Measuring banking sector development

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1 Financial Sector Indicators Note: 1 Part of a series illustrating how the (FSDI) project enhances the assessment of financial sectors by expanding the measurement dimensions beyond size to cover access, efficiency and stability. Data on these dimensions, as well as other information relevant for financial sector assessment, is intended to become available online during Spring 26. Measuring banking sector development Traditional measures of size and depth of banking systems limit assessment New measure on access to banking, efficiency and stability enhance the analyses Conventional measures of banking sector The traditional indicators utilized for assessing the size, depth and development of a country s banking (financial) sector are: The ratio of M2 to GDP The ratio of private credit to GDP. In particular, both these measures have been used to show the causal effects of financial development on economic growth. However, both measures have some limitations: The ratio of M2 to GDP captures the degree of monetization in the system, but does not capture the degree of bank intermediation. The ratio of private credit to GDP does not control for non-performing loans and more generally, the quality of credit allocation. Both measures do not capture the broad access to bank finance by individuals and firms, the quality of bank services and the efficiency of providing banking services. In general, the quality and availability of indicators on financial stability is limited and the documentation of institutional framework supporting banking lacks robustness. for banking Traditional New Size Access Size Broad access Deposit money bank assets to GDP Branch and ATM density Central bank assets to GDP Average loan and deposit size M2 to GDP Loan & deposit accounts per capita Deposits to GDP Household access Intermediation % of people with bank account Private credit to GDP Firm access Private credit to total credit Collateral needed for loan Private credit to deposits % of firms with financing constraints Efficiency Size of banking sector Percent of GDP Percent Profitability Return on assets 1.5 Net interest margin NPL/Total Loans 12 Private Efficiency credit/ GDP Operating costs Lending spread Days to clear check Competitiveness Concentration ratio Ownership Stability Capital adequacy Capital adequacy ratio High-income: Developing Asset quality OECD countries (a) Lenders NPL refers to non-performing loans. Non-performing loans Real credit growth Loan concentration Large loan exposures to capital (b) Borrowers Firm leverage Interest coverage ratio Household debt to GDP Liquidity Liquid asset ratio Other Net FX position-to-capital Default probability of banks New indicators for going beyond the size The (FSDI) project has compiled indicators that go beyond size, and can help assess access, efficiency and stability of financial systems across and within countries. Banking systems can score very differently on each of these four dimensions. It is therefore important to consider these dimensions jointly and in various combinations. The conventionally used, as well as new indicators relevant for assessment of banking system are summarized in the table above. The page 1

2 indicators within each dimension are also summarized in a composite index for the purposes of benchmarking and classifying countries. The majority of the new indicators refer to access to finance. These indicators summarize the ability of households and firms in a country to access finance and the actual usage of banking services. New indicators on efficiency include the number of days it takes to clear a check or to do a wire transfer in a country, a new measure of the degree of bank competition, and information on the degree of state or foreign ownership of banks. New indicators on the stability of the banking sector, among others, comprise market-based measures of the probability of default of banks in a country, and data on the quality and performance of corporate sector and household borrowers, thus incorporating the user side of finance. In addition, the stability dimension includes some of the new financial stability indicators collected by the IMF, such as information on large loan exposures and concentration of lending activity. The FSDI also comprises data on the development of other parts of the financial sector, such as capital markets and insurance, thus capturing the relationships between the banking and various other sectors. There are also new indicators on the quality of the legal infrastructure that supports bank finance, such as creditor rights, bankruptcy framework, credit information, and bank regulation and supervision. Number of bank accounts per person This measure is an indicator of the use of banking services. Based on a questionnaire circulated among bank regulatory agencies and publicly available data, information on the number and value of deposits for 54 countries for the year 24 was collected. A higher number of bank accounts is interpreted as a signal of greater use of services. This is the first compilation and analysis of consistent and comparable cross-country data on the outreach or penetration of banking systems. Access limited in low-income countries Utilizing information from new indicators, it becomes clear that while the difference between the high-income and developing countries is relatively less pronounced in terms of size and depth, it is quite stark in terms of access. Using the traditional measure of financial development, private credit to GDP, the difference between the rich and poor countries is comparatively less pronounced. The ratio of private credit to GDP varies from 15 percent in low income countries to 95 percent in high income countries, or in other words a 6-fold difference. However, access to finance varies widely across countries, both in terms of high versus low-income and within developing countries themselves. The number of bank accounts per person in highincome countries is on average 2.2, compared to an average of.1 in low-income countries, or a 22-fold difference. In Madagascar, only 14 out of 1 people have a bank account, while in Austria; on average people have more than 3 bank accounts. Such a comparison, otherwise restricted without information on bank accounts, suggests that access to finance is particularly curtailed in low income countries. Private credit and number of deposits accounts, 24 Percent Units Private credit to GDP Developing countries Highincome Lowincome Number of accounts per person Lower Upper Middle-income page 2

3 Classification of countries by number of bank deposits Number of deposits per 1, people Bottom 5 countries Madagascar 14 Bolivia 41 Uganda 47 Kenya 7 Nicaragua 96 Top 5 countries Austria 312 Belgium 38 Denmark 276 Malta 2496 Greece 2418 Bank branches and ATMs Bank branches ATMs (per 1,) (per 1,) Bottom-5 Bottom-5 Ethiopia.4 Bangladesh.1 Uganda.5 Nepal.1 Tanzania.6 Tanzania.2 Madagascar.7 Madagascar.2 Honduras.7 Pakistan.5 Top-5 Top-5 Portugal 52 Portugal 19 Italy 52 Japan 114 Belgium 53 United States 121 Austria 54 Spain 127 Spain 96 Canada 135 The limited access to bank finance is also highlighted in the relationship between traditional measures of size (or depth and development) and other new data on access to banking. The chart (top) shows the relationship between M2/ GDP (a traditional measure of financial depth) and the number of bank accounts (deposits) per person, which is a proxy for the use of banking services. The data on bank accounts are collected using a extensive survey of bank regulatory agencies. The data show that, especially at intermediate levels of financial development, financial size and access to banking are not correlated. This illustrates the importance of comparing data on access to finance when assessing financial development in countries. Concentration does not imply low efficiency For the bank efficiency dimension, FSDI includes not only traditional measures of bank profitability (e.g. return on assets) and efficiency (e.g. ratio of operating costs to assets) but also information on the structure of banking system and measures of the competitiveness of the banking systems (e.g. percentage of banks assets that are foreign or state-owned, or the three-bank concentration ratio). Financial depth and access Number of deposit accounts per capita Depth and access not correlated at intermediate level of financial development R 2 = M2/GDP (%) Concentration is not correlated with efficiency Operating costs to total assets bank asset concentration ratio (%) page 3

4 The general notion is that a more concentrated banking sector is less efficient. However, the chart (bottom, previous page) below shows that the three-bank asset concentration is not correlated with the ratio of operating cost to assets, a traditional measure of efficiency. This suggests that one should not focus solely on concentration ratios as a measure for competition when making inferences about the efficiency of the banking sector. But less depth does indicate less efficiency Financial depth and efficiency, on the other hand, appear more closely correlated. The chart (top) shows the ratio of M2/GDP (financial depth) against the ratio of average operating costs-to-total assets, a traditional measure of bank operating efficiency. The figure shows quite clearly that countries with less deep banking systems also have less efficient banks. Banking and corporate vulnerabilities For the stability dimension of the financial sector, FSDI covers not only traditional CAMEL-type indicators using banks balance sheets, but also indicators based on the balance sheets of corporate borrowers. The combination of banking and corporate sector indicators provides a more comprehensive picture of the health of the banking sector. The chart (bottom) shows that firms financial leverage, measured as the ratio of corporate debt-to-equity, is positively correlated with the banks share of non-performing loans in the banking sector. This illustrates the relationship between the vulnerability of the corporate sector and the quality of banking sector assets. Legal rights facilitate intermediation Finally, FSDI contains detailed information about the legal and regulatory infrastructure for the banking sectors, including creditor rights and supervisory rules and practices. The main variables for this set of information are presented in table below. Legal protection of credi- More efficient banking systems exhibit greater depth M2/GDP (%) Corporate leverage and bank non-performing loans Non-performing loans to total loans (%) R 2 = Operating costs to Total assets CAMEL Indicators The acronym "CAMEL" refers to the five components of a bank's condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, and Liquidity. These aspects reflect the variation in bank asset risk and leverage, because they capture the market, credit, operational, and liquidity risk faced by banks. R 2 = Corporate Debt to Equity Capital (%) tor rights features as an important determinant of bank lending. The chart (next page) shows the strong correlation between private credit-to- GDP, a measure of financial intermediation, against an index of legal rights that measures the degree to which collateral and bankruptcy laws facilitate lending. page 4

5 Legal rights index This index, reflecting the legal rights of borrowers and lenders, measures the degree to which collateral and bankruptcy laws facilitate lending. It is based on data collected through study of collateral and insolvency laws, supported by the responses to the survey on secured transactions laws. The index includes 3 aspects related to legal rights in bankruptcy and 7 aspects found in collateral law. A score of 1 is assigned for each of the following features of the laws: Secured creditors are able to seize their collateral when a debtor enters reorganization there is no automatic stay or asset freeze imposed by the court. Secured creditors, rather than other parties such as government or workers, are paid first out of the proceeds from liquidating a bankrupt firm. Management does not stay during reorganization. An administrator is responsible for managing the business during reorganization. General, rather than specific, description of assets is permitted in collateral agreements. General, rather than specific, description of debt is permitted in collateral agreements. Any legal or natural person may grant or take security in the property. A unified registry that includes charges over movable property operates. Secured creditors have priority outside of bankruptcy. Parties may agree on enforcement procedures by contract. Creditors may both seize and sell collateral out of court. The index ranges from to 1, with higher scores indicating that collateral and bankruptcy laws are better designed to expand access to credit. Intermediation correlated with creditor's legal rights Private credit to GDP (%) R 2 = Legal Rights Index Select references Beck, T., Demigurc-Kunt, A., and Martinez Peria, S. (25). Reaching out: Access to and use of banking services across countries. Claessens, S., and Laeven, L. (25). What Drives Bank Competition? Some International Evidence, Journal of Money, Credit, and Banking 36(3), Djankov, S., McLiesh, C., and Shleifer, A. (25). Private Credit in 129 Countries, Department of Economics, Harvard University. Levine, R. (24). Finance and Growth: Theory and Evidence. forthcoming in Philippe Aghion and Steven Durlauf, eds. Handbook of Economic Growth. The Netherlands: Elsevier Science. Infrastructure and regulations Creditor rights Legal protection of creditor rights Cost to complete bankruptcy (% of estate) Cost to resolve disputes (% of debt value) Credit information sharing Cost of registering property (% of property value) Supervision and regulation Activity and ownership restrictions Bank entry restrictions Capital stringency Official supervisory action Official supervisory resources Independence of supervisory authority Availability of information through the FSDI Web site Data on traditional, as well as new indicators for assessment of banking sectors will all become available through the FSDI interactive Web site, currently under construction. Such indicators, along with various other variables, would form part of an overall framework for assessing financial sectors that would be available online. Provision of regional and country details in the Web site will offer users the flexibility of customizing information to their unique requirement. page 5