Financial Soundness Indicators

Financial soundness indicators (FSIs) are indicators of the current financial health and soundness of the financial institutions in a country, as well as of their corporate and household counterparts, and FSIs play a crucial role in financial stability assessments. FSIs include both aggregated individual institution data and indicators that are representative of the markets in which the financial institutions operate. FSIs are calculated and dissemi­nated for use in macroprudential surveillance, which is the assessment and monitoring of the strengths and vulnerabilities of financial systems.

FSIs are a relatively new body of economic statistics that reflect a mixture of influ­ences. Some of the concepts are drawn from prudential and commercial measurement frameworks, which have been developed to monitor individual entities. Other concepts

Table 2.3. The Core Set of Financial Soundness Indicators

Indicator

Indicates

Comment

Deposit-taking institutions’*

Regulatory capital to risk-weighted assets

Capital adequacy

Broad measure of capital, including items giving less protection against losses, such as subordinated debt, tax credits, and unrealized capital gains

Regulatory Tier I capital to risk-weighted assets

Capital adequacy

Highest quality capital such as shareholder equity and retained earnings, relative to risk-weighted assets

Nonperforming loans net of provisions to capital

Capital adequacy

Indicates the potential size of additional provisions that may be needed relative to capital

Nonperforming loans to total gross loans

Asset quality

Indicates the credit quality of banks’ loans

Sectoral distribution of loans to total loans

Asset quality

Identifies exposure concentrations to particular sectors

Return on assets and return on equity

Earnings and profitability

Assesses scope for earnings to offset losses relative to capital or loan and asset portfolio

Interest margin to gross income

Earnings and profitability

Indicates the importance of net interest income and scope to absorb losses

Noninterest expenses to gross income

Earnings and profitability

Indicates extent to which high noninterest expenses weakens earnings

Liquid assets to total assets and liquid assets to short-term liabilities

Liquidity

Assesses the vulnerability of the sector to loss of access to market sources of funding or a run on deposits

Net open position in foreign exchange to capital

Exposure to FX risk

Measures foreign currency mismatch

a. Domestically controlled institutions, that may be grouped in different categories according to control, business lines, or group structure.

are drawn from macroeconomic measurement frameworks, which have been developed to monitor aggregate activity in the economy. A list of FSIs, grouped into a core set and an encouraged set, is presented in tables 2.3 and 2.4 and will be discussed in this chapter. Detailed exposition and guidance on those FSIs can be obtained from the Compilation Guide on Financial Soundness Indicators (IMF 2004). It contains a discussion of the distinc­tion between a “core set” for which data are generally available and are found to be highly relevant for analytic purposes in almost all countries and an “encouraged set” for which data are not as readily available and whose relevance could vary across countries.12

The list of FSIs discussed herein consists mainly of aggregate balance sheet measures. This type of aggregation of individual institution-level indicators (microprudential indicators) into financial soundness indicators (macroprudential indicators) necessarily involves a loss of information because the distribution of prudential indicators of indi­vidual institutions is also a crucial dimension of financial stability. Although aggregation is required for facilitating macroprudential analysis and international comparison, the assessments could be strengthened by allowing some disaggregation through peer groups or through the monitoring of the distributional characteristics of various indicators. In addition, FSIs themselves are either backward-looking or contemporaneous indicators of financial soundness, available often with a lag or low frequency. Therefore, proper interpretation and use of FSIs requires a range of analytical tools (discussed in chapter 3), which includes conducting stress tests of individual institutions and monitoring the

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Table 2.4. The Encouraged Set of Financial Soundness Indicators

 

Indicator

 

Indicates

 

Comment

 

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Provides an indication of credit risk because a highly leveraged corporate sector is more vulnerable to shocks Indicates the extent to which earnings are available to cover losses

Indicates the extent to which earnings available to cover losses are reduced by interest and principal payments Reveals corporate sector vulnerability to exchange rate movements

Broad measure of capital adequacy, which is a buffer for losses

Identifies credit exposure concentrations to particular countries by the banking system

Provides a crude indicator of exposure to derivatives

Provides a crude indicator of exposure to derivatives

Identifies credit exposure to large borrowers

Indicates the dependence on trading income

Indicates the extent to which high noninterest expenses reduces earnings

Indicates level of competition in the banking sector and the dependence of earnings on the interest rate spread

Market indicator of counterparty risks in the interbank market

Assesses the vulnerability to loss of access to customer deposits

Measures risk to loan portfolios from foreign exchange movements

Measures extent of dollarization

Measures exposure to equity price movements

Indicates liquidity in the securities market Indicates liquidity in the securities market

Indicates size and significance within the financial sector Indicates size and significance within the financial sector

Provides an indication of credit risk because a highly leveraged household sector is more vulnerable to shocks Indicates a household’s ability to cover its debt payments

Measures trends in the real estate market

Measures banks’ exposure to the residential real estate sector

Measures banks’ exposure to the commercial real estate sector

 

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a. See Compilation Guide for Financial Soundness Indicators (IMF 2004) for a detailed definition and exposition of encouraged indicators.

b. These may be grouped in different categories based on ownership, business lines, or group structure.

c. May be in notional amounts or market value. The latter provides a better measure of exposure but may be more difficult to obtain.

d. Or in other markets that are most relevant to bank liquidity, such as foreign exchange markets.

e. Other indicators such as additional balance sheet data (e. g., maturity mismatches in foreign currency), data on the life insurance sector, or information on the corporate and household sector may be added.

 

distribution of stress tests results, as well as examining the determinants of FSIs and fore­casting their future course.

In addition, FSIs can be complemented by various market-based indicators, which are forward-looking indicators of soundness and are available with higher frequency. The various categories of FSIs are discussed in the following sections.

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