5.10 Financial depth and efficiency See Table 5.10 here

Commentary
About the data
Definitions
Data sources

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Households and institutions save and invest in isolation. The role of the financial system is to intermediate between them. Savers accumulate claims on the financial institutions, which pass the funds they obtain this way to the final users. Gradually, as an economy develops, this indirect lending by savers to investors results in greater financial assets relative to GDP. This wealth allows increased saving and investment, enhancing the economy's rate of growth.

The financial system develops with the economy. As more specialized savings and financial institutions emerge, a greater diversity of instruments becomes available, helping to reduce risk for liability holders. And as securities markets mature, savers are able to invest their resources directly in financial assets issued by firms.

No less important than the size and structure of the financial sector is its efficiency, indicated by the margin between the cost of mobilizing liabilities and the earnings on assets. Small margins are crucial for economic growth, since they reduce interest rates and thus the overall cost of investment. Interest rates reflect the responsiveness of financial institutions to competition and price incentives.

Selective credit controls and controls on deposit and lending rates distort financial markets in some countries. In addition, interest rates may reflect the diversion of resources to finance the public sector deficit through direct borrowing from the banking system and statutory reserve requirements. Moreover, in economies where the financial sector is dominated by state-owned banks, credit allocation decisions may be excessively influenced by noncommercial considerations.

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There are several reasons for caution in using the indicators in the table. These indicators are quantitative assessments, but qualitative assessments of policy actions, laws, and regulations are needed in analyzing overall financial conditions. In addition, the accuracy of financial data is dependent on the quality of accounting systems, which are weak in some developing economies. Some of these indicators are highly correlated, particularly the ratios of liquid liabilities, quasi-liquid liabilities, and bank credit to GDP, because changes in liquid and quasi-liquid liabilities flow directly from changes in bank credit. The precise definition of the financial aggregates on which data are presented varies from one economy to another. Monetary data are end-of-year levels.

The ratio of domestic credit provided by the banking sector to GDP is used as a measure of the growth of the banking system because it reflects the extent to which savings are financial. Liquid liabilities include bank deposits of generally less than one year plus currency. The ratio of these assets to GDP indicates the ease with which their owners can use them to buy goods and services without incurring any cost. Quasi-liquid liabilities are long-term deposits and assets, such as certificates of deposit, commercial paper, and bonds, that can be converted into currency or demand deposits but at a cost.

The interest rate spread is a summary measure of the efficiency of the banking system, known as the intermediation margin. This measure may not be reliable to the extent that information about interest rates is inaccurate, banks do not monitor firm managers, or the government intervenes to fix deposit and lending rates. The spread over LIBOR reflects the interest rate differential between a country's lending rate and the London Interbank Offer Rate (ignoring expected changes in the exchange rate). Interest rates are annual averages.

The indicators here do not capture the activities of the informal sector, which remains important, especially in developing economies. Because financial arrangements based on personal contacts inspire more confidence among owners and users of funds, personal credit or credit extended through community-based pooling of assets may be the only source of credit available to small farmers, small businesses, or home-based producers. In economies characterized by financial repression, the rationing of formal credit forces many borrowers and lenders to turn to the informal market.

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• Domestic credit provided by banking sector includes all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net. The banking sector includes monetary authorities and deposit money banks, as well as other banking institutions where data are available (including institutions that do not accept transferable deposits but do incur such liabilities as time and savings deposits). Examples of other banking institutions are savings and mortgage loan institutions and building and loan associations.

• Liquid liabilities are also known as broad money, or M3. They are the sum of currency and deposits in the central bank (M0), plus transferable deposits and electronic currency (M1), plus time and savings deposits, foreign currency transferable deposits, certificates of deposit, and securities repurchase agreements (M2), plus travelers checks, foreign currency time deposits, commercial paper, and shares of mutual funds or market funds held by residents.

• Quasi-liquid liabilities are the M3 money supply less M1.

• Interest rate spread is the interest rate charged by banks on loans to prime customers minus the interest rate paid by commercial or similar banks for demand, time, or savings deposits.

• Spread over LIBOR (London Interbank Offer Rate) is the interest rate charged by banks on loans to prime customers minus LIBOR. LIBOR is the most commonly recognized international interest rate and is quoted in several currencies. The average three-month LIBOR on U.S. dollar deposits is used here.

Data on money and interest rates are collected from central banks and finance ministries and are reported in the print and electronic versions of the International Monetary Fund's International Financial Statistics.

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