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.

Many systemically important countries have participated, including most G-20 members. As of September 2009, assessments for China, Indonesia, and the United States were underway.

Lessons from the 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 some 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 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 the crisis, in September 2009 the IMF and World Bank revamped the program.

Key elements of the program remain unchanged

• Participation in the FSAP remains voluntary, which is important to ensure country buy in and ownership.
• FSAP assessments remain a joint World Bank-IMF undertaking in low-income and emerging market countries. Assessments in advanced economies will continue to be the responsibility of the Fund alone.

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.
• More flexible modular assessments, tailored to country needs. Instead of infrequent “one-size-fits-all” assessments, the possibility now exists of more frequent, targeted, and focused assessments of either financial stability (IMF) or financial development (Bank).
• Better cross-country perspectives. An examination of cross-border capital flows and ownership of financial institutions, global liquidity conditions, spillover effects from systemically important countries or markets, and supervisory information-sharing and cooperation arrangements.
• Better targeting of standards assessments. More targeted, risk-based assessments of the standards that apply to the regulation and supervision of banks, securities markets, and insurance.

Broader view of surveillance

FSAP findings have provided valuable input to the IMF's broader surveillance of countries' economies, known as Article IV consultations, and the recent crisis has demonstrated the need for an even more seamless integration of these two strands of the Fund's work. Some of the new features mentioned above will help, including by giving greater scope for higher frequency, more focused assessments and by encouraging greater cross-country comparability.