Financial Sector Development - Measurement of Financial Development

Measurement of Financial Development

A good measurement of financial development is crucial in evaluating the progress of financial sector development and understanding the corresponding impact on economic growth and poverty reduction.

However in practice, it is difficult to measure financial development given the complexity and dimensions it encompasses. Empirical work done so far is usually based on standard quantitative indicators available for a longer time period for a broad range of countries. For instance, ratio of financial institutions’ assets to GDP, ratio of liquid liabilities to GDP, and ratio of deposits to GDP.

However, since the financial sector of a country comprises a variety of financial institutions, markets and products, these measures only serve as a rough estimate and do not fully capture all aspects of financial development.

The World Bank’s Global Financial Development Database (GFDD) developed a comprehensive yet relatively simple conceptual 4x2 framework to measure financial development worldwide. This framework identifies four sets of proxy variables characterizing a well-functioning financial system: financial depth, access, efficiency, and stability. These four dimensions are then broken down for two major components in the financial sector, namely the financial institutions and financial markets:

Financial Institutions Financial Markets
Depth
  • Private Sector Credit to GDP
  • Financial Institutions’ asset to GDP
  • M2 to GDP
  • Deposits to GDP
  • Gross value added of the financial sector to GDP
  • Stock market capitalization and outstanding domestic private debt securities to GDP
  • Private Debt securities to GDP
  • Public Debt Securities to GDP
  • International Debt Securities to GDP
  • Stock Market Capitalization to GDP
  • Stocks traded to GDP
Access
  • Accounts per thousand adults(commercial banks)
  • Branches per 100,000 adults (commercial banks)
  • % of people with a bank account (from user survey)
  • % of firms with line of credit (all firms)
  • % of firms with line of credit (small firms)
  • Percent of market capitalization outside of top 10 largest companies
  • Percent of value traded outside of top 10 traded companies
  • Government bond yields (3 month and 10 years)
  • Ratio of domestic to total debt securities
  • Ratio of private to total debt securities (domestic)
  • Ratio of new corporate bond issues to GDP
Efficiency
  • Net interest margin
  • Lending-deposits spread
  • Non-interest income to total income
  • Overhead costs (% of total assets)
  • Profitability (return on assets, return on equity)
  • Boone indicator (or Herfindahl or H-statistics)
  • Turnover ratio for stock market
  • Price synchronicity (co-movement)
  • Private information trading
  • Price impact
  • Liquidity/transaction costs
  • Quoted bid-ask spread for government bonds
  • Turnover of bonds (private, public) on securities exchange
  • Settlement efficiency
Stability
  • Z-score
  • Capital adequacy ratios
  • Asset quality ratios
  • Liquidity ratios
  • Others (net foreign exchange position to capital etc)
  • Volatility (standard deviation / average) of stock price index, sovereign bond index
  • Skewness of the index (stock price, sovereign bond)
  • Vulnerability to earnings manipulation
  • Price/earnings ratio
  • Duration
  • Ratio of short-term to total bonds (domestic, int’l)
  • Correlation with major bond returns (German, US)


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