• Traditional measures of size and depth of banking systems limit assessment
• New measure on access to banking, efficiency and stability enhance the analyses
Conventional measures of banking sector The traditional indicators utilized for assessing the size, depth and development of a country’s banking (financial) sector are:
• The ratio of M2 to GDP
• The ratio of private credit to GDP.
In particular, both these measures have been used to show the causal effects of financial development on economic growth. However, both measures have some limitations:
• The ratio of M2 to GDP captures the degree of monetization in the system, but does not capture the degree of bank intermediation.
• The ratio of private credit to GDP does not control for non-performing loans and more generally, the quality of credit allocation.
• Both measures do not capture the broad access to bank finance by individuals and firms, the quality of bank services and the efficiency of providing banking services.
• In general, the quality and availability of indica- tors on financial stability is limited and the documentation of institutional framework supporting banking lacks robustness.
New indicators for going beyond the size The Financial Sector Development Indicators (FSDI) project has compiled indicators that go beyond size, and can help assess access, efficiency and stability of financial systems across and within countries. Banking systems can score very differently on each of these four dimensions. It is therefore important to consider these dimensions jointly and in various combi-
nations. The conventionally used, as well as new indicators relevant for assessment of banking system are summarized in the table above. The
Measuring banking sector development
Financial Sector Development Indicators for banking
Traditional New
Size Access
Size Broad access
Deposit money bank assets to GDP Branch and ATM density Central bank assets to GDP Average loan and deposit size
M2 to GDP Loan & deposit accounts per capita
Deposits to GDP Household access
Intermediation % of people with bank account
Private credit to GDP Firm access
Private credit to total credit Collateral needed for loan Private credit to deposits % of firms with financing constraints
Efficiency Profitability Return on assets Net interest margin Efficiency Operating costs Lending spread Days to clear check Competitiveness Concentration ratio Ownership Stability Capital adequacy Capital adequacy ratio Asset quality (a) Lenders
Non-performing loans Real credit growth Loan concentration
Large loan exposures to capital (b) Borrowers
Firm leverage Interest coverage ratio Household debt to GDP Liquidity
Liquid asset ratio Other
Net FX position-to-capital Default probability of banks NPL refers to non-performing loans.
0.0 0.5 1.0 1.5
0 4 8 12 Size of banking sector
Percent of GDP
NPL/Total Loans Private
credit/ GDP
Percent
High-income:
OECD
Developing countries
indicators within each dimension are also summarized in a composite index for the pur- poses of benchmarking and classifying coun- tries.
The majority of the new indicators refer to access to finance. These indicators summarize the ability of households and firms in a country to access finance and the actual usage of banking services. New indicators on efficiency include the number of days it takes to clear a check or to do a wire transfer in a country, a new measure of the degree of bank competition, and information on the degree of state or foreign ownership of banks. New indicators on the stability of the banking sector, among others, comprise market-based measures of the prob- ability of default of banks in a country, and data on the quality and performance of corporate sector and household borrowers, thus incorpo- rating the user side of finance. In addition, the stability dimension includes some of the new financial stability indicators collected by the IMF, such as information on large loan exposures and concentration of lending activity.
The FSDI also comprises data on the develop- ment of other parts of the financial sector, such as capital markets and insurance, thus captur- ing the relationships between the banking and various other sectors. There are also new indicators on the quality of the legal infrastruc- ture that supports bank finance, such as creditor rights, bankruptcy framework, credit information, and bank regulation and supervision.
0 20 40 60 80 100
0 1 2 3 Private credit and number of deposits accounts, 2004 Percent
Private credit to
GDP
Number of accounts per person
Units
High- income
Developing countries
Low-
income Middle-income
Lower Upper
Number of bank accounts per person
This measure is an indicator of the use of banking services. Based on a questionnaire circulated among bank regulatory agencies and publicly available data, information on the number and value of deposits for 54 countries for the year 2004 was collected. A higher number of bank accounts is interpreted as a signal of greater use of services. This is the first compilation and analysis of consistent and comparable cross-country data on the outreach or penetration of banking systems.
Access limited in low-income countries Utilizing information from new indicators, it becomes clear that while the difference between the high-income and developing countries is relatively less pronounced in terms of size and depth, it is quite stark in terms of access. Using the traditional measure of financial development, private credit to GDP, the difference between the rich and poor countries is comparatively less pronounced. The ratio of private credit to GDP varies from 15 percent in low income countries to 95 percent in high income countries, or in other words a 6-fold difference. However, ac- cess to finance varies widely across countries, both in terms of high versus low-income and within developing countries themselves. The number of bank accounts per person in high- income countries is on average 2.2, compared to an average of 0.1 in low-income countries, or a 22-fold difference. In Madagascar, only 14 out of 1000 people have a bank account, while in Austria; on average people have more than 3 bank accounts. Such a comparison, otherwise restricted without information on bank accounts, suggests that access to finance is particularly curtailed in low income countries.
The limited access to bank finance is also highlighted in the relationship between traditional measures of size (or depth and development) and other new data on access to banking. The chart (top) shows the relationship between M2/
GDP (a traditional measure of financial depth) and the number of bank accounts (deposits) per person, which is a proxy for the use of banking services. The data on bank accounts are col- lected using a extensive survey of bank regula- tory agencies. The data show that, especially at intermediate levels of financial development, financial size and access to banking are not correlated. This illustrates the importance of comparing data on access to finance when assessing financial development in countries.
Concentration does not imply low efficiency For the bank efficiency dimension, FSDI in- cludes not only traditional measures of bank profitability (e.g. return on assets) and efficiency (e.g. ratio of operating costs to assets) but also information on the structure of banking system and measures of the competitiveness of the banking systems (e.g. percentage of banks assets that are foreign or state-owned, or the three-bank concentration ratio).
Classification of countries by number of bank deposits Number of deposits per 1,000 people Bottom 5 countries
Madagascar 14
Bolivia 41
Uganda 47
Kenya 70
Nicaragua 96
Top 5 countries
Austria 3120
Belgium 3080
Denmark 2706
Malta 2496
Greece 2418
R2 = 0.2565
0 1 2 3 4
0.0 0.5 1.0 1.5
Financial depth and access Number of deposit accounts per capita
M2/GDP (%) Depth and access not correlated at intermediate level of financial development
0.00 0.06 0.12 0.18
0 50 100 150 200
3-bank asset concentration ratio (%) Concentration is not correlated with efficiency Operating costs to total assets
Bank branches and ATMs Bank
branches ATMs
(per 100,000) (per 100,000)
Bottom-5 Bottom-5
Ethiopia 0.4 Bangladesh 0.1
Uganda 0.5 Nepal 0.1
Tanzania 0.6 Tanzania 0.2
Madagascar 0.7 Madagascar 0.2
Honduras 0.7 Pakistan 0.5
Top-5 Top-5
Portugal 52 Portugal 109
Italy 52 Japan 114
Belgium 53 United States 121
Austria 54 Spain 127
Spain 96 Canada 135
The general notion is that a more concentrated banking sector is less efficient. However, the chart (bottom, previous page) below shows that the three-bank asset concentration is not corre- lated with the ratio of operating cost to assets, a traditional measure of efficiency. This suggests that one should not focus solely on concentra- tion ratios as a measure for competition when making inferences about the efficiency of the banking sector.
But less depth does indicate less efficiency Financial depth and efficiency, on the other hand, appear more closely correlated. The chart (top) shows the ratio of M2/GDP (financial depth) against the ratio of average operating costs-to-total assets, a traditional measure of bank operating efficiency. The figure shows quite clearly that countries with less deep banking systems also have less efficient banks.
Banking and corporate vulnerabilities
For the stability dimension of the financial sector, FSDI covers not only traditional CAMEL-type indicators using banks’ balance sheets, but also indicators based on the balance sheets of corporate borrowers. The combination of bank- ing and corporate sector indicators provides a more comprehensive picture of the health of the banking sector. The chart (bottom) shows that firms’ financial leverage, measured as the ratio of corporate debt-to-equity, is positively corre- lated with the banks share of non-performing loans in the banking sector. This illustrates the relationship between the vulnerability of the corporate sector and the quality of banking sector assets.
Legal rights facilitate intermediation
Finally, FSDI contains detailed information about the legal and regulatory infrastructure for the banking sectors, including creditor rights and supervisory rules and practices. The main variables for this set of information are pre- sented in table below. Legal protection of credi-
R2 = 0.131
0 5 10 15 20 25
0 50 100 150 200 250
Corporate Debt to Equity Capital (%) Corporate leverage and bank non-performing loans Non-performing loans to total loans (%)
R2 = 0.2875
0 100 200 300
0.00 0.05 0.10 0.15
Operating costs to Total assets More efficient banking systems exhibit greater depth M2/GDP (%)
CAMEL Indicators
The acronym "CAMEL" refers to the five components of a bank's condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, and Liquidity. These aspects reflect the variation in bank asset risk and leverage, because they capture the market, credit, operational, and liquidity risk faced by banks.
tor rights features as an important determinant of bank lending. The chart (next page) shows the strong correlation between private credit-to- GDP, a measure of financial intermediation, against an index of legal rights that measures the degree to which collateral and bankruptcy laws facilitate lending.
R2 = 0.2504
0 40 80 120 160
0 2 4 6 8 10
Legal Rights Index
Intermediation correlated with creditor's legal rights Private credit to GDP (%)
Infrastructure and regulations Creditor rights
Legal protection of creditor rights Cost to complete bankruptcy (% of estate) Cost to resolve disputes (% of debt value) Credit information sharing
Cost of registering property (% of property value) Supervision and regulation
Activity and ownership restrictions Bank entry restrictions
Capital stringency Official supervisory action Official supervisory resources Independence of supervisory authority Legal rights index
This index, reflecting the legal rights of borrowers and lenders, measures the degree to which collateral and bankruptcy laws facilitate lending. It is based on data collected through study of collateral and insolvency laws, supported by the responses to the survey on secured transactions laws. The index includes 3 aspects related to legal rights in bankruptcy and 7 aspects found in collateral law. A score of 1 is assigned for each of the following features of the laws:
• Secured creditors are able to seize their collateral when a debtor enters reorganization — there is no “automatic stay” or “asset freeze” imposed by the court.
• Secured creditors, rather than other parties such as government or workers, are paid first out of the proceeds from liquidating a bankrupt firm.
• Management does not stay during reorganization. An administrator is responsible for managing the business during reorganization.
• General, rather than specific, description of assets is permitted in collateral agreements.
• General, rather than specific, description of debt is permitted in collateral agreements.
• Any legal or natural person may grant or take security in the property.
• A unified registry that includes charges over movable property operates.
• Secured creditors have priority outside of bankruptcy.
• Parties may agree on enforcement procedures by contract.
• Creditors may both seize and sell collateral out of court.
The index ranges from 0 to 10, with higher scores indicating that collateral and bankruptcy laws are better de- signed to expand access to credit.
Select references
Beck, T., Demigurc-Kunt, A., and Martinez Peria, S.
(2005). “Reaching out: Access to and use of banking services across countries.”
Claessens, S., and Laeven, L. (2005). “What Drives Bank Competition? Some International Evidence”, Journal of Money, Credit, and Banking 36(3), 563-583.
Djankov, S., McLiesh, C., and Shleifer, A. (2005). “Private Credit in 129 Countries”, Department of Economics, Harvard University.
Levine, R. (2004). “Finance and Growth: Theory and Evidence.” forthcoming in Philippe Aghion and Steven Durlauf, eds. Handbook of Economic Growth. The Netherlands: Elsevier Science.
Availability of information through the FSDI Web site Data on traditional, as well as new indicators for assess- ment of banking sectors will all become available through the FSDI interactive Web site, currently under construction.
Such indicators, along with various other variables, would form part of an overall framework for assessing financial sectors that would be available online. Provision of regional and country details in the Web site will offer users the flexibility of customizing information to their unique requirement.
