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