Global Financial Development Report 2013Global Financial Development Report 2013 is the first in a new World Bank series. It provides a unique contribution to financialsector policy debates, building on novel data, surveys, research, and wide-ranging country experience, with emphasis onemerging-market and developing economies. Development Report The global financial crisis has challenged conventional thinking on financial sector policies. Launched on the fourthanniversary of the Lehman Brothers collapse—a turning point in the crisis—this volume re-examines a basic question: what is Global Financialthe proper role of the state in financial development? To address the question, this report synthesizes new and existing evidenceon the state’s performance as financial sector regulator, overseer, promoter, and owner. It calls on state agencies to providestrong regulation and supervision and ensure healthy competition in the sector, and to support financial infrastructure, such asthe quality and availability of credit information. It warns that direct interventions—such as lending by state-ownedbanks, used in many countries to counteract the crisis—may end up being harmful. The report also tracks financial systems in more than 200 economies before and during the global financial crisis. Accompany-ing the publication is a website (http://www.worldbank.org/financialdevelopment) that contains extensive datasets, research Rethinking the Role of the State in Financepapers, and other background materials, as well as interactive features. The report’s findings and policy recommendations are relevant for policy makers; staff of central banks, ministries of finance,and financial regulation agencies; nongovernmental organizations and donors; academics and other researchers and analysts;and members of the development community. 2013 Rethinking the Role of the State in Finance ISBN 978-0-8213-9503-5 SKU 19503
x o n t e n t s c GLOBAL financial DEVELOPMENT REPORT 2013 2.1 Examples of Weak Supervisory Capacity Identified in the FSAP. . . . . . . . . . . . . . . . 52 2.2 Differences between Crisis and Noncrisis Countries. . . . . . . . . . . . . . . . . . . . . . . . . 57 2.3 Summary of the Basel III Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 2.4 Summary of Selected Proposals for Regulatory Reform. . . . . . . . . . . . . . . . . . . . . . .69 B3.5.1 Competition in MENA and across Regions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 B3.6.1 Cross-Country Determinants of Banking Competition. . . . . . . . . . . . . . . . . . . . . . . 96 B4.4.1 Determinants of the Growth of Total Gross Loans. . . . . . . . . . . . . . . . . . . . . . . . . 110 B4.5.1 Credit Cycles and Government Ownership of Banks. . . . . . . . . . . . . . . . . . . . . . . . 113 5.1 Credit Reporting, Coverage by Region. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 B5.3.1 Bank Concentration and Credit Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141 A.1 Countries and Their Financial System Characteristics, Averages, 2008–2010. . . . . 161
ForewordT he Global Financial Development The World Bank Group has been actively Report comes at a time when the engaged in financial sector work for some worldwide financial crisis has starkly time, aiming to help various parts of the insti-highlighted the importance of financial sys- tutional mosaic—including regulation andtems and their role in supporting economic supervision, corporate governance, and finan-development, ensuring stability, and reducing cial infrastructure—ensure that the financialpoverty. sector contributes meaningfully to strong and Finance matters, both when it functions inclusive growth. This report seeks to advancewell and when it functions poorly. Sup- the global financial sector policy debate,ported by robust policies and systems, finance highlighting the important perspective ofworks quietly in the background, contribut- emerging markets and developing economies.ing to economic growth and poverty reduc- It contains a rich array of new financial sectortion. However, impaired by poor sector data that are also publicly available as part ofpolicies, unsound markets, and imprudent our Open Data Agenda.institutions, finance can lay the foundation Sharpening the focus on the central role offor financial crises, destabilizing economies, finance in socioeconomic development andhindering economic growth, and jeopardizing understanding how financial systems can behard-won development gains among the most strengthened are crucial if we are to realizevulnerable. our goal of boosting prosperity and eradi- Fostering sustainable financial develop- cating poverty. The Global Financial Devel-ment and improving the performance of opment Report is an important step in thisfinancial systems depends on numerous insti- process.tutional factors and stakeholders. The policymaker, the regulator, the banker, and the Jim Yong Kimfinancial consumer must all play their part. President The World Bank Group g l o b a l f i n a n c i a l d e v e l o p m e n t R EPO R T 2 0 1 3 xi
PrefaceT he goal of this inaugural Global Finan- ideological views, instead aiming to develop cial Development Report is to contrib- a more nuanced approach to financial sec- ute to the evolving debate on the role tor policy based on a synthesis of new data,of the state in the financial sector, highlighted research, and operational experiences.from the perspective of development. The The report emphasizes that the state has areport is aimed at a broad range of stakehold- crucial role in the financial sector—it needs toers, including governments, international provide strong prudential supervision, ensurefinancial institutions, nongovernmental orga- healthy competition, and enhance financialnizations, think tanks, academics, private sec- infrastructure. Regarding more direct inter-tor participants, donors, and the wider devel- ventions, such as state ownership of banks,opment community. The report offers policy the report presents new evidence that stateadvice based on research and lessons from involvement can help in mitigating adverseoperational work. effects of a crisis. However, the report cau- This marriage of research and operational tions that over longer periods, direct statework was possible thanks to the engagement involvement can have important negativeof a diverse set of experts inside and outside effects on the financial sector and the econ-the World Bank Group. The report reflects omy. Therefore, as crisis conditions recede,inputs from Bank staff in a broad range of the evidence suggests that it is advisable forunits and collaboration with leading research- governments to shift from direct to indirecters on finance and development. Reflecting interventions.the close links between financial develop- Because the financial system is dynamicment and stability, counterparts at the Inter- and conditions are constantly changing, regu-national Monetary Fund have also provided lar updates are essential. Hence, this reportvaluable contributions. should be seen as part of an ongoing project The report benchmarks financial institu- aimed at supporting systematic evaluation,tions and markets around the world, rec- improving data, and fostering broader part-ognizing the diversity of modern financial nerships. Future reports might address finan-systems. In its analysis of the state’s role in cial inclusion, the development of local cur-finance, the report seeks to avoid simplistic, rency capital markets, the financial sector’s g l o b a l f i n a n c i a l d e v e l o p m e n t R EPO R T 2 0 1 3 xiii
xiv r e f a c e p GLOBAL financial DEVELOPMENT REPORT 2013 role in long-term financing, and the state’s and sound financial systems for robust eco- role in financing health care and pensions. nomic performance. We hope that this new series of analytical reports will prove useful to all stakeholders in Mahmoud Mohieldin promoting evidence-based decision making Managing Director The World Bank Group
AcknowledgmentsT he 2013 Global Financial Develop- Christova, Margaret Miller, Leora Klapper, ment Report reflects the efforts of a Shalini Sankaranarayan, Alban Pruthi, and broad and diverse group of experts Thilasoni Benjamin Musuku (chapter 5).both inside and outside the World Bank. The The report was prepared under the over-report was cosponsored by the World Bank’s sight of Janamitra Devan, Vice PresidentFinancial and Private Sector Development (FPD and IFC); Justin Yifu Lin, Chief Econo-Vice Presidency (FPD) and the Development mist and Senior Vice President (DEC); andEconomics Vice Presidency (DEC). It reflects Martin Ravallion, Acting Chief Economistinputs from World Bank Group staff across a and Senior Vice President (DEC). Worldrange of units, including all the regional vice Bank Presidents Robert B. Zoellick and Jimpresidencies, the Poverty Reduction and Eco- Yong Kim and Managing Director Mahmoudnomic Management Network, and External Mohieldin provided overall guidance. TheAffairs, as well as staff of the International authors received invaluable advice from theFinance Corporation (IFC). FPD Council (Aslı Demirgüç-Kunt, Augusto Aslı Demirgüç-Kunt was the director of Lopez-Claros, Gaiv Tata, Gerardo Corro- ˇthis project. Martin Cihák led the core team, chano, Janamitra Devan, Klaus Tilmes, Loicwhich included Cesar Calderón, Martin Chiquier, Marialisa Motta, Pierre Guislain,Kanz, Subika Farazi, and Mauricio Pinzon Sujata Lamba, Tilman Ehrbeck, and TuncLatorre. Other key contributors were Erik Uyanik) as well as the World Bank–Interna-Feyen (chapter 1); Maria Soledad Martínez tional Monetary Fund Financial Sector Liai- ˙Pería (chapters 2, 3, and 4); Inci Ötker-Robe, son Committee.Martín Vázquez Suárez, Miquel Dijkman, Peer reviewers of the report were StijnValeria Salomao Garcia, R. Barry Johnston, Claessens, Augusto de la Torre, Ross Levine,and Nicolas Véron (chapter 2); Thorsten Beck Norman Loayza, Roberto Rocha, and Tuncand Klaus Schaeck (chapter 3); Marcin Piat- Uyanik. Luis Servén also reviewed the con-kowski, Eva Gutierrez, José De Luna Mar- cept note. Comments on individual chapterstinez, Carlos Leonardo Vicente (chapter 4); were also received from Aart Kraay, RossOuarda Merrouche, Miriam Bruhn, Mas- Levine, Roberto Rocha, and Sergio Schmuk-simo Cirasino, Marco Nicoli, Maria Teresa ler (chapter 1); Gerard Caprio, Patrick Hono-Chimienti, Froukelien Wendt, Luchia Marius han, Alain Ize, Ross Levine, and Damodaran g l o b a l f i n a n c i a l d e v e l o p m e n t R EPO R T 2 0 1 3 xv
xvi c k n o w l e d g m e n t s a GLOBAL financial DEVELOPMENT REPORT 2013 Krishnamurti (chapter 2); Franklin Allen, assistance was provided by Hedia Arbi, Gra- Thorsten Beck, Michael Fuchs, and Martha cia Sorensen, and Agnes Yaptenco. Other Martinez Licetti (chapter 3); and Viral Acha- valuable assistance was provided by Benja- rya, Charles Calomiris, Heinz Rudolph, and min Levine and Vin Nie Ong. Sergio Schmukler (chapter 4). Aart Kraay Mauricio Pinzon Latorre and Subika reviewed all chapters for consistency and Farazi were instrumental in compiling and quality multiple times. updating the databases underlying the report. The authors also received valuable sug- In so doing, they benefited from the work of gestions and other contributions at various the current FinStats database team, which stages of the project from Hormoz Aghadey, includes Katie Kibuuka and Diego Sour- Shamshad Akhtar, Deniz Anginer, Mad- rouille, who in turn relied on key efforts from elyn Antoncic, Zsofia Arvai, Steen Byskov, previous FinStats team members, including Kevin Carey, Jeffrey Chelsky, Loic Chiquier, Ed Al-Hussainy, Haocong Ren, and Andrea Gerardo Corrochano, Mariano Cortes, Rob- Coppola. Joanna Nasr, Mariana Carvalho, ert Cull, Stefano Curto, Mansoor Dailami, and Zarina Odinaeva helped with the data Katia D’Hulster, Maya Eden, Tilman Ehr- on the credit information systems used in beck, Matthias Feldmann, Aurora Ferrari, chapter 5. Manuela Ferro, Jose Antonio Garcia, Egbert The work on the 2011 update of the Gerken, Swati Ghosh, David Gould, Neil Banking Regulation and Supervision Survey Gregory, Mario Guadamillas, Pankaj Gupta, started with the collaboration of Maria Sole- Mary Hallward-Driemeier, Darrin Hartzler, dad Martínez Pería, Roberto Rocha, Con- Richard Hinz, Mustafa Zakir Hussain, Sujit stantinos Stephanou, and Haocong Ren. The Kapadia, Isfandyar Khan, Thomas Kirch- survey benefited from contributions from meier, Kalpana Kochhar, Rachel Kyte, Jeffrey numerous banking regulation experts in the Lewis, Samuel Maimbo, Mariem Malouche, World Bank, including David Scott, Krish- Cledan Mandri-Perrott, Claire Louise namurti Damodaran, Katia D’Hulster, Ced- McGuire, Martin Melecky, Dino Merotto, ric Mousset, and others outside the World Sebastian Molineus, Fredesvinda Montes, Bank, in particular, Michael Andrews and Cedric Mousset, Nataliya Mylenko, Makoto Jan-Willem van der Vossen. Insights and Nakagawa, Harish Natarajan, Aloysius Uche encouragement from Gerard Caprio, Ross Ordu, Jorge Patiño, Jean Pesme, Tigran Pog- Levine, and James Barth, who organized hosyan, John Pollner, Daniel Pulido, Hao- the previous rounds of the survey, are grate- cong Ren, Ivan Rossignol, Heinz Rudolph, fully acknowledged. PKF (UK) and Auxilium Consolate Rusagara, Andre Ryba, David helped with compiling and following up on Scott, James Seward, Sophie Sirtaine, Con- the survey responses. Amin Mohseni pro- stantinos Stephanou, Mark Stone, Vijay Tata, vided excellent research assistance on the Marilou Uy, S. Kal Wajid, Juan Zalduendo, survey. Catiana Garcia-Killroy (FPD), Dilek Laura Zoratto, and participants in seminars Aykut and Eung Ju Kim (both DEC), and and briefings organized at the World Bank. Isabella Reuttner (World Economic Forum) The report would not be possible with- provided helpful consultations on data. Tariq out the production team, including Merrell Khokhar, Neil Fantom, Ibrahim Levent, and Tuck-Primdahl and Nicole Frost, as well as William Prince were instrumental in integrat- Stephen McGroarty, Santiago Pombo, Jose ing the report’s data with the World Bank’s De Buerba, Jane Zhang, Ryan Hahn, Mary Open Data Initiative. Donaldson, and Xenia Zia Morales. Aziz The authors would also like to thank the Gokdemir was the production editor, with many country officials and other experts who Debra Naylor as the graphic designer. Roula participated in the surveys underlying this Yazigi assisted the team with the website report, including the Bank Regulation and and communications. Paul Holtz was the Supervision Survey and the Financial Devel- language editor. Excellent administrative opment Barometer.
GLOBAL financial DEVELOPMENT REPORT 2013 c k n o w l e d g m e n t s xvii a Financial support from State Secretariat Change program and the Research Supportfor Economic Affairs (Switzerland) is grate- Budget provided funding for the underlyingfully acknowledged. The latest update of the research program in DEC. Frank Sader hadBank Regulation and Supervision Survey and a key role in FPD’s fundraising efforts for therelated research was financed with financial Global Financial Development Report.support from the U.K. Department for Inter-national Development. The Knowledge forExternal AdvisersViral Acharya CV Starr Professor of Economics, New York University Stern School of Business; Program Director for Financial Economics, Centre for Economic Policy ResearchFranklin Allen Nippon Life Professor of Finance and Professor of Economics at the Wharton School of the University of PennsylvaniaThorsten Beck Professor of Economics and Chairman of the European Banking Center, Tilburg University, NetherlandsCharles Calomiris Henry Kaufmann Professor of Financial Institutions, Graduate School of Business, Columbia UniversityGerard Caprio William Brough Professor of Economics and Chair, Center for Development Economics, Williams CollegeStijn Claessens Assistant Director, Research Department, International Monetary FundPatrick Honohan Governor, Central Bank of IrelandR. Barry Johnston Former Assistant Director, Monetary and Capital Markets Department, International Monetary FundRoss Levine James and Merryl Tisch Professor of Economics; Director, William R. Rhodes Center for International Economics and Finance, Department of Economics, Brown UniversityMonica Rubiolo Head of Macroeconomic Support, State Secretariat for Economic Affairs, SwitzerlandKlaus Schaeck Professor of Empirical Banking, Bangor UniversityNicolas Véron Senior Fellow, Bruegel Institute; Visiting Fellow, The Peterson Institute for International Economics The report also benefited from suggestions and insights from country officials and otherexperts participating in the Financial Development Barometer and the other surveys and dis-cussions underlying this report. The findings, interpretations, and conclusions expressed in thisreport do not necessarily reflect the views of the advisers or institutions with which they areaffiliated.
xviii c k n o w l e d g m e n t s a GLOBAL financial DEVELOPMENT REPORT 2013 Peer Reviewers Stijn Claessens Assistant Director, Research Department, International Monetary Fund Augusto de la Torre Chief Economist, Latin America and the Caribbean Vice Presidency, World Bank Ross Levine James and Merryl Tisch Professor of Economics; Director, William R. Rhodes Center for International Economics and Finance, Department of Economics, Brown University Norman Loayza Lead Economist and Director, 2014 World Development Report: Risks, Vulnerabilities, and the Crisis, World Bank Roberto Rocha Senior Adviser, Financial and Private Sector Vice Presidency, World Bank Tunc Uyanik Director, Financial Systems Global Practice and East Asia and Pacific Region, Financial and Private Sector Vice Presidency, World Bank
Abbreviations and GlossaryATP/TA after-tax profits to assets e-MID Electronic Market for InterbankBANSEFI Banca de Ahorro Nacional y Deposit Servicios Financieros FIRA Fideicomisos Instituidos enBB Banco do Brasil Relación con la Agricultura,BCB Banco Central do Brasil MexicoBCBS Basel Committee for Banking FIRST Financial Sector Reform and Supervision Strengthening InitiativeBIS Bank for International FOGAPE State-Owned Guarantee Fund Settlements for Small Entepreneurs, ChileBNDES Banco Nacional de FSA Financial Sector Assessment Desenvolvimento Econômico e FSAP Financial Sector Assessment Social (state-owned development Program bank, Brazil) FSB Financial Stability BoardBTP/TA before-tax profits to assets FSSA Financial System StabilityCCP central counterparty AssessmentCEF Caixa Econômica Federal GCC Gulf Cooperation CouncilCoCo contingent capital GDP gross domestic productCPSIPS Core Principles for Systemically GOB government-owned bank Important Payment Systems GTS global trading systemCPSS Committee on Payment and HHI Herfindahl-Hirschman index (of Settlement Systems market concentration)CR5 concentration ratio (share of IDB Inter-American Development the five largest banks in total Bank banking system assets) IFC International FinanceDB development bank CorporationDNS deferred net settlement IFRS International FinancialDTAs deferred tax assets Reporting StandardsEAP East Asia and Pacific IMF International Monetary FundECA Europe and Central Asia IOSCO International Organization ofEMDEs emerging markets and Securities Commissions developing economies IRB international ratings-based g l o b a l f i n a n c i a l d e v e l o p m e n t R EPO R T 2 0 1 3 xix
xx b b r e v i a t i o n s a and glossary GLOBAL financial DEVELOPMENT REPORT 2013 KfW Kreditanstalt für Wiederaufbau, PKO BP PKO Bank Polski Germany PRISM Pakistan Real Time Interbank KOTEC Korean government guarantor Settlement Mechanism LAC Latin America and the PSEFT Payment System and Electronic Caribbean Fund Transfer LIBOR London interbank offered rate PwC Pricewaterhouse Coopers LLP loan loss provisioning RCCP Recommendations for Central M2 M2 measure of money supply Counterparties MENA Middle East and North Africa ROA return on assets MFI microfinance institution RSSS Recommendations for Securities MIC Collateralized Interbank Settlement Systems Market (Italy) RTGS real-time gross settlement MSR mortgage servicing rights RWA risk-weighted assets NAFIN Nacional Financiera, Mexico SAR Special Administrative Region NBFI nonbank financial institution SBP State Bank of Pakistan NBP National Bank of Poland SECO State Secretariat for Economic NI net interest income Affairs, Switzerland NII non-interest income SELIC Sistema Especial de Liquidação NPL nonperforming loan e de Custódia NPS national payment system SIFIs systemically important financial NSFR net stable funding ratio institutions OECD Organisation for Economic SME small and medium enterprise Co-operation and Development SSA Sub-Saharan Africa OLS ordinary least squares STR Sistema de Transferência de OTC over the counter Reservas OV overhead costs TA/A taxes to assets P/E price-to-earnings ratio Glossary of key terms used throughout the report The financial The financial system in a country is defined to include financial insti- system tutions (banks, insurance companies, and other nonbank financial institutions) and financial markets (such as those in stocks, bonds, and financial derivatives). It also includes the financial infrastructure (which includes, for example, credit information–sharing systems and payment and settlement systems). Financial Conceptually, financial development is a process of reducing the costs development of acquiring information, enforcing contracts, and making transac- tions. Empirically, measuring financial development directly is chal- lenging. Instead, the report measures four financial system character- istics (depth, access, efficiency, and stability) for financial institutions and financial markets (“4x2 framework”). The state The state is defined in a broad economic sense, to include not only the country’s government but also autonomous or semiautonomous agen- cies such as a central bank or a financial supervision agency. The roles of the The roles of the state in the financial sector include those of a pro- state moter, owner, regulator, and overseer. The report focuses on areas that were highlighted by the crisis and are of particular relevance for financial development. Country A territorial entity for which statistical data are maintained and pro- vided internationally on a separate and independent basis (not neces- sarily a state as understood by international law and practice).
OverviewO n September 15, 2008, the failure of the U.S. investment banking giantLehman Brothers marked the onset of the larg- Which lessons about the connections between finance and economic development should shape policies in coming decades?est global economic meltdown since the Great On the surface, the main contrast betweenDepression. The aftershocks have severely this global crisis and those in recent decades isaffected the livelihoods of millions of people that developed economies were affected mucharound the world. The crisis triggered policy more strongly and more directly than weresteps and reforms designed to contain the cri- developing economies. But some developedsis and to prevent repetition of these events. financial systems (such as those of Australia, Four years later, with banking woes ongo- Canada, and Singapore) have shown remark-ing in various parts of the world (most nota- able resilience so far, while some developingbly in the euro area), it is a good time to ones have been brought to the brink of col-evaluate these reforms and their likely con- lapse. The bigger point is that the quality oftribution to long-run financial development. a state’s policy for the financial sector mat-The crisis experience is thus an important ters more than the economy’s level of devel-part of the motivation for this inaugural opment. This report reassesses the role of theGlobal Financial Development Report. The state in finance, based on updated data, ongo-crisis has prompted many people to reassess ing research, and World Bank Group experi-various official interventions in financial ences from around the world.systems, from regulation and supervision of Two building blocks underlie the report’sfinancial institutions and markets, to com- view of the role of the state in finance. First,petition policy, to state guarantees and state there are sound economic reasons for theownership of banks, and to enhancements in state to play an active role in financial sys-financial infrastructure. tems. Second, there are practical reasons to But the crisis does not necessarily negate be wary of the state playing too active a rolethe considerable body of evidence on these in financial systems. The tensions inherent intopics accumulated over the past few decades. these two building blocks emphasize the com-It is important to use the crisis experience to plexity of financial policies. Though econom-examine what went wrong and how to fix it. ics identifies the social welfare advantages of g l o b a l f i n a n c i a l d e v e l o p m e n t R EPO R T 2 0 1 3 1
2 v e r v i e w O GLOBAL financial DEVELOPMENT REPORT 2013 certain government interventions, practical Nevertheless, with ample reservations and experience suggests that the state often does cautions, this report teases out broad lessons not intervene successfully. Furthermore, since for policy makers from a variety of experi- economies and the state’s capacity to regu- ences and analyses (see box O.1 for a sum- late differ across countries and over time, mary of the main messages). the appropriate involvement of the state in The state tends to play a major role in the financial system also varies case by case. the modern financial sector, as promoter, BOX O.1 Main Messages of This Report The report’s overall message is cautionary. The global bility. However, research presented in this report financial crisis has given greater credence to the idea suggests that, for the most part, factors such as poor that active state involvement in the financial sector regulatory environment and distorted risk-taking can help maintain economic stability, drive growth, incentives promote instability, rather than competi- and create jobs. There is evidence that some interven- tion itself. With good regulation and supervision, tions may have had an impact, at least in the short bank competition can help improve efficiency and run. But there is also evidence on potential longer- enhance access to financial services, without neces- term negative effects. The evidence also suggests that, sarily undermining systemic stability. Rather than as the crisis subsides, there may be a need to adjust restricting competition, it is necessary to address the role of the state from direct interventions to less distorted competition, improve the flow of informa- direct involvement. This does not mean that the state tion, and strengthen the contractual environment. should withdraw from overseeing finance. To the con- Lending by state-owned banks can play a positive trary, the state has a very important role, especially in role in stabilizing aggregate credit in a downturn, but providing supervision, ensuring healthy competition, it also can lead to resource misallocation and dete- and strengthening financial infrastructure. rioration of the quality of intermediation. The report Incentives are crucial in the financial sector. The presents some evidence that lending by state-owned main challenge of financial sector policies is to better banks tends to be less procyclical and that some align private incentives with public interest without state-owned banks even played a countercyclical role taxing or subsidizing private risk-taking. Design of during the global financial crisis. However, the track public policy needs to strike the right balance—pro- record of state banks in credit allocation remains gen- moting development, yet in a sustainable way. This erally unimpressive, undermining the benefits of using approach leads to challenges and trade-offs. state banks as a countercyclical tool. Policy makers In regulation and supervision, one of the crisis les- can limit the inefficiencies associated with state bank sons is the importance of getting the “basics” right credit by paying special attention to the governance first. That means solid and transparent institutional of these institutions and schemes and ensuring that frameworks to promote financial stability. Specifi- adequate risk management processes are in place. cally, it means strong, timely, and anticipatory super- However, this oversight is challenging, particularly in visory action, complemented with market discipline. weak institutional environments. In many developing economies, that combination of Experience points to a useful role for the state in basic ingredients implies a priority on building up promoting transparency of information and reducing supervisory capacity. Here, less can mean more: less counterparty risk. For example, the state can facili- complex regulations, for instance, can mean more tate the inclusion of a broader set of lenders in credit effective enforcement by supervisors and better moni- reporting systems and promote the provision of high- toring by stakeholders. quality credit information, particularly when there The evidence also suggests that the state needs to are significant monopoly rents that discourage infor- encourage contestability through healthy entry of mation sharing. Also, to reduce the risk of freeze-ups well-capitalized institutions and timely exit of insol- in interbank markets, the state can create the condi- vent ones. The crisis fueled criticisms of “too much tions for the evolution of markets in collateralized competition” in the financial sector, leading to insta- liabilities.
GLOBAL financial DEVELOPMENT REPORT 2013 O v e r v i e w 3owner, regulator, and overseer. Indeed, eco- that pay off, bank owners reap the profits.nomics provides several good motivations But when such gambles fail, the bank mayfor an active role for the state in finance. not bear the full cost. For example, bail-These motivations reflect the effects of “mar- outs of troubled banks spread the cost ofket imperfections,” such as the costs and failed bets broadly among others in societyuncertainties associated with (a) acquiring who had no connection to the original riskyand processing information, (b) writing and investment decision. This potential for cas-enforcing contracts, and (c) conducting trans- cading events can be a reason for the state toactions. These market imperfections often intervene by imposing “speed limits” on riskcreate situations in which the actions of a few taking by banks.people or institutions can adversely influence Third, limitations on the ability of peoplemany other people throughout society. These to process information, and the tendency ofexternalities provide the economic rationale some people to follow the crowd, can moti-for the government to intervene to improve vate governments to take an active role inthe functioning of the financial system. financial markets. For example, when people A few examples demonstrate how market have difficulty fully understanding compleximperfections motivate government action. investments or do not appreciate the possibil-First, when one bank fails, this can cause ity of rare but extreme events, this can leaddepositors and creditors of other banks to investors to make systematic mistakes, whichbecome nervous and start a run on these can jeopardize the stability of the economy,other banks. This “contagion”—whereby the with potentially adverse ramifications forweakness in one bank can cause stress for people who neither make those investmentsotherwise healthy financial institutions—can nor have any influence over those that do.reverberate through the economy, causing Governments can limit the adverse reper-problems for the individuals and firms that cussions of these market failures. For exam-rely on those otherwise healthy institutions. ple, regulation and supervision can limit riskThis is the classic bank run. taking by financial institutions to avoid the A second example stresses the externali- potential externalities associated with finan-ties associated with risk taking, especially cial fragility. Also, authorities can regulatefor large financial institutions. For the sake information disclosure to facilitate soundof this illustration, imagine a busy road with decisions, and even regulate financial prod-cars and trucks. If a car or truck goes faster, it ucts, similar to how governments regulatecan get to its destination sooner, but there is a the sale of food and drugs. Thus, economicschance that it will be involved in a crash. The provides many reasons for an active role oflikelihood of a crash is small but it increases the state in finance.with speed. Crashes involving large vehicles But just because the state can ameliorateare particularly costly to others involved in market imperfections and improve the oper-the crash and very disruptive to traffic in gen- ation of financial systems does not mean thateral. Nobody wants to be involved in a crash, it will. Designing and enforcing appropriateof course. But when deciding on how fast to policy can be tricky. Returning to the previ-go, a car or truck driver may not fully con- ous analogy with speed limits for cars andsider the costs that a crash might have on oth- trucks, having a single speed limit may noters in terms of injuries, damages, time lost in seem very effective, because some vehiclestraffic jams, and so on. The state can play a have better safety features, such as brakingrole, for example by imposing and enforcing systems, and therefore are less likely to endspeed limits, and perhaps imposing stricter up in a crash. If vehicles with better brakesregulation of vehicles that pose bigger risks, were allowed to go faster, they could spendsuch as large trucks. less time on the road, and traffic could ease Similarly, financial institutions often do up. But brake quality is difficult to monitornot bear the full risks of their portfolios. in real time. So, differentiated speed lim-When a large bank makes risky investments its can be difficult to design and enforce,
4 v e r v i e w O GLOBAL financial DEVELOPMENT REPORT 2013 resulting in more speeding and crashes. The objectives, including less altruistic ones, such state could also intervene directly by pro- as helping friends, family, cronies, and politi- viding government-approved drivers for all cal constituents. When this happens, the gov- cars and trucks. That way, the state can have ernment can do serious harm in the financial more control over safety and soundness, but system. These arguments suggest a sober it can become quite expensive for taxpay- wariness concerning the role of the state in ers. Alternatively, the state could build large finance that will vary according to confidence speed bumps on the road, so that there are in the political system’s ability to promote the almost no crashes; however, traffic would public good. slow down to a crawl. Determining the proper role of the state in The analogy underscores that correct- finance is thus as complex as it is important: ing market imperfections is a complicated one size does not fit all when it comes to pol- task, requiring considerable information and icy intervention. In less developed economies, expertise to design, implement, and enforce there may seem to be more scope for the gov- sound policies. State interventions in finance ernment’s involvement in spearheading finan- need to be risk-sensitive, but measuring risk cial development. However, less development properly and enforcing risk-based regulations is often accompanied by a less effective insti- is far from straightforward. The state can try tutional framework, which in turn increases to run parts of the financial system directly, the risk of inappropriate interventions. And but evidence shows that approach to be very the role of the state naturally changes as the costly. And if the state required banks to hold financial system creates new products, some capital as large as their loans, the risk of fail- of which obviate the need for particular poli- ures would be minimal, but financial inter- cies while others motivate new government mediation would grind to a halt since banks interventions. Reflecting this complexity, would not be able to lend. country officials and other financial sector An important complicating factor is that experts often hold opposing views and opin- the same government policies that ameliorate ions on the pros and cons of various state one market imperfection can create other— interventions—a point illustrated by a recent sometimes even more problematic—distor- informal global opinion poll carried out by tions. For example, when the government the Global Financial Development Report insures the liabilities of banks to reduce the team (box O.2). possibility of bank runs, the insured credi- The Global Financial Development tors of the bank may not diligently monitor Report provides new insights on financial the bank and scrutinize its management. development and the role of the state in finan- This can facilitate excessive risk taking by cial systems, building on the experience from banks. The state can try to limit risk tak- the global financial crisis. Varying economic ing by large, interconnected financial insti- and political circumstances across countries tutions. However, such interventions might imply that financial sector policies require reduce the incentives of private shareholders customization: appropriate policies will dif- to exert strong corporate control over these fer across countries and over time. But there institutions, because they think the govern- are common lessons and guidelines. While ment is already doing it. Thus, state interven- recognizing the complexity of the issue and tions can create even more reliance on the the limits of existing knowledge, this report state. contributes new data and analysis to the pol- An even deeper issue is whether the state icy discussion. always has sufficient incentives to correct for market imperfections. Governments do not Benchmarking Financial always use their powers to address market Systems imperfections and promote the public inter- est. Sometimes, government officials use A growing body of evidence shows that the power of the state to achieve different financial institutions and financial markets
GLOBAL financial DEVELOPMENT REPORT 2013 O v e r v i e w 5 BOX O.2 Views from Some of the World Bank Clients As part of its effort to find out more about client firmed various areas of agreement. For example, country views, the Global Financial Development there is a widespread notion that state-owned Report team carried out an informal global poll— financial institutions and government-backed credit the 2011/12 Financial Development Barometer. This guarantees can in principle play a useful role. The poll, which covered country officials and financial poll also shows many respondents seeing potential sector experts from 78 countries (23 developed and benefits in more stringent supervision of new finan- 55 developing), provides interesting insights into cial instruments in light of the crisis. A majority views about financial development and the role of also see a scope for a more active role of the state the state in finance. in promoting technological innovations in financial Despite the crisis experience, 90 percent of the infrastructure. country officials and experts surveyed in the poll Perhaps more interestingly, the poll also indi- perceive that positive effects of finance (in particular cated many key policy areas where the views for and those on economic growth and poverty reduction) against are almost evenly split. This split includes, outweigh its potential negative effects. A majority for example, opinions on the need for stringency of the respondents therefore see that their country’s and greater scope of regulation and supervision, the financial sector needs to grow, especially in terms pros and cons of greater competition in countries’ of financial markets and nonbank financial institu- financial systems, the possible countercyclical role tions, to better serve its clients and expand to new of state-owned financial institutions, and the role of ones. the state in promoting information sharing—all top- As regards the role of the state in the financial ics that are examined in the current Global Finan- sector, the Financial Development Barometer con- cial Development Report. Selected Responses from the 2011/12 Financial Development Barometer Views were split on important aspects of the state’s role . . . Agree? (%) “In view of the global financial crisis, more stringent financial sector regulation and supervision is needed.” 49 “In view of the global financial crisis, there is a need for broadening the scope of financial sector regulation and supervision.” 54 “More financial sector competition would help financial stability in my home country.” 58 “State-owned financial institutions played an effective countercyclical role during the recent global financial crisis.” 48 “Government-backed credit guarantee schemes do play an important role in promoting financial stability.” 64 “The development of collateral registries can be left, fully or mostly, to the private sector.” 42 Note: The Financial Development Barometer is an informal global poll covering country officials and financial sector experts from 78 economies (23 developed and 55 developing). The response rate was 65 percent. Results are percentages of total responses received.exert a powerful influence on economic the banking industry as a proxy for financialdevelopment, poverty alleviation, and the development. However, size is not a measurestability of economies around the world. Yet of quality, efficiency, or stability. Moreover,measuring the functioning of the financial the banking sector is only one componentsystem has important shortcomings. Indeed, of financial systems. This report, along withempirical work has largely—though not the accompanying public database, assemblesexclusively—relied on measures of the size of and improves cross-country data that can be
6 v e r v i e w O GLOBAL financial DEVELOPMENT REPORT 2013 used to benchmark financial systems. Chap- less deep and also somewhat less efficient and ter 1 addresses questions such as: How can to provide less access, their stability has been one empirically describe different charac- comparable to developed-country financial teristics of financial systems? How can one systems. These measures are then used to compare financial systems across countries characterize and compare financial systems and regions and through time? How have across countries and over time, highlight- financial systems been affected by the global ing the multidimensional nature of financial financial crisis, and what are the key recent development. Country-by-country informa- trends? tion on the key financial system characteris- To measure and benchmark financial sys- tics is presented in the Statistical Appendix, tems, the report develops several measures with more data available through the report’s of four characteristics of financial institu- website. tions (banks, insurance companies, and so on) and financial markets (stock markets and Rethinking the Role of bond markets): (a) the size of financial insti- the State in the Financial tutions and markets (financial depth), (b) the Sector degree to which individuals can and do use financial institutions and markets (access), The report addresses the following key pol- (c) the efficiency of financial institutions icy questions: (a) What is the early postcrisis and markets in providing financial services thinking on transforming regulatory prac- (efficiency), and (d) the stability of financial tices around the world? (b) How should gov- institutions and markets (stability). These ernments promote competition in the finan- four characteristics are measured both for cial sector without planting the seeds of the financial institutions and financial markets, next crisis? (c) When do direct government leading to a 4x2 matrix of the characteristics interventions—such as state ownership and of financial systems. A basic comparison (fig- guarantees—help in developing the financial ure O.1) confirms that although developing- sector, and when do they fail? and (d) What economy financial systems tend to be much should states do to support robust financial Figure O.1 Benchmarking Financial Development, 2008–10 a. Financial institutions b. Financial markets Depth Depth 100 100 75 75 50 50 25 25 0 Stability 0 Access Stability Access Developed economies (%) Efficiency Developing economies (%) Efficiency ˇ Source: Calculations based on Cihák, Demirgüç-Kunt, Feyen, and Levine 2012. Note: Average values are shown for 2008–10 with simple (unweighted) averages across country groups. The 0 corresponds to a historical low of the proxy variable, and 100 corresponds to a historical high calculated for all countries over the period 1960–2010. For the explanation of individual proxy variables for financial depth, access, stability, and efficiency, see chapter 1.
GLOBAL financial DEVELOPMENT REPORT 2013 O v e r v i e w 7 BOX O.3 Navigating This Report In addition to this Overview, the report has two Chapter 4 examines direct state interventions, main parts. The first part (chapter 1) introduces particularly the experience with state-owned banks measures of different characteristics of financial sys- during the financial crisis. It reviews existing and tems that are useful in benchmarking financial sys- new research and reexamines the performance of tems around the world. The second part (chapters 2 state-owned banks during crises. A large part of through 5) examines various aspects of the state’s the discussion focuses on state-owned commer- role in finance. cial banks as opposed to state-owned development Chapter 1 describes financial depth, access, effi- banks; nonetheless, the chapter also presents a new ciency, and stability across countries and regions, data set based on a recent survey of development especially in developing economies. Chapter 1 intro- banks. It also examines the role of credit guarantees. duces a major new database, the Global Financial Chapter 5 relates to the role of the state in finan- Development Database, and discusses how subse- cial infrastructure, with a focus on two topics high- quent editions of the report will revisit the analysis lighted by the crisis: (a) information sharing in credit and benchmarking of financial systems with updated markets, and (b) the role of the state in reducing and expanded data. counterparty risk in payments and securities settle- Chapter 2 examines the role of the state as reg- ment systems. ulator and supervisor. It presents results from a The accompanying website (http://www.world recently updated and substantially expanded World bank.org/financialdevelopment) contains a wealth Bank survey of regulation and supervision around of underlying research, additional evidence includ- the world, explores how crisis countries were differ- ing country examples, and an extensive database on ent from noncrisis countries, and tracks changes that financial development, providing users with interac- governments made after the crisis. The chapter also tive access to information on financial systems. The reviews international regulatory and supervisory website is also a place where users participate in an reforms and discusses proposals for further reforms. online version of the Financial Development Barom- Chapter 3 focuses on the role of the state in com- eter, provide feedback on this Global Financial petition policy. After discussing various measures of Development Report, and submit their suggestions competition, and presenting trends across countries for future issues of the report. and over time based on a new worldwide data set, it The report concentrates on banks. There are reviews the evidence on the implications of banking some references to and data on financial markets competition for bank efficiency, access to finance, and nonbank financial institutions (for example, in a and financial stability. The chapter then analyzes the discussion on the regulatory perimeter and on access policy drivers of competition and highlights the role by nonbank institutions to financial infrastructure). of the state in (a) promoting a contestable banking But to keep the report focused, much of the discus- system and (b) enabling a market-friendly informa- sion is devoted to banks. Future issues of the report tional and institutional environment. It also ana- will cover financial markets and nonbank financial lyzes the impact of government actions during crises institutions in more depth. on bank competition.infrastructure? Box O.3 provides an over- factors, including a country’s level of devel-view of the report’s chapters. opment and the government’s capacity. Two How should public policy be designed themes emerge throughout this report.to address these four key questions? The The first relates to direct and indirectissue of concern in this report is how best interventions. During the recent crisis, directto balance the various roles of the state as state interventions have increased, and earlypromoter, owner, regulator, and overseer. evidence reveals that some of these inter-The right balance depends on a number of ventions worked, at least in the short run.
8 v e r v i e w O GLOBAL financial DEVELOPMENT REPORT 2013 However, there is also evidence on potential Overall, there is broad agreement to longer-term negative effects. Therefore, as the address the “basics” first. This means hav- crisis subsides, there may be a need to rebal- ing in place a coherent institutional and legal ance toward less direct state involvement. framework that establishes market discipline The second important theme is the criti- complemented by strong, timely, and antici- cal role that incentives play in the financial patory supervisory action. In many develop- sector. The challenge for the state’s involve- ing economies, this also means that building ment is to better align private incentives with up supervisory capacity needs to be a top public interest, without taxing or subsidizing priority. Among the important lessons of private risk taking. The design of public pol- the global financial crisis are renewed focus icy needs to strike the right balance in order on systemic risk and the need to pay greater to promote sustainable development. This attention to incentives in the design of regula- leads to different challenges and trade-offs in tion and supervision. answering each of the four questions below. Using a new survey of regulation and supervision around the world (figure O.2), chapter 2 confirms that countries where What are the best ways to reform the global financial crisis originated had regulation and supervision? weaker regulation and supervisory practices The global financial crisis that intensified (for example, less stringent definitions of with the collapse of Lehman Brothers in Sep- capital, less stringent provisioning require- tember 2008 presented a major test of the ments, and greater reliance on banks’ own international architecture developed over risk assessment), as well as less scope for many years to safeguard the stability of the market incentives (for example, lower qual- global financial system. Although the causes ity of financial information made publicly of the crisis are still being debated, there is available, more generous deposit insurance agreement that the crisis revealed major coverage). Tracking changes during the cri- shortcomings in market discipline, regula- sis reveals that countries have stepped up tion, and supervision. The financial crisis efforts in the area of macroprudential pol- therefore has reopened important policy icy, as well as on issues such as resolution debates on financial regulation. After the regimes and consumer protection. However, onset of the meltdown, there was much talk it is not clear whether incentives for market about not wasting the crisis, and using it to discipline have improved. Some elements of push through necessary reforms. Indeed, disclosure and quality of information have many reforms have been enacted or are in improved, but deposit insurance coverage has process. Much has been done, but the system increased during the crisis. This increased was tested further by the more recent euro coverage, together with generous support for area crisis, leading to the questions: Are the weak banks, did not improve incentives for reforms adequate and will they be sufficient monitoring. The survey suggests that there is to reduce the likelihood and severity of future further scope for improving disclosures and financial crises? monitoring incentives. Regulation and supervision represent one Despite the progress made on regulatory area in which the role of the state is not in reform, there are still important areas of dis- dispute. The crucial role of the state is widely agreement. Hence, chapter 2 also presents acknowledged and is well established in the a number of reform proposals that call for economic and financial literature. Hence, the greater emphasis on simplicity and transpar- debate is not about whether the state should ency, as well as a focus on incentive-compat- regulate and supervise the financial sector, ible regulations. Importantly, these proposals but about how best to go about ensuring that warn against growing complexity of regula- regulation and supervision support sound tion, which may reduce transparency and financial development. accountability, increase regulatory arbitrage
GLOBAL financial DEVELOPMENT REPORT 2013 O v e r v i e w 9Figure O.2 Selected Features That Distinguish Crisis-Hit Countries Broader capital definition (Is Tier 3 allowed in regulatory capital?) More sophisticated modeling (Is an advanced internal ratings-based approach offered to banks?) Less strict provisioning I (Are minimum levels of specific provisions for loans and advances set by the regulator?) Less strict provisioning II (Is there a regulatory requirement for general provisions on loans and advances?) Less oversight of external auditors (Are external auditors subject to independent oversight by the supervisor?) Lower standards for public data quality (Do laws or regulations require auditors to conduct their audits in accordance with international standards?) 0 20 40 60 80 100 Crisis Non-Crisis ˇSource: Cihák, Demirgüç-Kunt, Martínez Pería, and Mohseni 2012.Note: Percentage of countries that responded “yes” to the question in parentheses. Based on the World Bank’s 2011 Bank Regulation and SupervisionSurvey. “Crisis” countries are defined as those that had a banking crisis between 2007 and 2011, as identified in Laeven and Valencia (2012).opportunities, and significantly strain regu- other risk-mitigating features. However, iflatory resources and capacity. The propos- the state does not have the capacity to moni-als suggest a regulatory approach that is tor and police such complex rules, the likelymore focused on proactively identifying and result is more speeding and more crashes.addressing incentive problems and making Similarly, complex approaches to calculat-regulations incentive-compatible. This can ing capital requirements are not appropriatehelp to end the continuous need to elimi- if there is limited capacity to verify the cal-nate deficiencies and close loopholes that are culations, do robustness checks, and policeinevitably present in ever more complex sets implementation.of regulations. Other proposals address the One of the positive developments triggeredincentives that the regulators face and either by the crisis is much greater debate and com-propose alternative institutional structures or munication among regulators, policy mak-suggest tools to identify incentive issues on an ers, and academics, who are striving to reachongoing basis. the common goal of designing regulations to In implementing supervisory best prac- minimize the occurrence and cost of futuretices, emerging markets and developing econ- crises. The diverse views and multiple reformomies should focus on establishing a basic proposals in this debate (presented in chapterrobust supervisory framework that reflects 2) are likely to inform the regulatory reformlocal financial systems’ characteristics, and process and improve future outcomes.refraining from incorporating unnecessary(and in several cases inapplicable) complex How should the state promoteelements. Referring back to the earlier anal- competition in the financial sector?ogy with speed limits for cars and trucks,it may be appealing to have a complex rule The global financial crisis also reignited thein which each car has its own speed limit, interest of policy makers and academics independing on the quality of its brakes and the impact of bank competition and the role