Financial Sector Assessment

A Handbook

September 29, 2005

This is a product of the staff of the International Bank for Reconstruction and Development (The World Bank) and The International Monetary Fund. The findings, interpretations, and conclusions expressed in this document do not necessarily reflect the views of the World Bank, the International Monetary Fund, their Executive Directors, or the governments they represent.

The Handbook presents an overall analytical framework for assessing financial system stability and developmental needs, providing broad guidance on approaches, methodologies, and techniques of assessing financial systems. Although the Handbook draws substantially on World Bank and IMF experience with the Financial Sector Assessment Program (FSAP) and from the broader policy and operational work in both institutions, it is designed for generic use in financial sector assessments, whether conducted by country authorities themselves, or by World Bank and IMF teams.

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Cover and Copyright Information (152Kb)
Abbreviations and Acronyms (117Kb)
Preface (101Kb)
Contributors (81Kb)
Chapter 1
Financial Sector Assessments: Overall Framework and Executive Summary (209Kb)
  1.1 Introduction
  1.2 Overall Analytical and Assessment Framework—Executive Summary
  Annex 1.A Tailoring Financial Sector Assessment to Country Needs
  References and Other Sources
Chapter 2
Indicators of Financial Structure, Development, and Soundness (354Kb)
  2.1 Financial Structure and Development
    2.1.1 System-wide Indicators
    2.1.3 Breadth of the Financial System
    2.1.3 Competition, Concentration, and Efficiency
    2.1.4 Scope and Coverage of Financial Services
  2.2 Financial Soundness Indicators
    2.2.1 Financial Soundness Indicators
    2.2.2 FSIs for Banking
    2.2.3 FSIs for Insurance
    2.2.4 FSIs for Securities Markets
    2.2.5 Market-Based Indicators of Financial Soundness
  2.3 Aggregate Balance Sheet Structure of Financial and Non-financial Sectors—Inter-sectoral Linkages
Chapter 3
Assessing Financial Stability (457Kb)
  3.1 Overall Framework for Stability Analysis and Assessment
  3.2 Macroeconomic and Financial Market Developments
  3.3 Macroprudential Surveillance Framework
    3.3.1 Analysis of Financial Soundness Indicators
    3.3.2 System-Focused Stress Testing
  3.4 Analysis of Macrofinancial Linkages
    3.4.1 Effect of Financial Soundness on Macroeconomic Developments
    3.4.2 Effect of Financial System Soundness on Debt Sustainability
    3.4.3 Effect of Financial Soundness on Growth and Financial Development
  3.5 Special Topics in Financial Stability Analysis
    3.5.1 International Financial Centers and Offshore Financial Centers
    3.5.2 Capital Account Liberalization
    3.5.3 Dollarization: Implications for Stability
    3.5.4 Islamic Banking—Stability Issues
  3.6 Key Policy Issues and Policy Priorities to Support Stability
Chapter 4
Assessing Financial Structure and Financial Development (445Kb)
  4.1 Overview
    4.1.1 Motivation for Assessing Financial Structure and Financial Development
    4.1.2 Scope of Analysis
    4.1.3 Stability and Development: Complementarities Despite the
Different Perspective
  4.2 Quantitative Benchmarking
  4.3 Review of Legal, Informational, and Transactional Technology Infrastructures for Access and Development
    4.3.1 Legal Infrastructure
    4.3.2 Competition Aspects
    4.3.3 Transactional Technology Infrastructures
  4.4 Sectoral Development Reviews
    4.4.1 Banking
    4.4.2 Near-banks
    4.4.3 Insurance and Collective Investment Arrangements
    4.4.4 Securities Markets
  4.5 The Demand-Side Reviews and the Effect of Finance on the Real Sector
    4.5.1 Enterprise Finance
    4.5.2 Households, Firms, and Microenterprises
  4.6 Reviews of Cross-Cutting Issues
    4.6.1 Missing Markets and Missing Products
    4.6.2 Taxation Issues
    4.6.3 Competition Aspects
    4.6.4 Development Obstacles Imposed by Unwarranted Prudential Regulation
  4.7 From Finding Facts to Creating Policies
Chapter 5
Evaluating Financial Sector Supervision: Banking, Insurance, and Securities Markets (1,258Kb)
  5.1 Legal and Institutional Framework for Financial Supervision
  5.2 Aspects of Financial Safety Nets
    5.2.1 Frameworks for Liquidity Support
    5.2.2 Deposit Insurance
    5.2.3 Investor and Policyholder Protection Schemes
    5.2.4 Crisis Management
  5.3 Assessment of Banking Supervision
    5.3.1 Basel Core Principles—Their Scope and Coverage, and Their Relevance to Stability and Structural Development
    5.3.2 Preconditions for Effective Banking Supervision
    5.3.3 Assessment Methodology and Assessment Experience
    5.3.4 Basel II
    5.3.5 Bank Insolvency Procedures: Emerging Bank-Fund Guidelines
    5.3.6 Large and Complex Financial Institutions
    5.3.7 Consolidated Supervision
    5.3.8 Unique Risks in Islamic Banking
  5.4 Assessment of Insurance Supervision
    5.4.1 Relevance to Stability and Development
    5.4.2 The Structure of the ICPs
    5.4.3 Assessment Methodology and Assessment Experience
  5.5 Assessment of Securities Market Regulation
    5.5.1 IOSCO Core Principles—Relevance to Stability Considerations and Structural Development
    5.5.2 Preconditions for Effective Securities Market Regulation
    5.5.3 Assessment Methodology and Assessment Experience
    5.5.4 Key Considerations in Conducting an Assessment
    5.5.5 Assessment Experience
    5.5.6 Special Topics in Securities Market Development and Regulation
  Annex 5.A Legal and Institutional Environment for Effective Bank Insolvency Procedures
    Autonomy of Banking Authority
    Legal Mandate
    Appropriate Legal Protection of Banking Authorities and Their Staff Members
    Accountability and Judicial Review
    Coordination among Banking Authorities
  Annex 5.B Consolidated Supervision
  Annex 5.C IAIS Insurance Core Principles
  Annex 5.D List of IOSCO Objectives and Principles of Securities Regulation
    Principles Relating to the Regulator
    Principles for Self-Regulation
    Principles for the Enforcement of Securities Regulation
    Principles for Cooperation in Regulation
    Principles for Issuers
    Principles for Collective Investment Schemes
    Principles for Market Intermediaries
    Principles for the Secondary Market
  Annex 5.E IOSCO Methodology—Scope and Use of Principle 8
    Principle 8
  Annex 5.F Enforcement and the Exchange of Information
Chapter 6
Assessing the Supervision of Other Financial Intermediaries (243Kb)
  6.1 Overview
  6.2 Objectives of the Legal and Regulatory Framework for OFIs
  6.3 Assessing Institutional Structure and Regulatory Arbitrage
  6.4 Assessing Regulatory Practice and Effectiveness
  6.5 Selected Issues on the Regulation and Supervision of Leasing Companies
  6.6 Selected Issues on the Regulation and Supervision of Factoring Companies
  6.7 Selected Issues on the Regulation and Supervision of Pension Funds
  Annex 6.A Regulation and Supervision of OFIs: A Few Guiding Principles
    A. The regulatory framework should minimize adverse effects on competition and encourage competition
    B. The regulatory framework should clearly define the power of the regulator and the permissible activities of OFIs
    C. Similar risks and functions should be supervised similarly to minimize scope for regulatory arbitrage
    D. The links between OFIs and other players in the financial sector should be closely monitored
    E. The unique risks of OFIs should be recognized within the supervisory structure and when defining prudential norms
    F. Supervision should be proportionate and consistent with costs and benefits
    G. Resources and skills should be targeted to the higher-impact and more-complex OFIs
    H. There should be a strengthening of the self-regulatory capacity
Chapter 7
Rural and Microfinance Institutions: Regulatory and Supervisory Issues (322Kb)
  7.1 Overview
  7.2 Rationale for Assessing the Regulatory Framework for Rural Finance and Microfinance Institutions
  7.3 Institutional Providers of Rural Finance and Microfinance Services
    7.3.1 Government Rural Finance, Microfinance, or SME Finance Programs or Agencies
    7.3.2 Non-bank, Non-profit NGO MFIs
    7.3.3 Membership-Based CFIs
    7.3.4 Postal Savings Banks
    7.3.5 Specialized Banking Institutions
    7.3.6 Commercial Banks
  7.4 Conceptual Framework for the Regulation of Rural Finance and Microfinance Institutions
  7.5 Assessment of the Regulatory Framework Issues for Rural Finance and Microfinance Institutions
  7.6 Some Cross-Cutting Issues Affecting Rural Finance and Microfinance Institutions
  7.7 Some Cross-Cutting Issues Affecting Rural Finance and Microfinance Institutions
  7.8 Consensus Guidelines on Regulating and Supervising Microfinance
Chapter 8
Assessing Financial System Integrity—Anti-Money Laundering and Combating the Financing of Terrorism (251Kb)
  8.1 AML–CFT Standards—Links to Stability and Institutional Development
  8.2 AML–CFT Standards—Scope and Coverage
  8.3 Preconditions for Effective Implementation of AML–CFT Standards
  8.4 Assessment Methodology and Assessment Experience
    8.4.1 AML–CFT Assessment Methodology
    8.4.2 Assessment Experience
  8.5 Special Topics in AML–CFT Assessments
    8.5.1 Assessing Preventive Measures: The Example of Customer Due Diligence
    8.5.2 Financial Intelligence Units
  Annex 8.A FATF 40+8 Recommendations for AML–CFT
    Forty Recommendations
    Special Recommendations for Combating the Financing of Terrorism
Chapter 9
Assessing the Legal Infrastructure for Financial Systems (240Kb)
  9.1 Financial Sector Legal Framework
    9.1.1 Central Banking Law
    9.1.2 Banking Law
    9.1.3 Payment Systems
    9.1.4 Government Debt Management
    9.1.5 Capital Markets
    9.1.6 Insurance
    9.1.7 Financial Safety Nets
  9.2 Commercial Laws
    9.2.1 Company Law
    9.2.2 Corporate Governance
    9.2.3 Consumer Protection
  9.3 Creditors Rights and Insolvency Systems
  9.4 Access to Credit and Land Rights
  9.5 The Judicial System
Chapter 10
Assessing Information and Governance Infrastructure (767Kb)
  10.1 Monetary and Financial Policy Transparency
    10.1.1 Code of Good Practices
    10.1.2 Assessment Methodology and Assessment Experience
  10.2 Accounting and Auditing Assessments
    10.2.1 Role of the Accounting and Auditing Framework: Relevance to Development and Stability
    10.2.2 Scope and Content of International Accounting and Auditing Standards
    10.2.3 ROSCs and Role of the Bank and the Fund
    10.2.4 Focus of A&A Assessments
    10.2.5 ROSC A&A Methodology
    10.2.6 Assessment Experience
  10.3 Credit-Reporting Systems and Financial Information Services
    10.3.1 Introduction to Credit-Reporting Systems
    10.3.2 Elements of a Robust Credit-Reporting System
    10.3.3 Credit Registries, Efforts to Strengthen Credit Risk Measurement, and New Basel Capital Accord (Basel II)
    10.3.4 Role of Credit Rating Agencies in Financial Stability and Development
  10.4 Corporate Governance Assessments
    10.4.1 Rationale for Good Corporate Governance?
    10.4.2 OECD Principles of Corporate Governance
    10.4.3 World Bank ROSC Corporate Governance Assessments
    10.4.4 Key Findings from Country Assessments
  10.5 Disclosure Regime for Financial Institutions
    10.5.1 Current Practices and Evolving Standards
    10.5.2 Pillar III and Market Discipline.
  Annex 10.A Code of Good Practices on Transparency in Monetary and Financial Policies
    1. Clarity of Roles, Responsibilities, and Objectives of Central Banks for Monetary Policy
    2. Open Process for Formulating and Reporting Monetary Policy Decisions
    3. Open Process for Formulating and Reporting Monetary Policy Decisions
    4. Accountability and Assurances of Integrity by the Central Bank
    5. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies
    6. Open Process for Formulating and Financial Policies
    7. Public Availability of Information on Financial Policies
    8. Accountability and Assurances of Integrity by Financial Agencies
  Annex 10.B Methodology for Assessing Accounting and Auditing.
    Part I: Assessment of the Accounting and Auditing Environment
    Part II: Assessment of National Accounting Standards with Reference to IAS
    Part III: Assessment of Actual Accounting Practices (Review of Compliance with Selected Local Accounting Requirements)
    Part IV: Assessment of Auditing Standards and Practices
    Due Diligence and Final Report
    Final Report
    Development and Implementation of a Country Action Plan
  Annex 10.C Financial Sector Governance—Selected Issues
Chapter 11
Assessing Systemic Liquidity Infrastructure (382Kb)
  11.1 Payment and securities settlement systems
    11.1.1 Payment Systems
    11.1.2 Securities Settlement Systems
  11.2 Monetary and Foreign Exchange Operations—Instrumentsand Effectiveness
  11.3 Monetary and Foreign Exchange Markets—Microstructure and Functioning
  11.4 Public Debt Management and the Government Securities Market
  11.5 Foreign Exchange Reserve Management
  11.6 Microstructure of Securities Markets—Trading Systems, Price Discovery, and Determinants of Market Liquidity and Efficiency
Chapter 12
Sequencing Financial Sector Reforms (194Kb)
  12.1 Development with Stability: The Role of Sequencing
  12.2 Strengthening Access to Foreign Capital
  12.3 Strengthening Access to Foreign Capital
Appendices (1,101Kb)
Appendix A
Financial Sector Assessment Program—Objectives, Procedures, and Overall Framework
Appendix B
Illustrative Data Questionnaires for Comprehensive Financial Sector Assessment
Appendix C
Data Sources for Financial Sector Assessments
Appendix D
Stress Testing
Appendix E
Benchmarking and Decomposing Interest Rate Spreads and Margins
Appendix F
Institutional Structure of Financial Regulation and Supervision
Appendix G
Banking Resolution and Insolvency—Emerging World Bank and International Monetary Fund Guidelines
Appendix H
Assessment of Pension Schemes from a Financial Sector Perspective