The FSAP ProgramPractice and Potential

Financial Sector Assessment Program

Diagnosis of potential vulnerabilities

and analysis of development priorities

in the financial sectors of member countries

Outline of presentation

• The FSAP program to date

• Use of standards and codes

• Stability aspects

• Development aspects

The FSAP program seeks to…

• Identify strengths and vulnerabilities

• Determine how key risks are being managed;

• Ascertain development and TA needs; and

• Help prioritize policy responses

Some institutional features

• Joint product of the IMF and the World Bank

– joint Bank-Fund Financial Sector Liaison Committee (FSLC)

– designed to strengthen IMF bilateral surveillance and World Bank’s financial sector development work.

• An international cooperative effort drawing on financial sector experts from collaborating official institutions as well as Bank-Fund staff

• Started May 1999 (pilot basis)

• Voluntary participation

FSAPs: 1999-2004

• Completed FSAPs: 73 countries

• FSAPs underway: 18 countries

• Future participation confirmed: 14 countries

• FSAP updates: 9 countries

FSAPs completed (1999-2006: 97)

Albania Algeria Armenia Austria Azerbaijan Bahrain Bangladesh Barbados Belarus Belgium Bolivia Brazil Bulgaria Cameroon Canada Chile Colombia Costa Rica Cote d’Ivoire Croatia Czech Rep. Dom. Rep.

ECCU Ecuador Egypt El Salvador Estonia Finland France Gabon Georgia Germany Ghana Greece Guatemala Honduras Hong Kong Hungary Iceland India Iran Ireland Israel Italy

Japan Jordan Kazakhstan Kenya Korea Kuwait Kyrgyz R. Latvia Lebanon Lithuania Luxembourg Macedonia Malta Mauritius Mexico Moldova Morocco Mozambique Namibia Netherlands New Zealand Nicaragua

Nigeria Norway Oman Pakistan Peru Peru Philippines Poland Romania Russia Rwanda Saudi Arabia Senegal Serbia Singapore Slovak R. Slovenia S. Africa Sri Lanka Sudan Sweden Switzerland

Tanzania Trinidad Tunisia UAE Uganda Ukraine UK Yemen Zambia

FSAPs underway or agreed (25)

Australia Bosnia-Herz. CEMAC Denmark Fiji Guyana Jamaica Madagascar

Mauritania Paraguay Portugal Sierra Leone Spain Thailand Turkey Uruguay

Botswana Brunei Darussalam Burkina Faso Burundi Cent. Afr. Rep. Mali Montenegro Qatar San Marino Switzerland

Building blocks

• Assembly of data on system functioning– Including scale, liquidity, efficiency, reach, exposure

• Standards and codes assessments – Detailed structured discussions with authorities

• Formal stress-testing• Interviews with market participants

Overall assessment

Codes are selected from…

• Basel Core Principles for Effective Banking Supervision (BCP)

• Transparency (Monetary & Financial Policies)

• Systemically Important Payment Systems (CPSIPS)

• Securities Regulation (IOSCO)

• Insurance (IAIS)

• AML-CFT (FATF)

For reviews: http://www1.worldbank.org/finance/html/tech_fsap.html

Basel Core Principles for Effective Banking Supervision

– Objectives, Autonomy, Powers, and Resources

– Licensing and Structure

– Prudential Regulations and Requirements

– Methods of Ongoing Supervision

– Information Requirements

– Formal Powers of Supervisors

– Cross-border Banking

Standards and Codes

– Organisation of an Insurance Supervisor Licensing and Changes in Control

– Corporate Governance

– Internal Controls

– Prudential Rules

– Market Conduct

– Monitoring, Inspection and Sanctions

– Cross-border Business Operations

– Supervisory Coordination and Cooperation, and Confidentiality

IAIS Insurance Core PrinciplesStandards and Codes

– The regulator

– Self-regulation

– Enforcement

– Cooperation in regulation

– Issuers

– Collective investment schemes

– Market intermediaries

– The secondary market

IOSCO Objectives and Principles for Securities Regulation

Standards and Codes

IMF Code of Good Practices on Transparency in Monetary and Financial Policies

– Clarity of roles, responsibilities and objectives of central banks / financial policies

– Open process for formulating and reporting monetary / financial policies decisions

– Public availability of information on monetary / financial policies

– Accountability and assurance of integrity by the central bank / financial policies

Standards and Codes

– Legal basis– System’s impact on risks and procedures for management of risks– Final settlement– Assets for settlement– Security and operational reliability and contingency arrangements– Practicality of the system – Objective and publicly disclosed criteria for participation– Governance of the system – its effectiveness, transparency and

accountability– Responsibilities of the central bank in applying the Core Principles– Securities settlement systems

CPSS Core Principles for Systemically Important Payment Systems

Standards and Codes

– Criminal justice measures • Including FIU, confiscation of proceeds, enforcement,

international co-operation,

– Preventive measures for financial institutions• Legal & institutional framework & implementation• Banking, Insurance, Securities: sector-specific criteria

– Information on controls and monitoring of cash and cross border transactions

Anti-Money Laundering & Countering the Financing of Terrorism (AML-CFT)

Standards and Codes

Frequency of codes in early FSAPs

0 20 40 60 80 100

AML

IAIS

IOSCO

CPSIPS

MFPT

BCP

Percentage

to Dec 2002

FSAPs vs. code assessments: What’s the difference? (1)

• Not all relevant codes can be covered– So need to be supplemented by less formal

work

• Cross-sectoral issues– Interaction between different sectors– Regulatory overlap or underlap

• Coverage gaps – e.g. contractual savings/social insurance

(financial sector aspects); deposit insurance

FSAPs vs. code assessments: What’s the difference? (2)

• Codes developed by regulatory bodies and reflect their partial focus

• Mechanical code diagnosis may miss national features

• Prioritization and highlighting

FSAPs vs. code assessments: What’s the difference? (3)

• No standards for key stability & development issues such as – Macrofinancial crisis management– Competition environment, – Tax, quasi-tax and subsidy issues– Access to financial services– Missing markets– Overall legal framework

The future (1): less reliance on full code assessments

• Subtlety and sophistication inapplicable in many environments (small, less developed systems)

• Attempt to retain enough of the essence of the code without excessively detailed questioning?

• Avoid “Fiddling while Rome burns” by selecting only most relevant codes…

…and switching resources to country needs

The future (2): FSAP updates

• Evolving towards a more flexible model differentiated in line with country needs

• Elements will include:– Ongoing surveillance (with Art. IV)– Coverage of additional sectors (rolling assessment)– Updates of ROSCs if warranted by changes– More in-depth development studies (e.g. involving

more continuous engagement)– Greater emphasis on TA/follow-up

Crisis prevention vs. prediction

• Can FSAPs predict a crisis?

• Is the system in “Zone of vulnerability”?

• Identifying channels of vulnerability

• Crisis management mechanisms

Vulnerability = Risks x Systemic Weakness

OBSERVANCE OF STANDARDS

LOW HIGH

HIGH UNSTABLE

CONSTANT VIGILANCE NEEDED TO SURVIVE FREQUENT SHOCKS

(e.g., some advanced economies)

SC

AL

E A

ND

F

RE

QU

EN

CY

OF

S

HO

CK

S

LOW STABLE UNTIL

SHOCKED (e.g. pre-reform systems)

STABLE

Stress testing (1)

Quality of stress test results =

quality of data X relevance & scale of shocks

http://www.imf.org/external/pubs/ft/wp/2001/wp0188.pdfhttp://www.imf.org/external/np/fsap/2003/022403a.htm

Stress testing (2)

(Mainly banking system)

Typical shocks: exchange rate, interest rate, liquidity, commodity price; housing prices; quality of loan classification

Scale of shocks: reference to history

Correlations: usually scenarios(More elaborate procedures used for some advanced

economies)

Stress testing (3)

Account sometimes taken of sectoral pattern of lending, market portfolio.

Must be bank-by-bank: averages can conceal

The essence: recalculate bank’s capital after shock

Impact of shock on loan performance usually judgmental -- occasionally use of historic relations; rarely use information on non-financial corporate finances

Approach to the development assessment

• Builds on information gathering part of the stability part & regulatory code assessments

• But takes a functional and systemic approach

• Seeks to trace deficiencies to (i) gaps in financial infractructure and (ii) flaws in policy

• Optimal policy recommendation highly country specific– Laissez-faire inadequate; activism often counterproductive– Political, governance & admin. preconditions important

Development assessment: the information gathering phase

• Quantitative benchmarking– size, depth, cost and price efficiency and penetration

• Infrastructural reviews– legal, informational and transaction technology

• Sectoral reviews– service provision, structure and regulation– (incl specialized development institutions)

• Demand-side reviews• Other cross-cutting aspects of policy environment

Development assessment: the analytical and reporting phase

Delivering the message:• Describe the functional gaps

– E.g. lack of term finance; no venture capital; high intermediation costs; limited access; nascent insurance industry…

• Pinpoint the source(s) of the difficulty• Propose strategic approach to solution

– highlighting cross-sectoral aspects

Outputs

• Aide Mémoire Working document, not for publication

• FSSA* (IMF Board) Financial sector stability assessment

• FSA** (WB Board) Financial sector assessment

• ROSCs* Summary report on observance of standards & codes (annexed to FSSA)

• Technical Notes On selected issues

• Detailed standards & codes assessmentsMexico examples:

*http://www.imf.org/external/pubs/ft/scr/2001/cr01192.pdf

**http://www1.worldbank.org/finance/assets/images/Mexico_FSA.pdf

Publication policy

• Aide Memoire given only to authorities• FSSAs and FSAs:

– are confidential but do not contain information concerning the health or prospects of individual financial institutions.

– voluntary publication (same publication and deletions policy as Article IV staff reports)

• Financial sector ROSCs:– voluntary publication; could be published separately from FSSA

• Detailed assessments of observance of standards and codes – can be published by authorities with the consent of IMF-WB

• Technical Notes– can be published by authorities with the consent of IMF-WB

management, with exception of stress test results and information on individual institutions, and with appropriate deletions for highly market-sensitive information.

What can we conclude from an FSAP?

• Is the system stable? If not, what actions required?

• How to strengthen the financial system further?– Improve code compliance;– Build infrastructure (human, organizational, physical);– Prioritize and sequence reform plans.

• How to help the process with technical assistance?

What countries like about the FSAP

• Informs domestic policy making– Provides a consistent, comprehensive framework for

financial sector stability issues and development needs– Helps country ownership of the reform process

• Provides a basis and incentive for national authorities to conduct self-assessments

• “Peer review” aspect — use of experts from collaborating official institutions from other countries

For the Bank and Fund…

The FSAP findings:

• Help strengthen the IMF's Article IV surveillance process

• Inform the work program between WB and authorities, and identify priority areas for support.

« Glögt er gests augađ »

(“Keen is the eye of the visitor”-- an Icelandic saying)

The greatest potential of the FSAP is not so much the ratings or the overall risk assessment,

but its ability to bring a new perspective to financial sector policy in the host country