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Global Financial Development Report   2013

Global Financial Development Report 2013 is the first in a new World Bank series. It provides a unique contribution to financial
sector policy debates, building on novel data, surveys, research, and wide-ranging country experience, with emphasis on
emerging-market and developing economies.




                                                                                                                                      Development Report
    The global financial crisis has challenged conventional thinking on financial sector policies. Launched on the fourth
anniversary of the Lehman Brothers collapse—a turning point in the crisis—this volume re-examines a basic question: what is




                                                                                                                                         Global Financial
the proper role of the state in financial development? To address the question, this report synthesizes new and existing evidence
on the state’s performance as financial sector regulator, overseer, promoter, and owner. It calls on state agencies to provide
strong regulation and supervision and ensure healthy competition in the sector, and to support financial infrastructure, such as
the quality and availability of credit information. It warns that direct interventions—such as lending by state-owned
banks, 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 Finance
papers, 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




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Global financial development report 2013
Rethinking the
Role of the State in Finance
Global financial development report 2013
Global Financial Development Report 2013




Rethinking the
Role of the State in Finance




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ISBN (paper): 978-0-8213-9503-5
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Contents




Foreword. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  xi

Preface. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  xiii

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv

Abbreviations and Glossary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  xix

Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1 Benchmarking Financial Systems around the World. . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

2  State as Regulator and Supervisor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
   The

3  Role of the State in Promoting Bank Competition . . . . . . . . . . . . . . . . . . . . . . . . . 81
   The

4 Direct State Interventions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

5  Role of the State in Financial Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
   The

Statistical Appendix. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175




	                                                                 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 	v
vi   o n t e n t s
   c                  	                                                                       GLOBAL financial DEVELOPMENT REPORT 2013




                     BOXES
                     O.1	      Main Messages of This Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

                     O.2	      Views from Some of the World Bank Clients. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

                     O.3	      Navigating This Report. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

                     1.1	Selecting the Representative Variables for Individual Characteristics. . . . . . . . . . . . . 24

                     1.2	      To Aggregate or Not. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

                     1.3	      China Case Study: Large Banks and the Need to Diversify to Markets. . . . . . . . . . . 38

                     1.4	      Romania Case Study: Rapid Growth Enabled by Foreign Funding. . . . . . . . . . . . . . 40

                     2.1	      Distorted Incentives: Subprime Crisis and Cross-Border Supervision . . . . . . . . . . . . 50

                     2.2	      What Is in the World Bank’s Bank Regulation and Supervision Survey?. . . . . . . . . . 56

                     2.3	      Reforming Credit Rating Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

                     2.4	      Institutional Structures for Regulation and Supervision. . . . . . . . . . . . . . . . . . . . . . . 64

                     2.5	      Impact of the Basel III Implementation in Developing Economies. . . . . . . . . . . . . . . 67

                     2.6	      Accounting Standards (Viewpoint by Nicolas Véron). . . . . . . . . . . . . . . . . . . . . . . . 73

                     2.7	Incentive Audits (Viewpoint by Martin Čihák, Asli Demirgüç-Kunt, and
                          R. Barry Johnston) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

                     2.8	      Regulatory Discipline and Market Discipline: Opposites or Complements? . . . . . . . 77

                     3.1	      Two Views on the Link between Competition and Stability . . . . . . . . . . . . . . . . . . . 82

                     3.2	      Decomposing Bank Spreads to Make Inferences about Bank Competition. . . . . . . . 84

                     3.3	      Measuring Banking Sector Concentration and Competition. . . . . . . . . . . . . . . . . . . 85

                     3.4	Analyzing Bank Competition Using Disaggregated Business Line Data:
                          Evidence from Brazil. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

                     3.5	      Banking Competition in the Middle East and North Africa . . . . . . . . . . . . . . . . . . . 90

                     3.6	      An Econometric Analysis of Drivers of Bank Competition. . . . . . . . . . . . . . . . . . . . 95

                     3.7	      Consumer Protection and Competition in South Africa. . . . . . . . . . . . . . . . . . . . . . .97

                     4.1	      Intervention Using State-Owned Banks in Brazil. . . . . . . . . . . . . . . . . . . . . . . . . . . 106

                     4.2	      The Recent Global Crisis and Government Bank Lending in Mexico. . . . . . . . . . . 108

                     4.3	State Commercial Banks in Action during the Crisis: The Case of Poland. . . . . . . . 109

                     4.4	Bank Ownership and Credit Growth during the 2008–09 Crisis:
                          Evidence from Eastern Europe and Latin America . . . . . . . . . . . . . . . . . . . . . . . . . 110
GLOBAL financial DEVELOPMENT REPORT 2013	                                                                                    o n t e n t s   vii
                                                                                                                            c




4.5	Macroeconomic Evidence on the Impact of Government Banks on Credit and
     Output Cycles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

4.6	      Two Views on the Role of State-Owned Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . 116

4.7	      Development Banks: What Do We Know? What Do We Need to Know?. . . . . . . . 120

5.1	      Argentina: Using Credit Registry Information for Prudential Supervision. . . . . . . . 138

5.2	Egypt: Removing Regulatory Barriers to the Development of a Private
     Credit Bureau . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140

5.3	      Monopoly Rents, Bank Concentration, and Private Credit Reporting. . . . . . . . . . . 141

5.4	Mexico: State Interventions to Prevent Market Fragmentation and Closed
     User Groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143

5.5	      Morocco: Public Support for the Development of a Private Credit Bureau. . . . . . . 145

5.6	      Reforming Large-Value Payment Systems to Mitigate Systemic Risk. . . . . . . . . . . . 151

5.7	      Italy: Reviving Interbank Money Markets through Collateralized Transactions. . . 156


FIGURES
O.1	      Benchmarking Financial Development, 2008–10. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

O.2	      Selected Features That Distinguish Crisis-Hit Countries. . . . . . . . . . . . . . . . . . . . . . . 9

O.3	      Market Power and Systemic Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

O.4	      Change in Bank Lending Associated with a 1% Increase in GDP Per Capita . . . . . . 12

O.5	      Credit Reporting vs. Banking System Concentration. . . . . . . . . . . . . . . . . . . . . . . . . 14

1.1	      Financial Depth and Income Inequality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

1.2	Socioeconomic Development, Financial Development, and Enabling
     Environment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

1.3	      Correlations between Characteristics in Same Category (example). . . . . . . . . . . . . . 25

1.4	      Correlations among Financial System Characteristics. . . . . . . . . . . . . . . . . . . . . . . . 31

1.5	      Financial System Characteristics, by Income Group, 2010 . . . . . . . . . . . . . . . . . . . . 34

1.6	      The Uneven Nature of Financial Systems (Illustration). . . . . . . . . . . . . . . . . . . . . . . 35

1.7	      Financial Systems: 2008–10 versus 2000–07 (Financial Institutions). . . . . . . . . . . . . 36

1.8	      Financial Systems: 2008–10 versus 2000–07 (Financial Markets). . . . . . . . . . . . . . . 37

B1.3.1	 The Chinese Financial Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

B1.4.1	 Romania’s Financial Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
viii   o n t e n t s
     c                 	                                                                     GLOBAL financial DEVELOPMENT REPORT 2013




                   2.1	      Introduction of Bank Governance Frameworks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

                   2.2	      New Insolvency Frameworks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

                   2.3	      Introduction of Deposit Protection Schemes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

                   2.4	      Financial Stability Reporting and Stress Test Publication, 1995–2011. . . . . . . . . . . .65

                   2.5	      Push to Implement New Basel Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

                   2.6	      Impact of the Move to Basel II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

                   2.7	      Quality of Capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

                   2.8	      Capital Adequacy Ratios: Minimum and Actual. . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

                   B2.5.1	 EMDEs: The Impact of Basel III Capital and Liquidity Requirements. . . . . . . . . . . . 67

                   3.1	      Five Bank Concentration Ratio (CR5): Developed and Developing Economies. . . . . 86

                   3.2	 Five Bank Concentration Ratio (CR5): Developing Regions, Median Values,
                   	1996–2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

                   3.3	      Regulatory Indicators of Market Contestability . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

                   3.4	      Bank Competition: Developed vs. Developing Economies. . . . . . . . . . . . . . . . . . . . . 89

                   3.5	      Bank Competition across Developing Regions, 1996–2007 . . . . . . . . . . . . . . . . . . . 89

                   3.6	      Bank Competition: Developed vs. Developing Economies. . . . . . . . . . . . . . . . . . . . . 91

                   3.7	      Bank Competition across Developing Regions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

                   4.1	      Trends in Government Ownership of Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

                   4.2	      Government Ownership across Developing Regions, 1970–2009. . . . . . . . . . . . . . 104

                   B4.1.1	 Ownership and Credit in Brazil. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106

                   B4.1.2	 BNDES: Sources of Funding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

                   B4.1.3	 Distribution of BNDES Disbursements by Size. . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

                   B4.2.1	 Gross Loan Portfolio Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108

                   B4.2.2	 Partial Credit Guarantees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108

                   B4.3.1	 PKO BP’s Loan Share, 2008–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

                   B4.3.2	 Nonperforming Loans for PKO BP, 2008–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

                   B4.4.1	
                          Growth of Gross Loans and Bank Ownership in Latin America and
                          Eastern Europe, 2004–2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

                   B4.5.1	 Evolution of Real GDP and Credit around Recoveries in Economic Activity . . . . . 114

                   B4.5.2	 Evolution of Real GDP and Credit around Recoveries in Economic Activity . . . . . 115
GLOBAL financial DEVELOPMENT REPORT 2013	                                                                                  o n t e n t s   ix
                                                                                                                          c




5.1	      The Development of Credit Reporting Institutions, 1980–2012. . . . . . . . . . . . . . . 134

5.2	      Prevalence of Credit Reporting by Income Group. . . . . . . . . . . . . . . . . . . . . . . . . . 135

5.3	      The Reach of Credit Reporting: Who Contributes Information?. . . . . . . . . . . . . . . 135

5.4	      The Depth of Credit Reporting: What Information Is Collected? . . . . . . . . . . . . . . 136

5.5	      GDP Turnover of Large-Value Payment Systems by Region, 2009 . . . . . . . . . . . . . 149

5.6	      The Adoption of Real-Time Gross Settlement Systems over Time, 1990–2010. . . . 150

5.7	Sources of Intraday Liquidity for Participants of
     Real-Time Gross Settlement Systems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

5.8	
    Interbank Money Market Rates in the United States
    and United Kingdom. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154

5.9	      Interbank Money Market Rates in Emerging Markets . . . . . . . . . . . . . . . . . . . . . . 155

B5.7.1	
       Interbank Rates in the Italian Collateralized Money Market (MIC) and Other
       Segments of the Euro Money Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156

B5.7.2	 Outstanding Volumes and Average Maturity Trend on the MIC. . . . . . . . . . . . . . . 157


MAPS

B2.2.1	 Coverage of the 2011 Bank Regulation and Supervision Survey. . . . . . . . . . . . . . . . 56

5.1	      Credit Information Systems around the World . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

A.1	      Depth—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167

A.2	      Access—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

A.3	      Efficiency—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

A.4	      Stability—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

A.5	      Depth—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

A.6	      Access—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172

A.7	      Efficiency—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

A.8	      Stability—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174


TABLES

1.1	Stylized 4x2 Matrix of Financial System Characteristics (with examples of
     candidate variables in each category). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

1.2	      Financial System Characteristics: Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
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
Foreword




T
       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 and
tems and their role in supporting economic       supervision, corporate governance, and finan-
development, ensuring stability, and reducing    cial infrastructure—ensure that the financial
poverty.                                         sector contributes meaningfully to strong and
   Finance matters, both when it functions       inclusive growth. This report seeks to advance
well and when it functions poorly. Sup-          the global financial sector policy debate,
ported by robust policies and systems, finance   highlighting the important perspective of
works 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 sector
tion. However, impaired by poor sector           data that are also publicly available as part of
policies, unsound markets, and imprudent         our Open Data Agenda.
institutions, finance can lay the foundation         Sharpening the focus on the central role of
for financial crises, destabilizing economies,   finance in socioeconomic development and
hindering economic growth, and jeopardizing      understanding how financial systems can be
hard-won development gains among the most        strengthened are crucial if we are to realize
vulnerable.                                      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 this
financial systems depends on numerous insti-     process.
tutional factors and stakeholders. The policy
maker, the regulator, the banker, and the                                        Jim Yong Kim
financial 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
Global financial development report 2013
Preface




T
       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 a
report is aimed at a broad range of stakehold-      crucial role in the financial sector—it needs to
ers, including governments, international           provide strong prudential supervision, ensure
financial institutions, nongovernmental orga-       healthy competition, and enhance financial
nizations, 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 state
advice based on research and lessons from           involvement can help in mitigating adverse
operational work.                                   effects of a crisis. However, the report cau-
   This marriage of research and operational        tions that over longer periods, direct state
work was possible thanks to the engagement          involvement can have important negative
of 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 for
units and collaboration with leading research-      governments to shift from direct to indirect
ers on finance and development. Reflecting          interventions.
the close links between financial develop-             Because the financial system is dynamic
ment and stability, counterparts at the Inter-      and conditions are constantly changing, regu-
national Monetary Fund have also provided           lar updates are essential. Hence, this report
valuable 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
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                    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
Acknowledgments




T
       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 President
Financial and Private Sector Development          (FPD and IFC); Justin Yifu Lin, Chief Econo-
Vice Presidency (FPD) and the Development         mist and Senior Vice President (DEC); and
Economics Vice Presidency (DEC). It reflects      Martin Ravallion, Acting Chief Economist
inputs from World Bank Group staff across a       and Senior Vice President (DEC). World
range of units, including all the regional vice   Bank Presidents Robert B. Zoellick and Jim
presidencies, the Poverty Reduction and Eco-      Yong Kim and Managing Director Mahmoud
nomic Management Network, and External            Mohieldin provided overall guidance. The
Affairs, as well as staff of the International    authors received invaluable advice from the
Finance Corporation (IFC).                        FPD Council (Aslı Demirgüç-Kunt, Augusto
   Aslı Demirgüç-Kunt was the director of         Lopez-Claros, Gaiv Tata, Gerardo Corro-
                       ˇ
this project. Martin Cihák led the core team,     chano, Janamitra Devan, Klaus Tilmes, Loic
which included Cesar Calderón, Martin             Chiquier, Marialisa Motta, Pierre Guislain,
Kanz, Subika Farazi, and Mauricio Pinzon          Sujata Lamba, Tilman Ehrbeck, and Tunc
Latorre. 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 Stijn
Valeria Salomao Garcia, R. Barry Johnston,        Claessens, Augusto de la Torre, Ross Levine,
and Nicolas Véron (chapter 2); Thorsten Beck      Norman Loayza, Roberto Rocha, and Tunc
and 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 chapters
tinez, Carlos Leonardo Vicente (chapter 4);       were also received from Aart Kraay, Ross
Ouarda 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
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                   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 Support
for Economic Affairs (Switzerland) is grate-      Budget provided funding for the underlying
fully acknowledged. The latest update of the      research program in DEC. Frank Sader had
Bank Regulation and Supervision Survey and        a key role in FPD’s fundraising efforts for the
related research was financed with financial      Global Financial Development Report.
support from the U.K. Department for Inter-
national Development. The Knowledge for


External Advisers

Viral Acharya          CV Starr Professor of Economics, New York University Stern School
                       of Business; Program Director for Financial Economics, Centre for
                       Economic Policy Research
Franklin Allen         Nippon Life Professor of Finance and Professor of Economics at the
                       Wharton School of the University of Pennsylvania
Thorsten Beck          Professor of Economics and Chairman of the European Banking
                       Center, Tilburg University, Netherlands
Charles Calomiris      Henry Kaufmann Professor of Financial Institutions, Graduate School
                       of Business, Columbia University
Gerard Caprio          William Brough Professor of Economics and Chair, Center for
                       Development Economics, Williams College
Stijn Claessens        Assistant Director, Research Department, International Monetary Fund
Patrick Honohan        Governor, Central Bank of Ireland
R. Barry Johnston      Former Assistant Director, Monetary and Capital Markets
                       Department, International Monetary Fund
Ross Levine            James and Merryl Tisch Professor of Economics; Director, William R.
                       Rhodes Center for International Economics and Finance, Department
                       of Economics, Brown University
Monica Rubiolo         Head of Macroeconomic Support, State Secretariat for Economic
                       Affairs, Switzerland
Klaus Schaeck          Professor of Empirical Banking, Bangor University
Nicolas 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 other
experts participating in the Financial Development Barometer and the other surveys and dis-
cussions underlying this report. The findings, interpretations, and conclusions expressed in this
report do not necessarily reflect the views of the advisers or institutions with which they are
affiliated.
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 Glossary




ATP/TA	  after-tax profits to assets         e-MID	        Electronic Market for Interbank
BANSEFI	 Banca de Ahorro Nacional y                        Deposit
         Servicios Financieros               FIRA	         Fideicomisos Instituidos en
BB	      Banco do Brasil                                   Relación con la Agricultura,
BCB	     Banco Central do Brasil                           Mexico
BCBS	    Basel Committee for Banking         FIRST 	       Financial Sector Reform and
         Supervision                                       Strengthening Initiative
BIS	     Bank for International              FOGAPE	       State-Owned Guarantee Fund
         Settlements                                       for Small Entepreneurs, Chile
BNDES	   Banco Nacional de                   FSA	          Financial Sector Assessment
         Desenvolvimento Econômico e         FSAP	         Financial Sector Assessment
         Social (state-owned development                   Program
         bank, Brazil)                       FSB	          Financial Stability Board
BTP/TA	  before-tax profits to assets        FSSA	         Financial System Stability
CCP	     central counterparty                              Assessment
CEF	     Caixa Econômica Federal             GCC 	         Gulf Cooperation Council
CoCo	    contingent capital                  GDP	          gross domestic product
CPSIPS	  Core Principles for Systemically    GOB	          government-owned bank
         Important Payment Systems           GTS	          global trading system
CPSS	    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 Finance
DB	      development bank                                  Corporation
DNS	     deferred net settlement             IFRS 	        International Financial
DTAs	    deferred tax assets                               Reporting Standards
EAP 	    East Asia and Pacific               IMF 	         International Monetary Fund
ECA 	    Europe and Central Asia             IOSCO 	       International Organization of
EMDEs	   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).
Overview




O        n September 15, 2008, the failure of
         the U.S. investment banking giant
Lehman 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 between
Depression. The aftershocks have severely         this global crisis and those in recent decades is
affected the livelihoods of millions of people    that developed economies were affected much
around the world. The crisis triggered policy     more strongly and more directly than were
steps and reforms designed to contain the cri-    developing economies. But some developed
sis 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 developing
bly 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 of
tribution 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 the
Global 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’s
financial 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 the
ownership 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 role
the considerable body of evidence on these        in financial systems. The tensions inherent in
topics 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

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                    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   3




owner, 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 may
for 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 of
ket imperfections,” such as the costs and            failed bets broadly among others in society
uncertainties associated with (a) acquiring          who had no connection to the original risky
and 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 to
actions. These market imperfections often            intervene by imposing “speed limits” on risk
create situations in which the actions of a few      taking by banks.
people or institutions can adversely influence          Third, limitations on the ability of people
many other people throughout society. These          to process information, and the tendency of
externalities 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 in
the functioning of the financial system.             financial markets. For example, when people
   A few examples demonstrate how market             have difficulty fully understanding complex
imperfections 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 lead
depositors and creditors of other banks to           investors to make systematic mistakes, which
become nervous and start a run on these              can jeopardize the stability of the economy,
other banks. This “contagion”—whereby the            with potentially adverse ramifications for
weakness in one bank can cause stress for            people who neither make those investments
otherwise 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 risk
This 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 regulate
for large financial institutions. For the sake       information disclosure to facilitate sound
of 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 regulate
can get to its destination sooner, but there is a    the sale of food and drugs. Thus, economics
chance that it will be involved in a crash. The      provides many reasons for an active role of
likelihood of a crash is small but it increases      the state in finance.
with speed. Crashes involving large vehicles            But just because the state can ameliorate
are 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 that
eral. Nobody wants to be involved in a crash,        it will. Designing and enforcing appropriate
of 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 and
sider the costs that a crash might have on oth-      trucks, having a single speed limit may not
ers in terms of injuries, damages, time lost in      seem very effective, because some vehicles
traffic jams, and so on. The state can play a        have better safety features, such as braking
role, for example by imposing and enforcing          systems, and therefore are less likely to end
speed limits, and perhaps imposing stricter          up in a crash. If vehicles with better brakes
regulation of vehicles that pose bigger risks,       were allowed to go faster, they could spend
such as large trucks.                                less time on the road, and traffic could ease
   Similarly, financial institutions often do        up. But brake quality is difficult to monitor
not 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 financial
development, poverty alleviation, and the                development. However, size is not a measure
stability of economies around the world. Yet             of quality, efficiency, or stability. Moreover,
measuring the functioning of the financial               the banking sector is only one component
system has important shortcomings. Indeed,               of financial systems. This report, along with
empirical work has largely—though not                    the accompanying public database, assembles
exclusively—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 indirect
issue of concern in this report is how best            interventions. During the recent crisis, direct
to balance the various roles of the state as           state interventions have increased, and early
promoter, 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   9




Figure 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

        ˇ
Source: 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 Supervision
Survey. “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, if
latory 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 likely
more 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 appropriate
help 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 police
inevitably present in ever more complex sets                                    implementation.
of regulations. Other proposals address the                                         One of the positive developments triggered
incentives 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 reach
ongoing basis.                                                                  the common goal of designing regulations to
   In implementing supervisory best prac-                                       minimize the occurrence and cost of future
tices, emerging markets and developing econ-                                    crises. The diverse views and multiple reform
omies should focus on establishing a basic                                      proposals in this debate (presented in chapter
robust supervisory framework that reflects                                      2) are likely to inform the regulatory reform
local financial systems’ characteristics, and                                   process and improve future outcomes.
refraining from incorporating unnecessary
(and in several cases inapplicable) complex
                                                                                How should the state promote
elements. 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 the
in which each car has its own speed limit,                                      interest of policy makers and academics in
depending on the quality of its brakes and                                      the impact of bank competition and the role
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Global financial development report 2013

  • 1. Global Financial Development Report 2013 Global Financial Development Report 2013 is the first in a new World Bank series. It provides a unique contribution to financial sector policy debates, building on novel data, surveys, research, and wide-ranging country experience, with emphasis on emerging-market and developing economies. Development Report The global financial crisis has challenged conventional thinking on financial sector policies. Launched on the fourth anniversary of the Lehman Brothers collapse—a turning point in the crisis—this volume re-examines a basic question: what is Global Financial the proper role of the state in financial development? To address the question, this report synthesizes new and existing evidence on the state’s performance as financial sector regulator, overseer, promoter, and owner. It calls on state agencies to provide strong regulation and supervision and ensure healthy competition in the sector, and to support financial infrastructure, such as the quality and availability of credit information. It warns that direct interventions—such as lending by state-owned banks, 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 Finance papers, 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
  • 3. Rethinking the Role of the State in Finance
  • 5. Global Financial Development Report 2013 Rethinking the Role of the State in Finance Washington, D.C.
  • 6. © 2012 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 15 14 13 12 This work is a product of the staff of The World Bank with external contributions. Note that The World Bank does not necessarily own each component of the content included in the work. The World Bank therefore does not warrant that the use of the content contained in the work will not infringe on the rights of third parties. The risk of claims resulting from such infringement rests solely with you. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Nothing herein shall constitute or be considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. Rights and Permissions This work is available under the Creative Commons Attribution 3.0 Unported license (CC BY 3.0) http://creativecommons.org/licenses/by/3.0. Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and adapt this work, including for commercial purposes, under the following conditions: Attribution—Please cite the work as follows: World Bank. 2012. Global Financial Development Report 2013: Rethinking the Role of the State in Finance. Washington, DC: World Bank. doi:10.1596/978- 0-8213-9503-5. License: Creative Commons Attribution CC BY 3.0 Translations—If you create a translation of this work, please add the following disclaimer along with the attribution: This translation was not created by The World Bank and should not be considered an official World Bank translation. The World Bank shall not be liable for any content or error in this translation. All queries on rights and licenses should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank .org. ISBN (paper): 978-0-8213-9503-5 ISBN (electronic): 978-0-8213-9504-2 doi: 10.1596/978-0-8213-9503-5 ISSN: 2304-957X Cover photos: Shutterstock Cover design: Naylor Design
  • 7. Contents Foreword. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Preface. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv Abbreviations and Glossary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xix Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 Benchmarking Financial Systems around the World. . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 2  State as Regulator and Supervisor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 The 3  Role of the State in Promoting Bank Competition . . . . . . . . . . . . . . . . . . . . . . . . . 81 The 4 Direct State Interventions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 5  Role of the State in Financial Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 The Statistical Appendix. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 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 v
  • 8. vi   o n t e n t s c GLOBAL financial DEVELOPMENT REPORT 2013 BOXES O.1 Main Messages of This Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 O.2 Views from Some of the World Bank Clients. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 O.3 Navigating This Report. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 1.1 Selecting the Representative Variables for Individual Characteristics. . . . . . . . . . . . . 24 1.2 To Aggregate or Not. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 1.3 China Case Study: Large Banks and the Need to Diversify to Markets. . . . . . . . . . . 38 1.4 Romania Case Study: Rapid Growth Enabled by Foreign Funding. . . . . . . . . . . . . . 40 2.1 Distorted Incentives: Subprime Crisis and Cross-Border Supervision . . . . . . . . . . . . 50 2.2 What Is in the World Bank’s Bank Regulation and Supervision Survey?. . . . . . . . . . 56 2.3 Reforming Credit Rating Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 2.4 Institutional Structures for Regulation and Supervision. . . . . . . . . . . . . . . . . . . . . . . 64 2.5 Impact of the Basel III Implementation in Developing Economies. . . . . . . . . . . . . . . 67 2.6 Accounting Standards (Viewpoint by Nicolas Véron). . . . . . . . . . . . . . . . . . . . . . . . 73 2.7 Incentive Audits (Viewpoint by Martin Čihák, Asli Demirgüç-Kunt, and R. Barry Johnston) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 2.8 Regulatory Discipline and Market Discipline: Opposites or Complements? . . . . . . . 77 3.1 Two Views on the Link between Competition and Stability . . . . . . . . . . . . . . . . . . . 82 3.2 Decomposing Bank Spreads to Make Inferences about Bank Competition. . . . . . . . 84 3.3 Measuring Banking Sector Concentration and Competition. . . . . . . . . . . . . . . . . . . 85 3.4 Analyzing Bank Competition Using Disaggregated Business Line Data: Evidence from Brazil. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 3.5 Banking Competition in the Middle East and North Africa . . . . . . . . . . . . . . . . . . . 90 3.6 An Econometric Analysis of Drivers of Bank Competition. . . . . . . . . . . . . . . . . . . . 95 3.7 Consumer Protection and Competition in South Africa. . . . . . . . . . . . . . . . . . . . . . .97 4.1 Intervention Using State-Owned Banks in Brazil. . . . . . . . . . . . . . . . . . . . . . . . . . . 106 4.2 The Recent Global Crisis and Government Bank Lending in Mexico. . . . . . . . . . . 108 4.3 State Commercial Banks in Action during the Crisis: The Case of Poland. . . . . . . . 109 4.4 Bank Ownership and Credit Growth during the 2008–09 Crisis: Evidence from Eastern Europe and Latin America . . . . . . . . . . . . . . . . . . . . . . . . . 110
  • 9. GLOBAL financial DEVELOPMENT REPORT 2013    o n t e n t s   vii c 4.5 Macroeconomic Evidence on the Impact of Government Banks on Credit and Output Cycles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 4.6 Two Views on the Role of State-Owned Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 4.7 Development Banks: What Do We Know? What Do We Need to Know?. . . . . . . . 120 5.1 Argentina: Using Credit Registry Information for Prudential Supervision. . . . . . . . 138 5.2 Egypt: Removing Regulatory Barriers to the Development of a Private Credit Bureau . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 5.3 Monopoly Rents, Bank Concentration, and Private Credit Reporting. . . . . . . . . . . 141 5.4 Mexico: State Interventions to Prevent Market Fragmentation and Closed User Groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 5.5 Morocco: Public Support for the Development of a Private Credit Bureau. . . . . . . 145 5.6 Reforming Large-Value Payment Systems to Mitigate Systemic Risk. . . . . . . . . . . . 151 5.7 Italy: Reviving Interbank Money Markets through Collateralized Transactions. . . 156 FIGURES O.1 Benchmarking Financial Development, 2008–10. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 O.2 Selected Features That Distinguish Crisis-Hit Countries. . . . . . . . . . . . . . . . . . . . . . . 9 O.3 Market Power and Systemic Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 O.4 Change in Bank Lending Associated with a 1% Increase in GDP Per Capita . . . . . . 12 O.5 Credit Reporting vs. Banking System Concentration. . . . . . . . . . . . . . . . . . . . . . . . . 14 1.1 Financial Depth and Income Inequality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 1.2 Socioeconomic Development, Financial Development, and Enabling Environment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 1.3 Correlations between Characteristics in Same Category (example). . . . . . . . . . . . . . 25 1.4 Correlations among Financial System Characteristics. . . . . . . . . . . . . . . . . . . . . . . . 31 1.5 Financial System Characteristics, by Income Group, 2010 . . . . . . . . . . . . . . . . . . . . 34 1.6 The Uneven Nature of Financial Systems (Illustration). . . . . . . . . . . . . . . . . . . . . . . 35 1.7 Financial Systems: 2008–10 versus 2000–07 (Financial Institutions). . . . . . . . . . . . . 36 1.8 Financial Systems: 2008–10 versus 2000–07 (Financial Markets). . . . . . . . . . . . . . . 37 B1.3.1 The Chinese Financial Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 B1.4.1 Romania’s Financial Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
  • 10. viii   o n t e n t s c GLOBAL financial DEVELOPMENT REPORT 2013 2.1 Introduction of Bank Governance Frameworks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 2.2 New Insolvency Frameworks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 2.3 Introduction of Deposit Protection Schemes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 2.4 Financial Stability Reporting and Stress Test Publication, 1995–2011. . . . . . . . . . . .65 2.5 Push to Implement New Basel Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 2.6 Impact of the Move to Basel II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 2.7 Quality of Capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 2.8 Capital Adequacy Ratios: Minimum and Actual. . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 B2.5.1 EMDEs: The Impact of Basel III Capital and Liquidity Requirements. . . . . . . . . . . . 67 3.1 Five Bank Concentration Ratio (CR5): Developed and Developing Economies. . . . . 86 3.2 Five Bank Concentration Ratio (CR5): Developing Regions, Median Values, 1996–2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 3.3 Regulatory Indicators of Market Contestability . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 3.4 Bank Competition: Developed vs. Developing Economies. . . . . . . . . . . . . . . . . . . . . 89 3.5 Bank Competition across Developing Regions, 1996–2007 . . . . . . . . . . . . . . . . . . . 89 3.6 Bank Competition: Developed vs. Developing Economies. . . . . . . . . . . . . . . . . . . . . 91 3.7 Bank Competition across Developing Regions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 4.1 Trends in Government Ownership of Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 4.2 Government Ownership across Developing Regions, 1970–2009. . . . . . . . . . . . . . 104 B4.1.1 Ownership and Credit in Brazil. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 B4.1.2 BNDES: Sources of Funding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 B4.1.3 Distribution of BNDES Disbursements by Size. . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 B4.2.1 Gross Loan Portfolio Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 B4.2.2 Partial Credit Guarantees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 B4.3.1 PKO BP’s Loan Share, 2008–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 B4.3.2 Nonperforming Loans for PKO BP, 2008–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 B4.4.1 Growth of Gross Loans and Bank Ownership in Latin America and Eastern Europe, 2004–2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 B4.5.1 Evolution of Real GDP and Credit around Recoveries in Economic Activity . . . . . 114 B4.5.2 Evolution of Real GDP and Credit around Recoveries in Economic Activity . . . . . 115
  • 11. GLOBAL financial DEVELOPMENT REPORT 2013    o n t e n t s   ix c 5.1 The Development of Credit Reporting Institutions, 1980–2012. . . . . . . . . . . . . . . 134 5.2 Prevalence of Credit Reporting by Income Group. . . . . . . . . . . . . . . . . . . . . . . . . . 135 5.3 The Reach of Credit Reporting: Who Contributes Information?. . . . . . . . . . . . . . . 135 5.4 The Depth of Credit Reporting: What Information Is Collected? . . . . . . . . . . . . . . 136 5.5 GDP Turnover of Large-Value Payment Systems by Region, 2009 . . . . . . . . . . . . . 149 5.6 The Adoption of Real-Time Gross Settlement Systems over Time, 1990–2010. . . . 150 5.7 Sources of Intraday Liquidity for Participants of Real-Time Gross Settlement Systems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153 5.8 Interbank Money Market Rates in the United States and United Kingdom. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154 5.9 Interbank Money Market Rates in Emerging Markets . . . . . . . . . . . . . . . . . . . . . . 155 B5.7.1 Interbank Rates in the Italian Collateralized Money Market (MIC) and Other Segments of the Euro Money Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156 B5.7.2 Outstanding Volumes and Average Maturity Trend on the MIC. . . . . . . . . . . . . . . 157 MAPS B2.2.1 Coverage of the 2011 Bank Regulation and Supervision Survey. . . . . . . . . . . . . . . . 56 5.1 Credit Information Systems around the World . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 A.1 Depth—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 A.2 Access—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 A.3 Efficiency—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169 A.4 Stability—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170 A.5 Depth—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171 A.6 Access—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 A.7 Efficiency—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 A.8 Stability—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174 TABLES 1.1 Stylized 4x2 Matrix of Financial System Characteristics (with examples of candidate variables in each category). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 1.2 Financial System Characteristics: Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
  • 12. 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
  • 13. Foreword T 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 and tems and their role in supporting economic supervision, corporate governance, and finan- development, ensuring stability, and reducing cial infrastructure—ensure that the financial poverty. sector contributes meaningfully to strong and Finance matters, both when it functions inclusive growth. This report seeks to advance well and when it functions poorly. Sup- the global financial sector policy debate, ported by robust policies and systems, finance highlighting the important perspective of works 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 sector tion. However, impaired by poor sector data that are also publicly available as part of policies, unsound markets, and imprudent our Open Data Agenda. institutions, finance can lay the foundation Sharpening the focus on the central role of for financial crises, destabilizing economies, finance in socioeconomic development and hindering economic growth, and jeopardizing understanding how financial systems can be hard-won development gains among the most strengthened are crucial if we are to realize vulnerable. 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 this financial systems depends on numerous insti- process. tutional factors and stakeholders. The policy maker, the regulator, the banker, and the Jim Yong Kim financial 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
  • 15. Preface T 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 a report is aimed at a broad range of stakehold- crucial role in the financial sector—it needs to ers, including governments, international provide strong prudential supervision, ensure financial institutions, nongovernmental orga- healthy competition, and enhance financial nizations, 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 state advice based on research and lessons from involvement can help in mitigating adverse operational work. effects of a crisis. However, the report cau- This marriage of research and operational tions that over longer periods, direct state work was possible thanks to the engagement involvement can have important negative of 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 for units and collaboration with leading research- governments to shift from direct to indirect ers on finance and development. Reflecting interventions. the close links between financial develop- Because the financial system is dynamic ment and stability, counterparts at the Inter- and conditions are constantly changing, regu- national Monetary Fund have also provided lar updates are essential. Hence, this report valuable 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
  • 16. 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
  • 17. Acknowledgments T 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 President Financial and Private Sector Development (FPD and IFC); Justin Yifu Lin, Chief Econo- Vice Presidency (FPD) and the Development mist and Senior Vice President (DEC); and Economics Vice Presidency (DEC). It reflects Martin Ravallion, Acting Chief Economist inputs from World Bank Group staff across a and Senior Vice President (DEC). World range of units, including all the regional vice Bank Presidents Robert B. Zoellick and Jim presidencies, the Poverty Reduction and Eco- Yong Kim and Managing Director Mahmoud nomic Management Network, and External Mohieldin provided overall guidance. The Affairs, as well as staff of the International authors received invaluable advice from the Finance Corporation (IFC). FPD Council (Aslı Demirgüç-Kunt, Augusto Aslı Demirgüç-Kunt was the director of Lopez-Claros, Gaiv Tata, Gerardo Corro- ˇ this project. Martin Cihák led the core team, chano, Janamitra Devan, Klaus Tilmes, Loic which included Cesar Calderón, Martin Chiquier, Marialisa Motta, Pierre Guislain, Kanz, Subika Farazi, and Mauricio Pinzon Sujata Lamba, Tilman Ehrbeck, and Tunc Latorre. 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 Stijn Valeria Salomao Garcia, R. Barry Johnston, Claessens, Augusto de la Torre, Ross Levine, and Nicolas Véron (chapter 2); Thorsten Beck Norman Loayza, Roberto Rocha, and Tunc and 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 chapters tinez, Carlos Leonardo Vicente (chapter 4); were also received from Aart Kraay, Ross Ouarda 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
  • 18. 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.
  • 19. 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 Support for Economic Affairs (Switzerland) is grate- Budget provided funding for the underlying fully acknowledged. The latest update of the research program in DEC. Frank Sader had Bank Regulation and Supervision Survey and a key role in FPD’s fundraising efforts for the related research was financed with financial Global Financial Development Report. support from the U.K. Department for Inter- national Development. The Knowledge for External Advisers Viral Acharya CV Starr Professor of Economics, New York University Stern School of Business; Program Director for Financial Economics, Centre for Economic Policy Research Franklin Allen Nippon Life Professor of Finance and Professor of Economics at the Wharton School of the University of Pennsylvania Thorsten Beck Professor of Economics and Chairman of the European Banking Center, Tilburg University, Netherlands Charles Calomiris Henry Kaufmann Professor of Financial Institutions, Graduate School of Business, Columbia University Gerard Caprio William Brough Professor of Economics and Chair, Center for Development Economics, Williams College Stijn Claessens Assistant Director, Research Department, International Monetary Fund Patrick Honohan Governor, Central Bank of Ireland R. Barry Johnston Former Assistant Director, Monetary and Capital Markets Department, International Monetary Fund Ross Levine James and Merryl Tisch Professor of Economics; Director, William R. Rhodes Center for International Economics and Finance, Department of Economics, Brown University Monica Rubiolo Head of Macroeconomic Support, State Secretariat for Economic Affairs, Switzerland Klaus Schaeck Professor of Empirical Banking, Bangor University Nicolas 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 other experts participating in the Financial Development Barometer and the other surveys and dis- cussions underlying this report. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the advisers or institutions with which they are affiliated.
  • 20. 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
  • 21. Abbreviations and Glossary ATP/TA after-tax profits to assets e-MID Electronic Market for Interbank BANSEFI Banca de Ahorro Nacional y Deposit Servicios Financieros FIRA Fideicomisos Instituidos en BB Banco do Brasil Relación con la Agricultura, BCB Banco Central do Brasil Mexico BCBS Basel Committee for Banking FIRST Financial Sector Reform and Supervision Strengthening Initiative BIS Bank for International FOGAPE State-Owned Guarantee Fund Settlements for Small Entepreneurs, Chile BNDES Banco Nacional de FSA Financial Sector Assessment Desenvolvimento Econômico e FSAP Financial Sector Assessment Social (state-owned development Program bank, Brazil) FSB Financial Stability Board BTP/TA before-tax profits to assets FSSA Financial System Stability CCP central counterparty Assessment CEF Caixa Econômica Federal GCC Gulf Cooperation Council CoCo contingent capital GDP gross domestic product CPSIPS Core Principles for Systemically GOB government-owned bank Important Payment Systems GTS global trading system CPSS 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 Finance DB development bank Corporation DNS deferred net settlement IFRS International Financial DTAs deferred tax assets Reporting Standards EAP East Asia and Pacific IMF International Monetary Fund ECA Europe and Central Asia IOSCO International Organization of EMDEs 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
  • 22. 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).
  • 23. Overview O n September 15, 2008, the failure of the U.S. investment banking giant Lehman 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 between Depression. The aftershocks have severely this global crisis and those in recent decades is affected the livelihoods of millions of people that developed economies were affected much around the world. The crisis triggered policy more strongly and more directly than were steps and reforms designed to contain the cri- developing economies. But some developed sis 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 developing bly 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 of tribution 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 the Global 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’s financial 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 the ownership 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 role the considerable body of evidence on these in financial systems. The tensions inherent in topics 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
  • 24. 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.
  • 25. GLOBAL financial DEVELOPMENT REPORT 2013 O v e r v i e w   3 owner, 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 may for 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 of ket imperfections,” such as the costs and failed bets broadly among others in society uncertainties associated with (a) acquiring who had no connection to the original risky and 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 to actions. These market imperfections often intervene by imposing “speed limits” on risk create situations in which the actions of a few taking by banks. people or institutions can adversely influence Third, limitations on the ability of people many other people throughout society. These to process information, and the tendency of externalities 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 in the functioning of the financial system. financial markets. For example, when people A few examples demonstrate how market have difficulty fully understanding complex imperfections 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 lead depositors and creditors of other banks to investors to make systematic mistakes, which become nervous and start a run on these can jeopardize the stability of the economy, other banks. This “contagion”—whereby the with potentially adverse ramifications for weakness in one bank can cause stress for people who neither make those investments otherwise 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 risk This 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 regulate for large financial institutions. For the sake information disclosure to facilitate sound of 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 regulate can get to its destination sooner, but there is a the sale of food and drugs. Thus, economics chance that it will be involved in a crash. The provides many reasons for an active role of likelihood of a crash is small but it increases the state in finance. with speed. Crashes involving large vehicles But just because the state can ameliorate are 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 that eral. Nobody wants to be involved in a crash, it will. Designing and enforcing appropriate of 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 and sider the costs that a crash might have on oth- trucks, having a single speed limit may not ers in terms of injuries, damages, time lost in seem very effective, because some vehicles traffic jams, and so on. The state can play a have better safety features, such as braking role, for example by imposing and enforcing systems, and therefore are less likely to end speed limits, and perhaps imposing stricter up in a crash. If vehicles with better brakes regulation of vehicles that pose bigger risks, were allowed to go faster, they could spend such as large trucks. less time on the road, and traffic could ease Similarly, financial institutions often do up. But brake quality is difficult to monitor not 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,
  • 26. 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
  • 27. 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 financial development, poverty alleviation, and the development. However, size is not a measure stability of economies around the world. Yet of quality, efficiency, or stability. Moreover, measuring the functioning of the financial the banking sector is only one component system has important shortcomings. Indeed, of financial systems. This report, along with empirical work has largely—though not the accompanying public database, assembles exclusively—relied on measures of the size of and improves cross-country data that can be
  • 28. 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.
  • 29. 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 indirect issue of concern in this report is how best interventions. During the recent crisis, direct to balance the various roles of the state as state interventions have increased, and early promoter, 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.
  • 30. 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
  • 31. GLOBAL financial DEVELOPMENT REPORT 2013 O v e r v i e w   9 Figure 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 ˇ Source: 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 Supervision Survey. “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, if latory 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 likely more 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 appropriate help 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 police inevitably present in ever more complex sets implementation. of regulations. Other proposals address the One of the positive developments triggered incentives 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 reach ongoing basis. the common goal of designing regulations to In implementing supervisory best prac- minimize the occurrence and cost of future tices, emerging markets and developing econ- crises. The diverse views and multiple reform omies should focus on establishing a basic proposals in this debate (presented in chapter robust supervisory framework that reflects 2) are likely to inform the regulatory reform local financial systems’ characteristics, and process and improve future outcomes. refraining from incorporating unnecessary (and in several cases inapplicable) complex How should the state promote elements. 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 the in which each car has its own speed limit, interest of policy makers and academics in depending on the quality of its brakes and the impact of bank competition and the role