Financial Soundness Indicators : Compilation Guide

International Monetary Fund

• Publisher: INTERNATIONAL MONETARY FUND
• eBook ISBN:
  9781589063853
• Year: 2006

NONE

1. Introduction

Background

1.6 By allocating funds for viable investment projects and providing payment services, healthy and robust financial systems help increase economic activity and welfare. However, experience has shown that financial systems are prone to instability and crisis that have the potential to disrupt financial activity and impose huge and widespread costs on the economy. With the liberalization of financial markets and the greater recognition of the importance of systemic effects of financial sector weakness, policymakers and others are paying increasing attention to the stability of national financial systems. Thus the long-established surveillance of individual institutions is being supplemented by the monitoring of risks to the stability of national financial systems arising from the collective behavior of individual institutions. This work is known as macroprudential analysis.

1.7 The traditional focus of prudential data reporting and analysis is on the microprudential objective of limiting the likelihood of failure of individual institutions. Macroprudential analysis has a somewhat different set of data requirements owing to its focus on identifying risks emerging in the financial system as a whole. For instance, while increased lending to the real estate market, or to the corporate sector, may be profitable to a bank in the short term, if such lending is mirrored in other banks, the resultant sharp expansion of the banking sector’s exposure to real estate or the corporate sector’s debt to equity ratio might raise concerns from a macroprudential viewpoint. In such instances, risks considered exogenous to any one institution are endogenous to the financial system.¹

1.8 Further, the magnitude and mobility of international capital flows has made it increasingly important to monitor the strength of financial systems and their resilience to capital flow volatility. The financial sector is often the conduit between global financial markets and domestic borrowers and, as such, is sensitive to external capital markets conditions, as well as domestic developments. Moreover, weaknesses in domestic banks can have a pervasive influence on consumer and investor confidence, capital flows, and public finances, as well as on domestic financial intermediation.

1.9 Attention also needs to be given to balance sheet and profitability indicators of nonfinancial corporations. Financial weaknesses such as a high leverage ratio and/or low profitability of these corporations can directly affect the strength of the financial sector because of their impact on asset quality. Also, financially weak corporations can render an economy more susceptible, and less resilient, to external shocks. Governments also play an important role.²

1.10 The recognition of the importance of macroprudential analysis has increased the need for supporting data. This consideration led the IMF to undertake in 2000 a survey of its member countries and of regional and international agencies to identify those indicators considered to be most relevant to the macroprudential work of national and regional authorities, both as compilers and users of data. A summary of the results is presented in Appendix I. Also, in 1999, the IMF and the World Bank launched the Financial Sector Assessment Program (FSAP), designed to identify financial system strengths and vulnerabilities and to help develop appropriate policy responses. This work has involved the use of FSIs, drawing on available data sources in countries.

1.11 Using the results of the survey of member countries, the experience from FSAPs, and discussions with international agencies interested in this work, a list of key FSIs was developed and presented to the IMF’s Executive Board in June 2001. From this meeting, the list of core and encouraged FSIs set out in Table 1.1 was agreed (agreed FSIs), based on various selection criteria.³ The list was modified by the Board in January 2004.⁴ To help prioritize future work, the core set is considered relevant for all countries, while the encouraged set might be developed as country circumstances require. At the same time, the Board encouraged the IMF’s staff to produce the Compilation Guide to help compilers develop the agreed indicators and undertake further development work in this field.

1.12 The Guide is a comprehensive document that not only explains how to compile the core and encouraged FSIs but also sets out the conceptual frameworks from which the data series required to calculate the FSIs could be drawn. A summary of the guidance for compiling each FSI is provided in Appendix II. In addition, in the process of consultation, some associated data series have been suggested that assist in the interpretation of FSIs, such as information on the structure of a country’s financial system. However, in reading the Guide compilers should be aware that in terms of data requirements the priority is the core set of FSIs, followed by the encouraged FSIs. Also, while as far as possible the Guide draws on existing data systems, compiling FSIs most likely will add to the statistical burden. The extent of any additional costs will depend on a number of factors, including the amount of data already available, the structure of the financial system, and the time horizon over which the data are developed.

Some Key Aspects of the Guide

1.13 From the work undertaken, it is clear that the range and type of FSIs compiled and disseminated differ among countries, but that given their pivotal role in all national economies, FSIs for the deposit takers—particularly the core set—are considered central to any analysis of the current health and soundness of a national financial system. This is reflected in the Guide. In addition, because of the importance of the credit quality of deposit takers’ assets to the profitability and soundness of these deposit takers, information on their main customers—particularly the corporate and household sectors—is relevant for such analysis. The need for FSIs for other financial corporations will vary depending on their importance within the economy.

1.14 FSIs need to cover several aspects of financial health and soundness. In a financial system, capital strength is important for all types of institutions, especially as a “cushion” against unexpected losses. In monitoring the financial soundness of financial institutions, important considerations are also the quality and composition of their assets, and exposures to financial risk. Information on income and expenses is also critical—without sufficient income generation, no entity is financially healthy or sound. For nonfinancial corporations, the focus is on their liabilities and their ability to meet their financial obligations as they fall due. In short, FSIs are intended for use in monitoring the development of positions (and exposures) and flows that could indicate increased financial sector vulnerability and could help assess the potential resilience of the sector to adverse circumstances.

1.15 Because most FSIs are in the form of ratios, definitions are required for the underlying series used to calculate FSIs. Further, in considering the definitions for these individual series, it is apparent that many are derivable from information contained in balance sheets and income statements. So for all sectors, including deposit takers and nonfinancial corporations, the Guide starts from the presumption that, as far as possible, the underlying series should be drawn from internally consistent financial statements that encompass an income and expense statement and a balance sheet. Calculating FSI ratios from data series derived from internally consistent financial statements enhances the analytical usefulness of the indicators and contributes to the quality control of published data owing to the well-established linkages among financial statement items.

1.16 In developing guidance on definitions, the Guide draws on the System of National Accounts 1993 (1993 SNA) (Commission of the European Communities and others, 1993) and related manuals (for example, the Monetary and Financial Statistics Manual [MFSM] [IMF, 2000a]), and the international accounting standards (IASs) and International Financial Reporting Standards (IFRSs) (IASB, 2004), developed by the International Accounting Standards Board (IASB).⁵ Both of these international measurement systems have developed their guidance within the context of internally consistent financial statement frameworks. For deposit takers, the work of the BCBS is also drawn upon. While there are many similarities between the international measurement systems, the conceptual approach in the Guide allows for flexibility to accommodate differences between them and meet the needs of macroprudential analysis. Further, Appendix IV explains how the guidance in the 1993 SNA and IASs/IFRSs correspond with the requirements of the Guide. The Guide also provides methodological guidance on measurement issues that are new at the international or even national level, for example, regarding real estate prices and certain financial market information.

1.17 Despite the reliance to the extent possible on existing measurement systems, the needs of macroprudential analysis are different from those the existing systems are addressing, and this is reflected in the framework developed.

1.18 For deposit takers, macroprudential analysis monitors the profitability, capital strength, quality and composition of assets, and exposures to financial risks faced by the sector as a whole. Supervisors have similar interests but at the level of the individual institution. Further, some supervisors adapt accounting guidance to meet the needs of individual institutions, whereas the consistent application of accounting rules across all entities in the sector is essential to avoid asymmetries in the macro-based data.

1.19 The sector focus and the consistent application of accounting rules are applicable for other macro-based data such as the national accounts, monetary aggregates, and the Bank for International Settlement’s (BIS’s) international banking statistics (IBS). However, there are differences in analytical focus. National accounts data are focused on production, income and its distribution and use, and the financial claims and liabilities generated. Compared with these data sets, the FSI framework focuses more on capital strength and profitability, making essential the avoidance of double counting capital, and activity based on that capital, at the sector level. So macroprudential analysis favors consolidation of group accounts, whereas national accounts data focus on the gross output and activity of individual entities within groups. Further, the buildup of claims and liabilities among deposit takers is of macroprudential interest, not least to monitor the potential for contagion, whereas monetary aggregates focus on deposit takers’ claims and liabilities vis-à-vis other sectors and so eliminate such intrasectoral positions.

1.20 Furthermore, it is worth noting that compared with other measurement systems, the extent of institutional coverage for macroprudential purposes is not clearly determined. While the Guide requires the compilation of FSIs on a consolidated group basis to support soundness analysis, this can invo...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Abbreviations
• 1 Introduction
• Part I: Conceptual Framework
• Part II: Specification of Financial Soundness Indicators
• Part III: Compilation and Dissemination of Financial Soundness Indicators
• Part IV: Analysis of Financial Soundness Indicators
• Footnotes