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World Economic and Financial Surveys

Regional Economic Outlook: Europe

Strengthening Financial Systems

November 2007



Strong fundamentals should allow Europe to weather financial turbulence relatively well. Nonetheless, growth is set to ease in 2008 in nearly all countries. Policymakers will need to deal up front with the financial market turmoil, while implementing fiscal consolidation and structural reforms, including in the financial sector, to address vulnerabilities, raise medium-term growth prospects, and deliver on the promise of convergence for emerging Europe. Three analytical chapters discuss reforms to strengthen Europe’s financial systems to allow advanced economies to benefit from innovation without incurring excessive risk and, in emerging economies, to manage rapid financial deepening and develop financial systems further.

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Contents

Foreword
Executive Summary
PART I
Outlook: Through Financial Turbulence to Sustained Growth
  Strong Fundamentals Should Help Overcome Financial Turbulence
  Protracted Credit Market Tightening Would Add Downside Risk
  Policymakers Are Facing Unexpected Uncertainty
  Reforms Are Key to Sustaining Growth
PART II
Analytical Focus: Strengthening Financial Systems
1. Tuning the Financial Systems of Advanced Economies
  Overview
  Evolution of Financial Systems
  Quality of the Financial System Matters
  Garnering Benefits without Incurring Excessive Risks
2. Managing Rapid Financial Deepening in Emerging Europe
  Finance’s Role in Convergence
  Driving Safely at High Speed
  Preparing for the Curve Ahead
3. Sustaining Financial Development in Emerging Europe
  What Is the State of Financial Development?
  Which Factors Are Key?
  How Can Progress Be Sustained?
References
Tables
1. European Countries: Real GDP Growth and CPI Inflation, 2006–08
2. European Countries: External and Fiscal Balances, 2006–08
3. Index of Economic Freedom: Ranking Compared with the Rest of the World, 2005
4. Credit to Nonfinancial Corporations and Households, 2000–06
5. Banks’ Exposure to Emerging Economies, 2006
Figures
1. Europe and the Rest of the World: Real GDP Growth, 2001–08
2. Convergence in Europe and in the Rest of the World, 2001–06
3. Euro Area: Average Interbank Offer Rates, July 25, 2007–October 3, 2007
4. Change in Banking Sector Stock Prices, July 25, 2007–October 3, 2007
5. Daily Stock Markets Indices, January 2005–October 2007
6. Sovereign Spreads, July 25, 2007–October 1, 2007
7. EU-27 Confidence Indicators, January 2005–September 2007
8. European Regions: General Government Balance, 2003–08
9. Emerging Europe: Monetary Conditions, 2000–06
10. Emerging Europe: Credit Growth, 1999–06
11. European Regions: Ratio of Current Account Balance to GDP, 2003–08
12. External Debt, 2006
13. Bank Credit to the Private Sector in Europe, 1995–06
14. Financial Innovation in Europe, June 1995–June 2007
15. Financial Integration in Europe, 1995–06
16. Financial Index by Subindices, 1995 and 2004
17. Interest Spread, 1995 and 2004
18. Assets of Nonbank Financial Institutions, 1995 and 2006
19. Stock Market Turnover, 1995 and 2005
20. Outstanding Amount of Domestic Debt Securities Issued by Nonfinancial Corporations, 1995 and 2006
21. Convergence in Europe, 2000–06
22. Current Account Balances and Income Levels in Europe, 2006
23. Convergence with and without Capital Inflows
24. Share of Foreign Assets and Liabilities in GDP, 2005
25. Credit to Nonfinancial Corporations, 2000–06
26. Credit to Households, 2000–06
27. Productivity, Flexibility, and the Current Account
28. Speed of Credit Growth and House Prices, 2002–06
29. Share of Foreign Currency Loans in Total Loans, 2006
30. Impact of Confidence on the Relative Price of Nontradables
31. Asset Share of Foreign-Owned Banks, 2000 and 2005
32. Two Stages of Convergence
33. Changing Composition of Production
34. Labor Market Rigidity and Speed of Credit Growth
35. Bank Credit to the Private Sector and Per Capita Income, 2006
36. Outstanding Debt Securities, 2006
37. Equity Market Turnover and Capitalization, 2006
38. Institutional Investor Size, 2006
39. Bank Credit and Institutional Quality
40. Institutional Quality Index, 2006
41. Borrowers and Lenders Legal Rights Index, 2006
42. Credit Information Index, 2006
43. Corporate Governance (Compliance with OECD Principles), 2004
44. Banking Reform and Interest Rate Liberalization Index, 2006
45. Regulatory and Supervisory Power Index, 2003
Boxes
1. Why Was Europe Affected by the Collapse of the U.S. Subprime Mortgage Market?
2. Europe’s Economic Integration
3. Continued Relevance of Relationship-Based Lending in an Evolving Financial System
4. Financial Intermediation at Work in Denmark
5. Upgrading a Financial System: Italy’s Experience
6. Addressing Financial Speeding in Latvia
7. Rapid Financial Deepening: Lessons from Portugal
8. National versus Regional Exchange Markets: Implications for Emerging Europe
9. Developing the Government Securities Market
10. Institutional Quality, Corporate Governance, and Financial Development: The Case of Ukraine