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O C C A S I O N A L   P A P E R      
Financial Soundness Indicators: Analytical Aspects and Country Practices

V. Sundararajan, Charles Enoch, Armida San José, Paul Hilbers, Russell Krueger, Marina Moretti, and Graham Slack
©2002 International Monetary Fund
April 8, 2002


List of Abbreviations

  1.   Overview

    Part I. Selected Analytical Aspects

  2.   Indicators for Macroprudential Analysis
        The Macroprudential Framework
        FSIs in the Context of the FSAP
        Qualitative Aspects

  3.   Banking System
        Bank Behavior and Vulnerabilities
        Banking Indicators

  4.   Other Sectors and Markets
        Nonbank Financial Intermediaries
        Corporate Sector
        Household Sector
        Real Estate Markets

  5.   Stress Testing of Financial Systems
        Defining System-Wide Stress Tests
        Measurement Techniques

    Part II. Country Practices

  6.   The IMF Survey on FSIs
        Response to the Survey

  7.   Usefulness of FSIs
        FSIs by Usefulness Group
        Additional FSIs Identified by Respondents

  8.   Compilation and Dissemination Practices
        Compilation and Dissemination of FSIs and Their Components
        Accounting, Regulatory, and Statistical Issues

  9.   Analytical Frameworks and Research
        Macroprudential Research
        Coverage of Financial Institutions
        Norms, Benchmarks, and Thresholds
        Composite Measures
        Business Surveys

  10.   Concluding Remarks
        Identification of Core and Encouraged Sets of FSIs
        Directions for Further Work



  1.   Explanation of FSI Terms
  2.   Aggregation Issues
  3.   Additional FSIs Identified by Respondents
  4.   Tables of Survey Results
  5.   Survey on the Use, Compilation, and Dissemination of
      Macroprudential Indicators


    1.1.  Definitions
    3.1.  Basel Capital Adequacy Ratio
    3.2.  Valuation of Capital
    4.1.  Sectoral Balance Sheet Analysis
    6.1.  Structure of the Survey on FSIs
    8.1.  Compilation and Dissemination Practices
    8.2.  Country Practices on Nonperforming Loans


    1.1.  Financial Soundness Indicators
    2.1.  FSIs Used in Financial System Stability Assessments
    3.1.  Income Summary
    4.1.  Determinants of Corporate Vulnerabilities
    4.2.  Indicators for the Corporate Sector
    4.3.  Cash Flow Summary
    4.4.  Household Indicators Used in Norway, Sweden, and the
            United Kingdom
    4.5.  Real Estate Indicators
    5.1.  Data Requirements for an Integrated VaR Analysis
    6.1.  Summary of the Responses by Type of Economy
    6.2.  Summary of the Responses by Indicator
    7.1.  Group I FSIs by Type of Economy
    7.2.  Group II FSIs by Type of Economy
    7.3.  Groups III–IV FSIs by Type of Economy
    8.1.  FSIs: Compilation and Dissemination Practices
    8.2.  Periodicity of FSIs
    8.3.  Valuation Practices Affecting FSIs by Data Source
    10.1.  Core Set of FSIs
    10.2.  Encouraged Set of FSIs


    2.1.  Components of Macroprudential Analysis
    5.1.  Decision Sequence for Stress Testing
    7.1.  Summary of the Usefulness of FSIs
    9.1.  Institutional Coverage of Analysis
    9.2.  Factors Used to Identify Key Subsectors
    9.3.  Presentation of FSIs

Appendix Tables

    A1.1.  Explanation of FSI Terms
    A4.1.  FSIs for Which Components Are Extensively Compiled
    A4.2.  SDDS Subscribers: Compilation and Dissemination of FSIs
              and Components
    A4.3.  Usefulness of FSIs by Type of User and Type of Economy
    A4.4.  Compilation and Dissemination of FSIs by Type of Economy
    A5.1.  MPI Survey—Part I (a): User Questionnaire
    A5.2.  MPI Survey—Part I (b): Supplementary Issues
    A5.3.  MPI Survey—Part II (a): Compilation and Dissemination
    A5.4.  MPI Survey—Part II (b): Supplementary Issues
    A5.5.  MPI Survey—Part II (c): Valuation Issue

I  Overview

Structural, institutional, and macroeconomic aspects of financial system stability are receiving growing attention both nationally and in international fora. The magnitude and mobility of international capital flows have made it increasingly important to strengthen the foundations of domestic financial systems as a way to build up resilience to capital flow volatility. The soundness of financial institutions is also a key part of the infrastructure for strong macroeconomic performance and effective monetary policy at the national level. Hence, central banks and governments are paying increasing attention to monitoring the health and efficiency of financial institutions and markets, and to macroeconomic and institutional developments that pose potential risks to financial stability.

Such activities are typically embedded in central banks' mandates to promote financial stability and sound payment systems. They differ from financial supervisory activities insofar as they are primarily directed at a range of factors that may pose risks to the financial system as a whole—systemic risks—with significant macroeconomic repercussions. Financial supervisory tasks, on the other hand, are often focused more directly on the health of individual institutions. Given the linkages between microeconomic conditions and macroeconomic and overall financial stability, the monitoring of developments and policy responses to ensure financial stability poses special challenges, particularly when financial supervision functions are separated from the central bank.

The development of measures of financial sector soundness, and of methods to analyze them, are the subjects of this occasional paper. We refer to them as financial soundness indicators (FSIs) and macroprudential analysis, respectively (see Box 1.1). The IMF has been accumulating experience in these areas as part of its surveillance, technical assistance, and policy development work, and, more recently, in the context of the Financial Sector Assessment Program (FSAP).1 An initial, relatively broad set of indicators—the so-called macroprudential indicators—was identified in this earlier work, comprising aggregated prudential indicators, macroeconomic variables associated with financial system vulnerability, and market-based indicators. A consultative meeting on macroprudential indicators was held at IMF headquarters in September 1999. High-level experts from central banks, supervisory agencies, international institutions, academia, and the private sector discussed their experiences in using, measuring, and disseminating indicators of financial system soundness. An IMF Executive Board meeting in January 2000 discussed the state of knowledge in these areas and proposals for further work.2 Recent Board papers on the Special Data Dissemination Standard (SDDS) and on the FSAP also discussed related issues.3

Box 1.1. Definitions

Financial soundness indicators (FSIs) are indicators compiled to monitor the health and soundness of financial institutions and markets, and of their corporate and household counterparts. FSIs include both aggregated information on financial institutions and indicators that are representative of markets in which financial institutions operate. Macroprudential indicators include both FSIs and other indicators that support the assessment and monitoring of the strengths and vulnerabilities of financial systems, notably macroeconomic indicators.

Macroprudential analysis is the assessment and monitoring of the strengths and vulnerabilities of financial systems. This encompasses quantitative information from both FSIs and indicators that provide a broader picture of economic and financial circumstances, such as GDP growth and inflation, along with information on the structure of the financial system, qualitative information on the institutional and regulatory framework—particularly through assessments of compliance with international financial sector standards and codes, and the outcome of stress tests (see Figure 2.1 in Chapter II).

Discussions at the January 2000 review highlighted the need for more research and analysis to improve understanding of what determines financial system soundness and to deal with the considerable conceptual and statistical difficulties that arise in defining and compiling indicators of financial soundness. The Board recommended that the IMF conduct a survey of member countries on their needs and practices related to indicators of financial soundness. The Board also concurred on the need for better indicators on developments in specific sectors and markets that have proven to be relevant in assessing financial sector vulnerabilities, but that have been difficult to gauge in practice. These include nonbank financial institutions, the corporate sector, households, and real estate markets. Moreover, the Board pointed to the need to select a smaller and more operationally useful "core set" of indicators, intended to serve as a basis for structuring data work in support of financial system monitoring, including through the FSAP, and as a focal point for efforts by the IMF to encourage compilation and dissemination of macroprudential information by national authorities.

Since then, the IMF has substantially advanced the work on the measurement and analysis of financial soundness, including through activities in the context of the FSAP and the Survey on the Use, Compilation, and Dissemination of Macroprudential Indicators, conducted in the summer of 2000.4 Efforts have been directed, in particular, to gauge the usefulness of specific indicators; identify analytically relevant definitions of these indicators; appraise compilation and dissemination practices among member countries; explore methods of macroprudential analysis, notably stress testing; and explore the role of nonbank financial intermediaries, the corporate sector, and real estate markets in assessing financial system vulnerabilities.

Other international organizations have also focused on these issues. For instance, the topic of the October 2000 Bank for International Settlements (BIS) annual meeting of central bank economists was Marrying the Macro- and Micro-Prudential Dimensions of Financial Stability.5 At the European Central Bank (ECB), the Working Group on Macroprudential Analysis of the Banking Supervision Committee received a mandate in 2000 to prepare semi-annual reports on macroprudential developments in Europe. These analyses, which are not made public, serve as input to discussions on financial stability issues in the ECB Governing Council. The Asian Development Bank has a program to collect and disseminate FSIs and related macroeconomic series for a group of Asian-Pacific countries. Similar efforts are ongoing at the national level in an increasing number of countries.6

This paper proposes two sets of indicators that are considered useful for the purpose of periodic monitoring, and for compilation and dissemination efforts by national authorities (Table 1.1). The core set includes indicators for the banking sector that should have priority in future compilation and monitoring of FSIs. The encouraged set includes additional banking indicators, as well as data on other institutions and markets that are relevant in assessing financial stability—the corporate sector, real estate markets, and nonbank financial institutions and markets. In particular, indicators of corporate health and of developments in real estate markets are considered a priority in light of their analytical significance for assessing financial vulnerabilities in a wide variety of circumstances. Their compilation, which is at present limited, should therefore be encouraged so that they could be included in the core set, in due course.

Table 1.1. Financial Soundness Indicators

  Core Set

Deposit-taking institutions                     
  Capital adequacy
Regulatory capital to risk-weighted assets
Regulatory tier I capital to risk-weighted assets
  Asset quality Nonperforming loans to total gross loans
Nonperforming loans net of provisions to capital
Sectoral distribution of loans to total loans
Large exposures to capital
  Earnings and profitability Return on assets
Return on equity
Interest margin to gross income
Noninterest expenses to gross income
  Liquidity Liquid assets to total assets (liquid asset ratio)
Liquid assets to short-term liabilities
  Sensitivity to market risk Duration of assets
Duration of liabilities
Net open position in foreign exchange to capital

  Encouraged Set

Deposit-taking institutions Capital to assets
Geographical distribution of loans to total loans
Gross asset position in financial derivatives to capital
Gross liability position in financial derivatives to capital
Trading income to total income
Personnel expenses to noninterest expenses
Spread between reference lending and deposit rates
. Spread between highest and lowest interbank rate
Customer deposits to total (noninterbank) loans
Foreign currency-denominated loans to total loans
Foreign currency-denominated liabilities to total liabilities
Net open position in equities to capital
Market liquidity Average bid-ask spread in the securities market1
Average daily turnover ratio in the securities market1
Nonbank financial institutions Assets to total financial system assets
Assets to GDP
Corporate sector Total debt to equity
Return on equity
Earnings to interest and principal expenses
Corporate net foreign exchange exposure to equity
Number of applications for protection from creditors
Households Household debt to GDP
Household debt service and principal payments to income
Real estate markets Real estate prices
Residential real estate loans to total loans
Commercial real estate loans to total loans

1Or in other markets that are most relevant to bank liquidity, such as foreign exchange markets.

Working with two sets of FSIs—a core set and an encouraged set—avoids a one-size-fits-all approach, and provides a degree of flexibility in the selection of indicators that are most relevant to assessing vulnerabilities in country-specific circumstances. Indicators of the core set can be combined with selected, additional indicators of the encouraged set that might be of particular relevance in the country concerned, depending on its level of financial development, institutional structure, and regional circumstances.

Six criteria were applied in order to identify the core set, and some of those were applied to suggest the encouraged set: focus on core markets and institutions; analytical significance; revealed usefulness; relevance in most circumstances (i.e., not country-specific); availability; and parsimony—that is, achieving the maximum information content with a limited number of FSIs. The revealed usefulness and availability were judged based on the results of the survey noted earlier (see Part II), the analytical significance and parsimony were judged based on a survey of the literature as well as new empirical analysis undertaken in the IMF on the definition, interpretation, and analysis of FSIs (see Part I). Both the survey and the analytical aspects were brought to bear in judging focus and country relevance.

Ideally, indicators included in the core and encouraged sets should also be comparable across countries—which would be possible if there existed in all areas internationally agreed prudential, accounting, and statistical standards to which all countries adhered—to facilitate monitoring of the financial system, not only at the national but also at the global level. The latter is important in view of the magnitude and mobility of international capital flows, and the risk of contagion of financial crises from one country to another. Advancing international comparability of FSIs and convergence toward best practice are important goals for further work in this area.

The review contained in this occasional paper highlights that work on measuring and analyzing FSIs has advanced substantially in recent years, and proposes specific areas where more work is needed.

  • National authorities should be encouraged to compile and monitor FSIs systematically, based on available data.

  • At the same time, guidelines are necessary to arrive at clear definitions of the indicators. Looking ahead, the IMF is working to produce, in consultation with national authorities and standard setters, a Compilation Guide on Financial Soundness Indicators.

  • At the IMF, monitoring and analysis of FSIs should continue to be strengthened through the FSAP process and, more broadly, in the context of surveillance, technical assistance, and policy development work.

  • Better indicators of the health of nonbank financial institutions and markets need to be developed—reflecting the specificities of each market segment—and of financial institutions' exposure to the household and real estate sectors.

  • With regard to the corporate sector, data availability remains a key obstacle, particularly for nonlisted companies, which represent a significant share of the sector in many countries. Further work to systematically compile FSIs of the nonfinancial corporate sector should be encouraged.

  • Analytical tools that use FSIs need to be further developed, including more refined methods of aggregate stress testing of financial systems.

  • Finally, the development of benchmarks for the level of FSIs would help monitor and interpret developments in the financial system, keeping in mind that benchmarks are most often country-specific and can change over time.

Monitoring and analysis of FSIs are just one element in an overall assessment of financial stability. Other elements include analyses of macroeconomic developments, market-based data such as stock prices and credit ratings, structural information on the financial sector, and—last but not least—qualitative assessments, in particular assessments of observance of relevant international standards and codes. These elements, which feed into macroprudential analysis, will help to identify various dimensions of risks as well as the capacity of the system to cope with and manage these risks, thereby helping to form a judgment on overall financial stability. While these tools still remain imperfect and continue to evolve, over time, macroprudential analysis can reduce the incidence of crises by providing national authorities with a set of tools to comprehensively assess their financial sectors and identify weaknesses at an early stage.

The paper is organized in two parts—Part I focuses on selected analytical aspects of defining and analyzing FSIs, and Part II discusses country practices in the use, compilation, and dissemination of FSIs.

Within Part I, Chapter II introduces the framework of macroprudential analysis, including its quantitative as well as qualitative aspects, and reviews the experience with macroprudential analysis and indicators gained through the FSAP. Chapter III focuses on the definition and interpretation of indicators of the current health of the banking system, primarily derived by aggregating indicators of the health of individual banks. Indicators of specific sectors and markets that can have an impact on financial system stability—specifically, nonbank financial intermediaries (NBFIs), the corporate sector, households, and real estate markets—are discussed in Chapter IV. Chapter V looks at stress testing as a key component of macroprudential analysis.

Within the second part of this paper, Chapter VI introduces the Survey on the Use, Compilation, and Dissemination of Macroprudential Indicators. Chapter VII discusses survey results in terms of perceived usefulness of specific FSIs. Survey results on the compilation and dissemination of FSIs or their components are reported in Chapter VIII, and responses related to the analytical frameworks used by countries to analyze these indicators are reported in Chapter IX.

Chapter X concludes with proposals for a core set and an encouraged set of indicators to be used for the purpose of periodic monitoring, and for compilation and dissemination by national authorities. The chapter also discusses directions for further work on FSIs.

1The FSAP was launched jointly by the IMF and the World Bank in May 1999. The program is designed to identify financial system strengths and vulnerabilities and to help to develop appropriate policy responses. Financial System Stability Assessments (FSSAs) are prepared by IMF staff in the context of Article IV consultations, by drawing on the FSAP findings, for discussion in the IMF Executive Board. In the World Bank, the FSAP reports provide the basis for producing Financial Sector Assessments and formulating financial sector development strategies. See IMF (2001a, b) and Hilbers (2001).
2See Evans, Leone, Gill, and Hilbers (2000).
3See IMF (2000c, 2001b).
4The survey explicitly listed around 60 indicators, identified in earlier work.
5See www.bis.org/publ.
6In some countries—for instance, Finland, Hungary, Iceland, Norway, Sweden, and the United Kingdom—central banks publish special reports dealing with financial stability issues.