concentration • Total number of institutions • Interest rate spreads and prices of financial services • Intermediary concentration ratios (market share of 3 or 5 of the largest institutions) • Financial market concentration ratios (market share of the largest financial instruments, as a percentage of total financial assets) • Herfindahl index Efficiency • Interest rate spreads • Intermediation costs (as percentage of total assets) Liquidity • Ratio of value traded to market capitalization • Average bid–ask spread
Chapter 2:Indicators of Financial,Development,and Soundness because,in many couries,traditional bank deposits are the most common form of finan- cial 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 3 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 informa tion on the degree of access to financial savings The ratio of private sector bank credit to DP is a common measure of the provision of credit to economy, as well as of banking this in mented by information atio of loans tot osits.Whe volume of finance raised through the issuance of bonds and mone y 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 econc A ke ns in market means of transfe ring funds s and making payments for goods T development of the payment system is o e,especially the cus on the variou 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 sys- tem,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 mone nsfer mechanisms.In additi n.it is relevant to examine the variou s risks ed with ne ents sys cators such as acc Lo s redit,size o for by comp nting the qualitative infor Payment System The major risk mitigation services offered by the financial system include insur- ance (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 workers' medical,and health n In additio markets opt ns,futures,swaps,and structured finance produc 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 transforma- tion and secondary market arrangements,which facilitate investment in high-yielding 21
21 Chapter 2: Indicators of Financial Structure, Development, and Soundness 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 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