Monetary & Financial Statistics: February 2004
An introduction to Financial Soundness Indicators
By Andrew Moorhouse
Tel: (020) 7601 4069
Email: andrew.moorhouse@bankofengland.co.uk
Introduction
Financial Soundness Indicators (FSIs) are statistical
measures for monitoring the financial health and
soundness of a country’s financial sector, and its
corporate and household counterparts. The development
of these experimental indicators is being co-ordinated by
the International Monetary Fund (IMF), with the support
of other international organisations, such as the World
Bank, the Bank for International Settlements, the
Organisation
for
Economic
Co-operation
and
Development (OECD), and the European Central Bank
(ECB), plus IMF member countries in all geographic
areas. Work to date has concentrated on the conceptual
underpinning for a range of possible measures but the
IMF hope to coordinate an initial pilot data collection for
about sixty countries in 2006, with FSIs published on a
regular basis by 2007.
was proposed to prioritise between data series regarded
as essential (for example, GDP data, Balance of
Payments data, Monetary Aggregates, Exchange Rates
and flow of funds data) and those regarded as important
(asset information, foreign currency reserve assets,
derivatives and Non-Performing Loans).
The IMF initiative
In October 1998, the Group of 22 Finance Ministers
(G22) had also acknowledged that better data provision
contributes to the improved functioning of markets: ‘a
view has emerged that better data provision allows
investors to make better informed investment decisions,
leading to improved resource allocation, as well as
highlighting potential problems at an early stage, so
reducing the likelihood of sudden shocks and hence
dislocation of capital flows with a consequential impact
on the real economy’3. G22 ministers recommended that
financial sector surveillance should be anchored to the
IMF surveillance process, with expert support from the
World Bank and elsewhere. The idea was to develop the
use of macroprudential indicators (MPIs)4 - defined as
indicators of the health and stability of financial systems.
While the compilation of FSIs for the United Kingdom
will involve data collected by a number of UK agencies the Bank of England, the Office for National Statistics
and the Financial Services Authority - it has been the
Bank who have been the lead UK body in this project.
This article provides some background to the IMF's FSI
programme, explains how it links in with other
international surveillance work, and provides some detail
about the data requested. The article will also discuss
issues of specific relevance to the United Kingdom, and
the timetable for this work.
IMF papers in September 19995 and April 20006, and a
consultative meeting at the IMF in September 1999
advanced the MPI (now referred to as FSI) development
program. The September meeting set out the motivation
for the development of aggregate national indicators, to
‘recognize potential problems at an early stage and
develop responses promptly to avoid costly systemic
crises’. The identification of a core series of FSIs,
possibly to become part of the IMF's Special Data
Dissemination Standards (SDDS), was also proposed.
Why are FSIs needed?
The Asian crises of 1997 are widely perceived as the
trigger that prompted recognition of the need for a new
financial stability data source. Davis (1998)1, claimed
that financial instability - described as bank failures
following loan or trading losses, market price volatility
after a shift in expectation, or a collapse of market
liquidity and issuance - had resulted in over 20
international financial crises between 1970-1998. As it
had been estimated that each of these crises had cost
around 15% of that country’s GDP, Davis argued for the
‘monitoring of conjunctural and structural trends in
financial markets so as to give warnings of the approach
of financial instability’. Certain data were highlighted as
of potential importance (flow of funds data, financial
prices, and monetary data). The importance of setting
benchmarks and norms for reporting countries was also
stressed.
The next step was a survey of IMF member countries,
undertaken in the summer of 2000, to identify their needs
and practices related to indicators of financial
soundness7. From the results of this survey, the IMF
Executive Board endorsed a ‘core’ and ‘encouraged’ set
of FSIs at a meeting in June 2001. Six criteria were
applied in drawing up this list: indicators should focus on
core markets and institutions; have analytical
significance; have revealed usefulness; have relevance in
most circumstances (i.e. should not be country-specific);
3
Quote taken from G22 meeting , as reported in ‘Financial Market Data
for International Financial Stability’ E.Philip Davis, Robert Hamilton,
Robert Heath, Fiona Mackie, Aditya Narain
4
MPI is the generic term for an FSI
5
‘IMF Survey, Macroprudential Indicators’ Paul Hilbers and Marina
Moretti
6
‘Macroprudential Indicators of Financial System Soundness’ Staff
team led by Owen Evans, Alfredo M.Leone, Mahinder Gill and Paul
Hilbers
7
‘Survey on the Use, Compilation and Dissemination of
Macroprudential Indicators’
These thoughts led to a workshop in the Bank of
England2 in January 1999, which brought together users,
producers and standard setters. Amongst other things, it
1
E. Philip Davis ‘Financial Data Needs for Macroprudential
Surveillance – What are the Key Risks to Financial Stability? 1998.
2
This workshop was organized by the Centre for Central Banking
Studies (CCBS) within the Bank of England.
1
Monetary & Financial Statistics: February 2004
should be available; and be parsimonious - achieving
maximum information content from a limited number of
FSIs.
The Financial Sector Assessment Program
The work that ties in most closely with the FSI project
has been the Financial Sector Assessment Program
(FSAP), a joint IMF and World Bank initiative
introduced in May 1999. The aim of the FSAP program
is to increase the effectiveness of efforts to promote the
soundness of financial systems in the reporting country,
looking in particular at the structure of the financial
sector, and its regulation. Experts from a range of
agencies and bodies who work under the program seek to
identify specific information about the economy of the
country involved. The FSAP then forms the basis for a
Financial System Stability Assessment (FSSA). The
FSSA seeks to identify potential vulnerabilities of
financial institutions and markets to macroeconomic
shocks, as well as recommending structural reforms and
restructuring actions to promote financial system
stability. So far, over thirty countries (including the UK)
have taken part in the FSAP process.
In total, 39 FSIs have been agreed (see Appendix). Core
FSIs are those judged to be relevant to all countries, and
those that all countries should be able to produce. These
are to be compiled using harmonised definitions.
Encouraged FSIs can be developed as country
circumstances dictate. Many of these indicators, both
core and encouraged, are ratios, derived from the
aggregated balance sheets of individual financial
companies. As the appendix shows, there are a wide
range of indicators covering deposit takers (including
capital adequacy, asset quality, liquidity, earnings and
profitability, and currency breakdowns), as well as
further data on households, the non-financial corporate
sector (NFCs) and real estate markets.
The IMF are preparing a Compilation Guide for
Financial Soundness Indicators8 to assist compilation by
member countries. As well as listing the prospective
indicators, the Guide will provide comprehensive
guidance on the concepts and definitions. This includes
definitions of financial institutions, accounting rules, as
well as explaining concepts, and setting out the preferred
approaches to aggregation and consolidation. It will also
explain how each individual FSI should be calculated.
The finalised Guide is due to be published during 2004.
At the heart of the FSAP process is an analysis of
indicators produced by the reporting countries (in the
case of the UK, by the Bank, the Financial Services
Authority and the Treasury). It is the extension of this
idea that is the principle value of FSIs, as data similar to
these will be produced by a large number of countries,
rather than the smaller numbers that have completed the
full FSAP programme. However, while the FSIs will be
an invaluable resource for financial stability analysts, the
IMF are not claiming that these will be the only data
source necessary to fully analyse the prospects for any
country.
The latest Draft of the Compilation Guide9
includes a diagram depicting four different types of
financial surveillance. While the macro-prudential
surveillance framework can be largely covered by FSIs,
surveillance of current financial market conditions to
assess the risk of shocks, analysis of macro-financial
linkages and surveillance of macroeconomic conditions
will require other data sources, such as financial market
data, information on private and government sector debt,
interest and exchange rate data, as well as monetary data.
Other streams of work aimed at enhancing data
availability include the Committee of European
Supervisors’
work
on
streamlining
reporting
requirements, and an ECB initiative to publish data on
capital and profitability. This shows that FSIs will be a
valuable tool within themselves, but need to be combined
with others to allow reliable judgements about country
risks.
Other international initiatives
The IMF's FSI programme is by no means the only
international initiative concerned with data requirements
for monitoring financial Stability. In the mid to late1990’s, the Financial Stability Forum (FSF), and the
Committee on the Global Financial System (CGFS) were
established. Part of the mandate of the FSF was to
strengthen the monitoring and assessment of systemic
vulnerabilities, while the CGFS published pieces on
financial stability issues in developing markets in 1997,
and events surrounding financial turbulence in many
international markets in 1998. The ECB has also been
developing work to monitor financial stability, through
the ECB Working Group on Financial Fragility (WGFF).
The ECB WGFF carried out some preliminary work on
Macroprudential
Indicators
(MPIs),
separating
prospective indicators into three catogories: systemic
indicators of the health of the banking system;
macroeconomic factors that influence the banking
system; and contagion factors. This has evolved into the
ECB producing a list of MPIs that have similarities with
the IMF core set (10 of the 13 in the IMF core set match
with an ECB equivalent), yet will continue to be different
in other areas, principally due to the ECB focussing on
producing data of relevance more to ECB affiliated
countries rather than the IMF’s wider remit (i.e. ECB
indicators also focus on other dimensions of risk
concentrations, on competitive conditions, and on
cyclical and monetary conditions). The ECB have also
supported the IMF in its FSI work, not least by hosting
several of the FSI meetings at the ECB headquarters in
Frankfurt.
8
Looking ahead
Before the start of regular FSI dissemination from 2007,
a Coordinated Compilation Exercise (CCE) has been
planned for 2006. Participants will compile the twelve
core indicators, as well as selected encouraged FSIs. The
reference date for data will be end-December 2005, with
data to be disseminated by September 2006.
The CCE will promote and support the efforts of national
authorities to compile the core FSIs, promote good
quality cross-country comparable FSI data, and increase
9
http://www.imf.org/external/np/sta/fsi/eng/guide/index.htm
2
http://www.imf.org/external/np/sta/fsi/eng/guide/index.htm
Monetary & Financial Statistics: February 2004
transparency about data, mainly through the encouraged
dissemination of metadata. To help the efforts of the
countries volunteering for this project (expected to be
around 60, preferably a mix of developed, emerging and
developing nations), Fund staff will conduct regional
workshops before and after the exercise, as well as
providing on-going technical advice.
different countries’ FSIs, as there could be differences in
methodology. Due to the difficulties many countries will
have in improving data sources, this problem is unlikely
to be alleviated in the short term. In recognition of this
limitation, the IMF stress that there will be a greater
flexibility in implementation and that, for the foreseeable
future, data will be recorded on a best efforts basis.
The United Kingdom is likely to participate in the 2006
compilation exercise. The preparation of UK FSIs has
already benefited from experience in compiling data for
the FSAP process, and further development work is
continuing. However, there are a number of areas where
additional data may be needed if IMF guidance is to be
met in full. These primarily result from the need to use
worldwide consolidated data, which is currently collected
and used for supervisory rather than statistical purposes,
and is not collected on the same frequency or timetable
as statistical data. There are also some data necessary for
FSIs that are not collected on a consolidated basis.
Nevertheless, FSIs seem likely to become an important
tool for providing insight into the health and soundness
of the financial sector of a country. They will give
valuable information on financial stability for a large
number of emerging and developing countries, in
particular helping to identify potential financial stability
risks at an early stage. While directly comparing
individual countries’ FSIs may be problematic, it will be
possible to look at trends amongst the data for different
countries. This may give an indication of any potential
financial stability issues. FSIs will also assist and
complement other surveillance work being undertaken by
international bodies. Under the IMF’s current schedule,
FSIs should be widely available for analysis within three
years.
In practice, few if any countries will be able to produce
the data exactly as is specified in the Guide by 2007.
This may limit the scope to compare directly two
3
Monetary & Financial Statistics: February 2004
APPENDIX
Table 1: Financial Soundness Indicators: The Core and Encouraged Sets
Core Set
Deposit-taking institutions
Capital adequacy
Asset quality
Earnings and profitability
Liquidity
Sensitivity to market risk
Regulatory capital to risk-weighted assets
Regulatory Tier I capital to risk-weighted assets
Nonperforming loans to total gross loans
Nonperforming loans net of provisions to capital
Sectoral distribution of loans to total loans
Return on assets
Return on equity
Interest margin to gross income
Noninterest expenses to gross income
Liquid assets to total assets (liquid asset ratio)
Liquid assets to short-term liabilities
Net open position in foreign exchange to capital
Encouraged Set
Deposit-taking institutions
Other financial corporations
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 (non-interbank) loans
Foreign currency-denominated loans to total loans
Foreign currency-denominated liabilities to total liabilities
Net open position in equities to capital
Large exposures to capital
Assets to total financial system assets
Assets to GDP
Nonfinancial corporate sector
Total debt to equity
Return on equity
Earnings to interest and principal expenses
Net foreign exchange exposure to equity
Number of applications for protection from creditors
Market liquidity
Average bid-ask spread in the securities market
Average daily turnover ratio in the securities market
Households
Household debt to GDP
Household debt service and principal payments to income
Real estate prices
Residential real estate loans to total loans
Commercial real estate loans to total loans
Real estate markets
4