Financial Sector Assessments: Overall Framework and Executive Summary

1.1. Introduction

The design of policies to foster financial system stability and development has become a key area of focus among policy makers globally. This policy focus reflects the growing evidence that financial sector development can spur economic growth whereas financial instability can significantly harm growth and cause major disruptions, as was seen in the financial crises of the 1980s and 1990s (World Bank 2001).This focus also reflects the recognition that close two-way linkages between financial sector soundness and per­formance, on the one hand, and macroeconomic and real sector developments, on the other hand, need to be considered when designing macroeconomic and financial policies. Moreover, although the development and international integration of financial systems can strengthen access to foreign capital and can promote economic growth, there is a risk of cross-border spillovers of financial system disturbances. Effective surveillance of national financial systems, along with a harmonization and international convergence of key components of financial policies, will help minimize those types of risks and will pro­mote orderly development of the financial system. Thus, financial stability considerations and financial sector development policies are intrinsically interlinked.

Recognizing the need for stronger policies to foster financial stability and development, several entities around the world, including national authorities, multilateral development agencies, regional development institutions, and various standard-setting bodies are focus­ing on further developing the tools and methodologies of financial sector analysis and assess­ments. The purposes of those tools have been to monitor financial system soundness and developments, to analyze the linkages between the financial sector and the macro-economy, to assess the effectiveness of various aspects of monetary and financial policies, and to pro-

Box 1.1 Financial Sector Assessment Program (FSAP)—A Chronology

 

The program was developed by the World Bank and the International Monetary Fund to help strengthen financial systems in the context of IMF’s bilateral surveillance and World Bank’s Financial Sector devel­opment work. In consultation with the Bank’s regions and the Fund’s area departments, the World Bank – Fund Financial Sector Liaison Committee (FSLC)a coordinated the initial development of the program and later has helped manage the program. The FSLC has held several outreach meetings on FSAP with concerned country authorities and sought regular feedback on the program from participating countries to adapt the program to country needs and to use the feedback as input into various Board reviews of the programs.

Pilot program launch on May 1999. The man­agements of the Bank and the Fund inform the Boards that they have decided to launch jointly, on a pilot basis, the IMF-World Bank Financial Sector Assessment Program.

Interim Board discussion of the pilot program, September 1999. Bank and Fund Boards discussed an interim report on FSAP summarizing the early experience of the pilot. Directors provided guid­ance on scope and procedures of the pilot. The International Monetary and Financial Committee and Development Committee express support for the program in their fall 1999 communiques.

Comprehensive Board review of the pilot, March 2000. Bank and Fund Boards conducted a compre­hensive review of the progress and lessons of the FSAP pilot. Both Boards agreed to continue and expand the program and provided preliminary guidance on how to develop further the FSAP. Guidance covered the scope and pace of the program, links to IMF surveil­lance and technical assistance, relationship to assess­ments of standards, confidentiality considerations, and publication and circulation procedures.

Program update, September 2000, and a joint technical briefing on FSAP to both Boards, December 7, 2000. An update of the program was provided to both Boards. The co-chairs of FSLC provided a joint technical briefing for Bank and Fund Boards on the procedures and progress of the program in preparation for a comprehensive program review.

 

First review of FSAP, December 13, 2000 (Fund), and January 2001 (Bank). Bank and Fund Boards conducted a review of experience with the FSAP and established guidelines for the con­tinuation of the FSAP program for the period ahead; sought priority for systemically important countries in any one year while maintaining broad country coverage; affirmed the value of the Financial System Stability Assessment (FSSA) reports prepared by the FSAP teams as “the preferred tool for strengthen­ing the monitoring of financial systems under the Fund’s bilateral surveillance”; and suggested that Bank and Fund staff members should ensure that FSAP assessments are reflected in other aspects of country programming, including appropriate techni­cal assistance.

Second review of FSAP, March—April 2003.

Bank and Fund Boards conducted a comprehen­sive review of the FSAP and provided guidance in streamlining the program; achieving greater selec­tivity and flexibility in the scope and pace of the program; broadening the range of tools of financial sector surveillance that complement FSAP; increas­ing the focus on medium-term and structural issues in low-income countries, with a greater role for the World Bank in those countries; and including the anti-money-laundering and combating the financing of terrorism (AML-CFT) assessments in all FSAPs.

Third review of FSAP, February-March 2005.

Bank and Fund Boards reviewed the developments in the program since the last review, acknowledged the value of the program, and broadly endorsed the ongoing efforts to strengthen and refine the pro­gram, pending the upcoming further reviews of the FSAP by the Fund’s Independent Evaluation Office, and the Bank’s Operations Evaluation Department, whose recommendations will be considered by the Boards later.

Many Bank-Fund documents relating to the FSAP are available on the Web sites of the IMF (http:// www. imf. org/external/np/fsap/fsap. asp) and of the World Bank (http://www. worldbank. org/finance/fsap. html). For details on the March 2005 review of the FSAP by the Bank and the Fund Boards of Directors, see IMF and World Bank 2005.

 

a. The World Bank-Fund Financial Sector Liaison Committee was established in September 1998 by the Boards of the two institutions to improve coordination of Bank and Fund operations related to financial sector stability and development. Among other things, the FSLC helps to coordinate country selection for FSAPs, organizes Bank-Fund teams for FSAPs, and builds consensus on various procedural and policy matters related to financial sector assessment. The activities of the FSLC are reported in periodic progress reports. The FSLC has issued guidance on various FSAP procedures.

 

mote harmonization and international convergence of key financial policy areas. Those developments have increased the demand for guidance on good practices in conducting financial sector assessments and in designing appropriate policy responses.

In response, this Handbook presents a general analytical framework as well as specific techniques and methodologies for assessing the overall stability and development needs of financial systems in individual countries and for designing policy responses. The stabil­ity and state of development of a financial system depend on a broad range of structural, institutional, and policy factors that operate through two channels. First, they affect the attitude of the private sector toward risk taking, the scope and reach of financial services, and the quality of financial sector governance. Second, they influence the effectiveness of financial policies in fostering sound and well-functioning financial institutions and markets. Those considerations are reflected in the organization of the Handbook, which is explained more fully in section 1.2 below.

The Handbook draws particularly on the World Bank-IMF experience in conducting the Financial Sector Assessment Program (FSAP) and on the broader operational and policy development work on financial systems in both institutions. The World Bank and the IMF introduced the FSAP in May 1999 to monitor and help strengthen financial sys­tems in the context of IMF’s bilateral surveillance and of the World Bank’s financial sector development work and has since become a regular part of Bank and Fund operations (see box 1.1 for a chronology of the FSAP). The FSAP has been built on a range of analytical techniques and assessment tools developed in the IMF, World Bank, Bank for International Settlements (BIS), international standard-setting bodies, and national authorities. Appendix A at the end of this Handbook presents an overview of the current procedures for conducting FSAPs, updates, and follow-up work, including the preparation of relevant Reports on Observance of Standards and Codes (ROSCs) in the financial sector.

A key purpose of this Handbook is to help country authorities to conduct their own assessments of the soundness, structure, and development needs of the financial system. It also can be useful for Bank-Fund teams preparing for FSAP assessments and for country authorities preparing for the Bank-Fund assessments under the FSAP. It is not an expert’s handbook designed to provide detailed guidance to sectoral specialists. It is mainly designed to provide broad guidance on methodology and policy design to policy makers, team leaders, and specialists in one sector who are seeking background information on issues and topics in other related areas of assessment work. Detailed guidance for special­ist assessors is available from standard-setting bodies and other sources that are referred to in the text.

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