The recent global crisis has shown that the health of a country's financial sector has far-reaching implications for its economy as well as for other economies. The Financial Sector Assessment Program (FSAP), established in 1999, is a comprehensive and in-depth analysis of a country's financial sector. FSAP assessments are the joint responsibility of the IMF and World Bank in developing and emerging market countries and of the Fund alone in advanced economies, and include two major components: a financial stability assessment, which is the responsibility of the Fund and, in developing and emerging market countries, a financial development assessment, the responsibility of the World Bank. To date, more than three-quarters of the member countries have undergone assessments.
Assess financial stability and development
The focus of FSAP assessments is twofold: to gauge the stability of the financial sector and to assess its potential contribution to growth and development.
- To assess the stability of the financial sector, FSAP teams examine the soundness of the banking and other financial sectors; conduct stress tests; rate the quality of bank, insurance, and financial market supervision against accepted international standards; and evaluate the ability of supervisors, policymakers, and financial safety nets to respond effectively in case of systemic stress. While FSAPs do not evaluate the health of individual financial institutions and cannot predict or prevent financial crises, they identify the main vulnerabilities that could trigger one.
- To assess the development aspects of the financial sector, FSAPs examine the quality of the legal framework and of financial infrastructure, such as the payments and settlements system; identify obstacles to the competitiveness and efficiency of the sector; and examine its contribution to economic growth and development. Issues related to access to banking services and the development of domestic capital markets are particularly important in low-income countries.
Most systemically important countries have participated in the program.
Lessons from the global financial crisis: a revamped FSAP
The financial crisis underscored many of the FSAP’s strengths. In countries that had undergone assessments relatively close to the onset of the crisis, FSAP assessments were generally successful in pinpointing the main sources of risk. As the crisis unfolded, FSAP teams were quick to adapt the scope of their assessments to focus on critical issues, such as crisis management, liquidity support arrangements, and cross-border contagion, and their recommendations generally helped mitigate some of the consequences of the crisis.
The crisis also illustrated the weaknesses of the program. Its voluntary nature meant that countries that might have benefited from an in-depth examination of their financial sectors had not undergone an FSAP, or their assessments were dated. Even where the assessments were relatively recent, they did not always identify all sources of risk: for example, liquidity risks, sovereign risks, and cross-border or cross-market linkages were underappreciated. And where risks were accurately identified, the warnings were not always loud and clear.
In light of these lessons, in September 2009, the IMF and World Bank revamped the program, to include the following new features:
- More candid and transparent assessments. The introduction of a Risk Assessment Matrix, developed by the IMF based on an approach pioneered by the Bank of England and others, is designed to make the analysis of stability assessments in the context of the FSAP more systematic, candid, and transparent.
- Improved analytical toolkit. New assessment methodologies are being developed by the Fund to better identify linkages between the broader economy and the financial sector; and cover a greater variety of sources of risk. Also, more emphasis is being put on cross-country links, spillover effects, and coordination arrangements.
- More flexible modular assessments, tailored to country needs. Instead of “one-size-fits-all” assessments, there is now the flexibility to conduct financial stability or development assessments in separate modules, conducted by the IMF or the World Bank, respectively.
- Better targeting of standards assessments. Risk-based assessments of the standards that apply to the regulation and supervision of banks, securities markets, and insurance have been introduced to better target the assessments of these standards.
Integration of FSAP into IMF surveillance
FSAP findings provide valuable input to the IMF’s broader surveillance of countries’ economies, known as Article IV consultations. The recent crisis has demonstrated the need for an even more seamless integration of these two strands of the Fund’s work.
An important step was taken in the context of the broader debate on modernizing the Fund’s surveillance. In April 2010, the IMF’s Executive Board agreed to consider making stability assessments under the FSAP a mandatory part of bilateral surveillance. In September 2010, this agreement took on concrete shape, when the IMF made it mandatory for 25 jurisdictions with systemically important financial sectors to undergo financial stability assessments under the FSAP every five years. The list of jurisdictions for these mandatory assessments is based on the size and interconnectedness of their financial sectors, and will be reviewed periodically to make sure it reflects developments in the global financial system--the next review is scheduled for late 2013. A list of upcoming FSAPs is published on IMF.org.
This landmark decision moved the IMF’s financial sector surveillance towards a more risk-based approach by focusing surveillance resources on members with systemically important financial sectors. The decision did not affect the other components of the FSAP. Standards assessments would continue to be undertaken as part of FSAP assessments for all jurisdictions on a voluntary basis. The World Bank’s developmental assessments would also continue to be made available to developing and emerging market countries on a voluntary basis, as at present. These could either be performed in joint IMF-World Bank missions or as modular assessments described above.