System-wide Indicators

Financial structure is defined in terms of the aggregate size of the financial sector, its sectoral composition, and a range of attributes of individual sectors that determine their effectiveness in meeting users’ requirements. The evaluation of financial structure should cover the roles of the key institutional players, including the central bank, commercial and merchant banks, savings institutions, development finance institutions, insurance compa­nies, mortgage entities, pension funds, and financial market institutions. The functioning of financial markets, including money, foreign exchange, and capital markets (including bonds, equities, and derivative and structured finance products) should also be covered. For financial institutions, the structural overview should focus on identifying the number and types of institutions, as well as growth trends of major balance sheet aggregates; for financial markets, a description of the size and growth trends in various financial market instruments (volume and value) would be appropriate. The overview should also reflect new linkages among financial markets and institutions that may be forged from a variety of sources, including innovations in financial instruments, new entrants into financial markets (e. g., hedge funds), and changing practices among financial market participants (e. g., energy trading and investments by financial institutions).

The overall size of the system could be ascertained by the value of financial assets, both in absolute dollar terms and as a ratio of gross domestic product (GDP).1 Although identifying the absolute dollar amount of financial assets is informative, normalizing financial assets on GDP facilitates benchmarking of the state of financial development and allows comparison across countries at different stages of development. Other indica­tors of financial size and depth that could be usefully examined include ratios of broad money to GDP (M2 to GDP),2 private sector credit to GDP (DCP to GDP),3 and ratio of bank deposits to GDP (deposits/GDP). However, one should be careful in interpret­ing observed ratios because they are substantially influenced by the state of financial and general economic development in individual countries. Cross-country comparisons of economies at similar stages of development are, therefore, useful in obtaining reliable benchmarks for “low” or “high” ratios.

The description of the number and types of financial intermediaries and markets is also useful, and this information should be supplemented by information on the relative composition of the financial system. Even though many countries do have a wide range of non-bank financial intermediaries (NBFIs), banking institutions still tend to dominate overwhelmingly. In advanced markets and in many emerging markets, NBFIs, particularly pension funds or insurance companies, often play a larger part than do banks in domestic and global asset allocation (and, sometimes, in the providing of credit). Similarly, market participants such as hedge funds play an increased role in financial markets and in the per­formance of various asset classes. Hence, for one to get a true view of financial structure, it is useful to focus on the share of various sub-sectors (banks, non-banks, financial markets, etc.) in total financial assets by using assets of financial institutions in different sub-sectors and value of financial instruments in different markets as numerators. This type of focus on market shares enables the assessor to get a quick indication of the “effective” structure of the financial system. In addition, the presence of large financial conglomerates—also referred to as large and complex financial institutions (LCFIs)—in the domestic market (either foreign-owned or domestic) would warrant special attention to the scope and scale of their activities, including exposures to other domestic institutions, as well as to intra­group and cross-border exposures, to ascertain their local systemic importance.4

Evaluating the overall growth of the financial system and of major sub-sectors is important, and valuable information could be obtained by examining changes in the number and types of financial intermediaries, as well as the growth of financial assets in each sector over time, in both nominal and real terms. Although a description of trends is informative, it is also critical to indicate the driving forces behind (a) observed chang­es in institutions and their asset positions, and (b) the number of and growth rates of

available money and capital market instruments. One factor that has accounted for the observed growth of financial systems in many countries (number of institutions and size of assets) is financial liberalization, especially the softening of entry conditions for banks and other financial institutions and the liberalization of interest rates, which has stimu­lated financial markets (especially money markets). In addition, changes in prudential regulation and accounting standards often have provided incentives for developing new ways to manage risks (e. g., asset and liability management for insurance company and pension funds) and have led to development of new risk-transfer instruments in capital markets.

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