Public Information Notice No. 05/47

Public Information Notice: IMF Executive Board Reviews Experience with the Financial Sector Assessment Program

April 6, 2005

On March 18, 2005, the Executive Board of the International Monetary Fund (IMF) reviewed the experience to date with the Financial Sector Assessment Program (FSAP).¹

Background

The FSAP was introduced in May 1999 by the IMF and the World Bank to strengthen the monitoring of financial systems in the context of the IMF's bilateral surveillance and the World Bank's financial sector development work. The FSAP is designed to help countries enhance their resilience to crises and cross-border contagion, and to foster growth by promoting financial system soundness and financial sector diversity. The last Executive Board review of the program took place in March 2003.

Assessments of financial systems undertaken under the FSAP identify the strengths, risks and vulnerabilities in the financial system, and the two-way linkages between financial sector performance and the macroeconomy; ascertain the financial sector's development needs; and help national authorities to design appropriate policy responses. The comprehensive nature of these assessments requires a wide range of analytical tools and techniques, including financial stability analysis, stress testing and scenario analysis, and assessments of observance and implementation of relevant international financial sector standards, codes and good practices. In implementing the FSAP, IMF and World Bank staff have been drawing on feedback received from previous reviews of the program by the Executive Boards of the IMF and the World Bank, from countries that have already participated in the program, and from various international groups.

In addition to staff, the IMF and the World Bank draw on the knowledge of experts from a range of cooperating central banks, supervisory agencies, standard setting bodies, and other international institutions, in carrying out the assessments. As well as augmenting the pool of expertise already available in the World Bank and the IMF, outside experts provide a valuable element of peer review to the analysis undertaken in the FSAP, particularly as regards the assessments of observance of financial sector standards and codes which are an integral part of the program.

FSAP teams provide country authorities with an FSAP report that presents the team's analysis and findings. The IMF and the World Bank staff then each prepare separate summary reports for their Executive Boards—a Financial System Stability Assessment (FSSA) and a Financial Sector Assessment (FSA), respectively—which focus on the issues arising from the FSAP exercise that are of relevance to each institution's specific mandate and responsibilities. Summary assessments of financial sector standards prepared in the FSAP are also included in the FSSA and are issued as Reports on Observance of Standards and Codes (ROSCs). This diagnostic work is followed up by technical assistance and other forms of support to countries where vulnerabilities and development needs are identified.

Executive Board Assessment

Executive Directors reviewed the experience with the FSAP since the last Board review of the program. They noted that the program remains a cornerstone of financial sector work by the Fund and the Bank in member countries, and commended the staff on its continuing success. They observed that about 120 countries, two-thirds of the membership, have participated or requested participation in the program.

Directors noted that assessments continue to be comprehensive and to highlight a broad range of financial sector vulnerabilities, while heightening awareness of international financial standards in member countries. Greater expertise developed in the assessment process has also improved the quality of Fund and Bank advice with regard to the financial sector. In addition, especially in assessments of underdeveloped financial systems, FSAPs have rightly devoted more effort to explaining why specific markets are missing and broad access to financial services is limited. Directors were pleased that feedback from country authorities underscores the usefulness of the program in diagnosing stability and development issues in financial systems and in charting appropriate policy responses. They also took note of the authorities' suggestions of areas for further improvement, as key input into the ongoing process of strengthening the FSAP.

Joint and Voluntary Nature

Directors discussed the advantages and disadvantages of two key features of the program—its joint Bank-Fund character and voluntary nature. Most Directors agreed that these features should remain unchanged. Directors observed that the FSAP exercise is a good example of effective Fund-Bank collaboration. The joint nature efficiently pools resources from the two institutions, contributes to a broad perspective of financial issues in low- and middle-income countries, and leads to greater consistency in policy advice. Directors agreed that voluntary participation results in greater country ownership, and agreed that the program should remain voluntary. They stressed the importance of maintaining the case-by-case design of FSAPs to make the exercise useful to countries, within limits that preserved the program's integrity.

Streamlining

Directors were pleased to note that the streamlining measures adopted since the last review have been effective. Improved prioritization and streamlining have resulted in assessments that are better tailored to country circumstances. Along with the smaller average size of financial systems undergoing initial assessments in the last two years, this has contributed to lower average costs per FSAP. For the Fund, this has freed up resources for other work in financial sector surveillance such as FSAP updates and participation in Article IV missions, as envisioned in the previous Board review. For the Bank, more emphasis has been placed on development issues. As a result, the balance of resources used in the program has become more equally distributed between the two institutions. While encouraging the staff of the Bank and Fund to keep down the cost of the program, some Directors cautioned against FSAPs that are too narrow, thereby negating the benefits of the comprehensive assessment. Several Directors noted that the increasing share of resources devoted to AML/CFT assessments, while important, could crowd out other important assessments.

FSAP Updates

Directors welcomed the discussion of the size and scope of FSAP updates, especially as the number of these exercises is on the rise and will eventually account for the bulk of the program. They endorsed the definition of the minimum element of an update as comprising an assessment of financial sector developments and progress in implementing earlier FSAP recommendations. An update should contain a financial stability analysis, reassessments of key development and structural issues raised in the initial assessment, and factual updates of key standards and codes. At the same time, Directors agreed that updates can include additional elements if justified by new developments or particular risks. Flexibility would maximize the program's usefulness to country authorities and its contribution to surveillance.

Directors agreed that, given the pace of financial sector development and the need to keep the staff's institutional knowledge current enough for effective financial sector work, an average frequency of FSAP updates of about five years seems reasonable. However, in any particular country, the frequency will depend on financial sector developments, the country's willingness to participate, its systemic importance, resource availability for the program, and its track record in implementing recommendations from the previous FSAP.

Development Issues

Directors welcomed efforts to deepen the treatment of developmental issues in low-income countries. They thought that in-depth fact-finding carried out, generally by Bank staff, before the main assessment or update mission can help identify the priority development issues. Directors said, however, that this should not affect the speed with which the main assessment report is prepared and should avoid being burdensome to the country authorities.

Country Coverage

Directors welcomed the broad country coverage that the program has achieved, especially of systemically-important countries, but noted the wide differences in coverage by region. Many Directors expressed concern that, some five years after the program's inception, several systemically-important countries have still not requested an initial assessment, and encouraged those countries to do so. Most Directors urged the staff to promote the program more actively, focusing on initial assessments in the under-represented regions and on updates in other regions. In this context, most Directors endorsed the proposal to institute annual reporting to the Board on country participation in the FSAP as a way to increase awareness of the program. Some Directors pointed out that some countries that have not yet undertaken FSAPs have opted for self-assessments and reform of their financial systems as an initial step, and considered that such efforts should be welcomed.

Follow-up

Directors welcomed steps being taken by staff to strengthen follow up monitoring of financial systems. They observed that more needs to be done to ensure that issues identified during the FSAP are followed-up through Fund surveillance. Thus, Directors welcomed and encouraged more systematic participation in Article IV consultations by financial sector specialists and more technical support from headquarters. To facilitate this process, Directors also suggested ways for authorities to report to staff on progress achieved. They encouraged staff to continue to strengthen financial sector work, as called for in the recent biennial surveillance review. In this connection, several Directors saw scope for integrating FSAPs more closely with Article IV surveillance, noting the crucial importance of the financial sector for a country's overall macroeconomic stability.

Directors also urged staff to continue to make technical assistance follow-up more systematic. They agreed that to improve country ownership, flexibility is needed in the way this is accomplished. They supported the idea of organizing, in appropriate country cases, follow-up meetings on technical assistance among the authorities, staff, and possibly other donors.

Publication

Directors discussed the publication policy. They noted that about two-thirds of countries have volunteered to publish the Financial Sector Stability Assessments arising out of the FSAP. A range of views was expressed with regard to the suggestion of moving to a policy of presumed publication of the FSSA. A number of Directors agreed that such a move contributes to the effectiveness of the program, not least through building support for reforms, and signals that the benefits of transparency are recognized. Many other Directors, however, noted that a move to presumed publication for the FSSA is not consistent with the voluntary nature of the program. In the absence of a clear consensus by the Board, we will return to this issue at a later time.

Additional Work

Directors encouraged staff to continue research on developmental and stability issues, to better underpin policy advice in the financial sector. Directors saw great potential value in regional financial exercises for regions with substantial cross-border links. They agreed that countries can gain from deepening such linkages while addressing related vulnerabilities, since enhanced trading of financial products can help overcome structural weaknesses and shallow financial systems.

Next Review

Directors noted that further proposals may arise from the upcoming reviews of the program by the Independent Evaluation Office (IEO) and the Bank's Operations Evaluation Department (OED). These studies, together with the Fund's own strategic review, will provide an opportunity to make a more in-depth and critical assessment of the progress so far and the program's overall effectiveness. In this context, Directors agreed that the next review of the FSAP should take place in three years, to allow for the implementation of recommendations from those reviews, and the upcoming Board review of the standards and codes initiative.