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Financial Sector Assessment Program
A Commentary
By Manuel Conthe, Vice President for the Financial Sector
World Bank
And by Stefan Ingves, Director of Monetary and Exchange Affairs Department
International Monetary Fund

An edited version of the article appeared in
American Banker
March 9, 2001

The crises that have swept emerging markets in recent years have left no one in any doubt about the importance of a strong and well-regulated financial sector. The recent turmoil in Turkey is only the most recent reminder of the danger that a weak financial sector poses to economic stability. Many industrialized countries are no strangers to financial crises either. In fact, three-fourths of the 180-plus country members of the IMF and the World Bank have experienced a financial sector crisis in the last two decades. This high incidence of crises has led to a global effort to preserve financial stability. One such initiative is a joint program—the Financial Sector Assessment Program (FSAP)—introduced by our two institutions.

The FSAP is a comprehensive health check-up of a country's financial sector. While financial sector assessment has always been an important part of IMF and World Bank activities, the FSAP is envisaged as a more comprehensive analysis, with a much higher degree of scrutiny. To supplement the expertise of our own staff, the program makes use of outside experts, whose knowledge and judgment provides an element of international "peer review". So far, more than 50 institutions—central banks, supervisory agencies and others—have agreed to provide experts for this program.

What tests are performed as part of the FSAP? One of them assesses how well the country's financial institutions would handle adversity. This is done through "stress tests" that show whether individual institutions, and the banking sector as a whole, would remain solvent in the face of shocks such as large change in world interest rates or movements in exchange rates.

The FSAP also provides a reading on indicators—called "macroprudential indicators"—that have in the past signaled crises. For example, high short-term borrowing in foreign currencies (in excess of a country's foreign exchange reserves) has been associated with many past crises. High readings on such indicators that have signaled crises in the past may suggest the need for remedial measures.

Observance of internationally accepted standards and codes, such as the Basle Core Principles for Effective Banking Supervision, is also assessed as part of the FSAP. This allows the government to compare its regulatory, supervisory, and other practices against best practices elsewhere in the world. It also provides a basis to judge how well risks and vulnerabilities in the financial system are being managed.

Beyond an assessment of existing institutions, the FSAP checks if there are gaps in the financial system that need to be filled to ensure that a reasonable range of financial services is provided to all citizens.

The results of the FSAP help the IMF and the World Bank fulfill some of our core responsibilities to our country members. Stability of the domestic financial system is essential both to a country's own macroeconomic stability and—in systemically important countries—to the stability of the international financial system, a key goal. Financial stability is important to the achievement of developmental goals as well, since financial crises are very costly in economic terms and roll back socio-economic gains. And a well-functioning financial sector is essential to ensure private sector-led growth—the most important driver of poverty reduction—and to provide the poor with access to credit and other financial services.

After an initial pilot phase, the program's coverage has been expanded to about 24 countries this year, with a further expansion envisaged in the future. As is the case with health check-ups, follow-up to FSAP missions will be critical to derive the full benefit of the program. In addition, the IMF and the World Bank are taking steps to ensure that technical assistance is available to countries that seek to remedy deficiencies identified by the FSAP.

Though the experience with FSAP so far has been positive, it is important not to over-sell it. Even a more developed FSAP would not be a vaccine that would inoculate all countries against financial crises. The tests can signal crises, but they are not foolproof. And, to some extent, risk-taking—and occasional crises—are an integral part of a dynamic, market economy. But, by identifying weaknesses in a country's financial sector and suggesting remedial policies, the FSAP should, over time, contribute to reducing the incidence of crises.




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