The Financial Development Report 2009

ISBN-13: 978-92-95044-27-2

The importance of financial systems as a key factor in economic growth has become

even more pronounced in recent years, yet there is still surprisingly little agreement

about how to define and measure their development. To address this gap, the World

Economic Forum has undertaken an ongoing initiative that aims to provide business

leaders and policymakers with a common framework to identify and discuss the drivers

of the development of global financial systems and markets.

The Financial Development Report 2009, the second edition since its first publication in

2008, measures and analyzes the factors enabling the development of financial systems

in 55 economies. The Report aims to provide a comprehensive means for countries to

benchmark the various aspects of their financial systems and establish priorities for

improvement. It is published annually so that countries can continue to benchmark

themselves and track their progress over time.

The Report presents the rankings of the second Financial Development Index (FDI)

developed by the World Economic Forum in collaboration with the academic community,

multilateral organizations, and business leaders. The FDI assembles a vast amount of

data to create a holistic assessment of the different aspects of complex financial

systems, including the institutional environment, the business environment, financial

stability, banks, capital markets, and overall capital availability and access. Essay

contributions elaborate on specific effects of the current crisis on emerging markets

and on the achievement of the Millennium Development Goals. The Report contains

detailed profiles for the 55 economies covered by the FDI this year. Data used in the

calculation of the Index are fully annotated and clearly presented.

Written in a nontechnical language and style, the Report appeals to a large audience of

policymakers, business leaders, academics, and different organizations of civil society. It

aims to provide policymakers with a balanced perspective as to which aspects of their

countrys financial system are most important and the ability to empirically calibrate this

view relative to other countries. 2009The FinancialDevelopment ReportThe Financial Developm

ent Report2009

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The Financial Development Report 2009

World Economic ForumGeneva, Switzerland

World Economic Forum USA Inc.New York, USA

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The terms country and nation as used in this report do not in all cases refer to a territorial entity that is a state as understoodby international law and practice. The termscover well-defined, geographically self-contained economic areas that may not bestates but for which statistical data are main-tained on a separate and independent basis.

World Economic Forum USA Inc.

Copyright 2009by the World Economic Forum USA Inc.

All rights reserved. No reproduction, copy ortransmission of this publication may be madewithout written permission.

No paragraph of this publication may bereproduced, stored in a retrieval system, ortransmitted, in any form or by any means,electronic, mechanical, photocopying, or oth-erwise without the prior permission of theWorld Economic Forum.

ISBN-10: 92-95044-27-4ISBN-13: 978-92-95044-27-2

This book is printed on paper suitable forrecycling and made from fully managed andsustained forest sources.

A catalogue record for this book is availablefrom the British Library.

A catalogue record for this book is availablefrom the Library of Congress.

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Contents

Contributors v

Academic Advisors vii

Preface ixby Klaus Schwab

Foreword xiby Kevin Steinberg

Executive Summary xiiiby Nouriel Roubini and James Bilodeau

Part 1: Findings from the Financial 1Development Index

1.1 The Financial Development Index: 3Taking Stock of Financial System Strength in a Time of Crisisby Nouriel Roubini and James Bilodeau

1.2 This Time Its Different: Transmission 29of the Global Financial Crisis to Emerging Market Economies and the Domestic and International Policy Responseby Nouriel Roubini and Ayah El Said

1.3 Financial Development, Financial Crises, 37and the Millennium Development Goalsby Erik Feyen

Part 2: Country/Economy Profiles 47How to Read the Country/Economy Profiles ..............................49

List of Countries/Economies........................................................51

Country/Economy Profiles............................................................52

Part 3: Data Tables 273How to Read the Data Tables ...................................................275

Index of Data Tables...................................................................277

Data Tables.................................................................................279

Technical Notes and Sources 351

About the Authors 361

Partner Institutes 363

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vCont

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LEAD ACADEMIC AND CO-AUTHORNouriel RoubiniProfessor of Economics and International Business,

New York University and Chairman, RGE Monitor

EDITOR AND CO-AUTHORJames BilodeauAssociate Director and Head of Emerging Markets Finance

World Economic Forum USA

PROJECT TEAMIbiye HarryProject Associate, World Economic Forum USA

Ayah El SaidEconomist, RGE Monitor

Toopan BagchiProject Manager, World Economic Forum USA (on secondment

from McKinsey & Co.)

PROJECT ADVISORSMargareta Drzeniek HanouzDirector, Senior Economist, World Economic Forum

Thierry GeigerAssociate Director, Economist, Global Leadership Fellow,

World Economic Forum

CONTRIBUTORErik Feyen, The World Bank

STEERING COMMITTEE*Sir David WrightVice-Chairman, Barclays Capital

Yasser El MallawanyChief Executive Officer, EFG-Hermes

Andrew CrockettPresident, JPMorgan Chase International

Peter SandsGroup Chief Executive, Standard Chartered Bank

Kevin SteinbergChief Operating Officer, World Economic Forum USA

OPERATING COMMITTEE*Michael DrexlerHead of Strategy and Planning, Barclays Capital

Nick ODonohoeGlobal Head of Research, JPMorgan Chase

Gerard LyonsChief Economist and Group Head of Research, Standard Chartered

Bank

Andrei SharonovManaging Director, Troika Dialog

Wael ZiadaHead of Research, EFG-Hermes

We would like to thank Dealogic and Thomson Reuters for theirgenerous contribution of data for this Report.

FROM THE WORLD ECONOMIC FORUM

Financial Institutions TeamKevin Steinberg, Chief Operating Officer and Head of the Centre

for Global Industries (New York), World Economic Forum USA

Max von Bismarck, Director and Head of Investors Industry

Giancarlo Bruno, Director and Head of Financial Services Industry

Anuradha Gurung, Associate Director

Trudy Di Pippo, Associate Director

Kerry Wellman, Senior Community Manager

Abel Lee, Senior Community Manager

Lisa Donegan, Community Manager

Tom Watson, Project Manager

Isabella Reuttner, Project Manager

Nadia Guillot, Senior CoordinatorMichal Richardson, Coordinator

Takae Ishizuka, Coordinator

Elisabeth Bremer, Coordinator

Global Competitiveness NetworkJennifer Blanke, Director, Senior Economist, Head of Global

Competitiveness NetworkMargareta Drzeniek Hanouz, Director, Senior EconomistIrene Mia, Director, Senior EconomistThierry Geiger, Associate Director, Economist, Global Leadership

FellowCiara Browne, Associate DirectorPearl Samandari, Community ManagerEva Trujillo Herrera, Research AssistantCarissa Sahli, Coordinator

We thank Hope Steele for her superb editing work and Neil Weinberg for his excellent graphic design and layout.

Contributors

*The Forum is grateful for the support of the Industry Partners who served on the Steering and Operating Committees. Any findings containedin the Report are solely the view of the Reports authors and do not reflect the opinions of the Steering or Operating Committee members.

Employees of the World Economic Forum USA.

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The Forum is grateful for the support of the Academic Advisors who contributed to the Report. Any findings contained in the Report aresolely the views of the Reports authors and do not reflect the opinions of the Academic Advisors.

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Franklin AllenThe Wharton School

Martin BailyBrookings Institution

Thorsten BeckTilburg University

Mario BlejerBanco Hipotecario

Richard CooperHarvard University

Howard DaviesLondon School of Economics

Erik FeyenThe World Bank

Linda GoldbergFederal Reserve Bank of New York

Subir LallInternational Monetary Fund

Ross LevineBrown University

Ashoka ModyInternational Monetary Fund

Sergio SchmuklerThe World Bank

Augusto de la TorreThe World Bank

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ix

Pref

ace

In the time since the first Financial Development Reportwas published, global leaders have mounted an unprece-dented response to a financial crisis, the effects of whichhave rippled across all regions and levels of society.Theurgency of the threat to the global economy and ourcollective prosperity has required pragmatic and at timesinventive responses that transcended the conventions ofrecent history. Now, with the publication of this, thesecond Financial Development Report, as leaders take stockof the efficacy of their actions, thoughts turn to theimplications of this crisis, to the assumptions on whichour global financial system is based, and to the legacy ofthis response.

As with past crises and episodes of dramatic change,decisions made now have the potential to impact gener-ations to come. New models for global governance andcooperation are needed that are commensurate with therealities of increasing financial integration and economicinterdependence.As dialogue and consensus develop onnew models for global financial governance, it is vital tobring a balanced and rich perspective to bear on thesedecisions. It is in this spirit that the World EconomicForum offers this years Financial Development Report as atransparent, analytical tool to help promote richness ofdialogue and comprehensiveness of debate.

It is not only the more visible decisions at the globallevel that matter but also those taken at the regional andlocal levels, which have the potential to build strongerfinancial systems that help extend prosperity to all. TheFinancial Development Report, in providing a depth ofinformation across a number of economies, serves tohighlight some of the variation across individual financialsystems that must be considered in building on existingstrengths and looking for workable solutions to problems.Once the priorities of stabilization have been achieved,reform and development must be undertaken with asensitivity to the requirements, levels of development,and specific circumstances of individual countries.

In the tradition of the Forums multi-stakeholderapproach to global issues, the creation of this Reportinvolved an extended program of outreach and dialoguewith members of the academic community, public fig-ures, representatives of nongovernmental organizations,and business leaders from across the world.This workincluded numerous interviews and collaborative sessionsto discuss the approach to the design of the Index on

which the Report is based. Other complementary publications from the World Economic Forum includeThe Global Competitiveness Report,The Global EnablingTrade Report,The Global Gender Gap Report,The GlobalInformation Technology Report, and The Travel & TourismCompetitiveness Report.

We would like to express our gratitude to the leadacademic on the project, Nouriel Roubini of New YorkUniversity, for his thought leadership in the design ofthe Financial Development Index and contributions tothis Report. We are grateful to our industry partners who served on the project Steering and OperatingCommittees, including Barclays Capital, EFG-Hermes,JP Morgan Chase & Co., Standard Chartered Bank,and Troika Dialog Group.We are appreciative of ouracademic advisors who generously contributed theirtime and ideas in helping shape this Report. We wouldalso like to thank James Bilodeau at the World EconomicForum USA, editor and co-author of the Report, for hisenergy and commitment to the project, as well as theother members of the project team, including IbiyeHarry,Ayah El Said, and Toopan Bagchi.We are gratefulto Margareta Drzeniek Hanouz and Thierry Geiger fortheir guidance as Project Advisors.Appreciation alsogoes to the Global Competitiveness Team, includingJennifer Blanke, Irene Mia, Ciara Browne, PearlSamandari, Eva Trujillo Herrera, and Carissa Sahli.Finally, we would like to thank our network of PartnerInstitutes, without whose enthusiasm and hard work theannual administration of the Executive Opinion Surveyand this Report would not be possible.

PrefaceKLAUS SCHWAB

Executive Chairman, World Economic Forum

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The World Economic Forum is pleased to release TheFinancial Development Report 2009, the second editionsince its inaugural publication last year.The Report rep-resents a key initiative undertaken as part of the ForumsIndustry Partnership Programme for Financial Services.The Programme provides a platform for CEOs and senior executives to engage with their peers and anextended community of academics, leaders from gov-ernment, and experts from civil society to tackle keyissues on the global agenda. Certainly, the ongoingfinancial crisis ranks as one of the most pressing issues to confront the global community in generations.

Implications of the financial crisisThe current crisis has revealed the extent of globalinterconnectedness, exposing an underappreciated set of linkages between players as diverse as homeowners in the United States, asset-backed securities traders inLondon, manufacturing firms in Asia, and agriculturalexporters in Latin America. Now a variety of stakeholdersacross many national and international platforms areinvolved in crafting an effective and lasting response.Financial stability must remain the near-term priority,yet the potential reach and lasting impact of reformposes a breadth of questions that must be considered bythese different stakeholders as well. It is our hope thatthe dimensions captured by the Financial DevelopmentIndex will inform this view and serve as a valuable toolfor those most closely involved in the reform process toaddress both short- and long-term considerations.

For regulators with macroprudential oversight, howdo they ensure that they have adequately addressed ele-ments of systemic risk without undermining the vital rolethat financial development plays as a driver of economicgrowth? Will proposed solutions adversely impact thedevelopment of robust and sizeable financial intermedi-aries? A key challenge is to balance careful regulatoryoversight while promoting innovation and entrepreneur-ship.As indicated by some results within the Index,countries with a high degree of stability do not neces-sarily have deep and active financial intermediation thathas been correlated with economic growth. Ongoingeconomic development may therefore depend on beingable to promote both simultaneously.

For financial intermediaries, the need to considersystemic issues in their investment and operational

decisions was highlighted in the current crisis.As financial services firms weigh where to base and thenmanage their operations in different regions, what arethe elements that should be considered? How should theythink about the different risks and tradeoffs associatedwith different operating environments? The stability offinancial systems must certainly be a central factor,but effective corporate governance, robust legal regimespromoting contract enforcement, availability of humancapital, and other factors are also critical to nurturingcompetitive and resilient financial systems.

For policymakers charged with the overall economicwelfare of the broader population, how do they ensurethat the financial system serves all constituencies,including those that are less privileged? The measures of financial access we capture in the Index illustrate that even while large corporations may have relativelyeasy availability of capital in particular markets, smallenterprises and individuals in the same countries maynot. Governments need to be quite nuanced in theirapproaches to ensure that financial markets can supportinnovation and growth at all levels of society.

The Financial Development Report 2009In light of these far-reaching questions, this years Report strives to move beyond an updated Index to abroader examination of the global impact of the crisison financial development. Part 1: Findings from theFinancial Development Index, begins with Chapter 1.1outlining the methodology for the Index, the academictheory and assumptions supporting it, and some of thekey findings from the Index results. Chapters 1.2 and1.3, which complete Part 1, include some thoughtfulcontributions to provide context on how the currentcrisis has impacted both emerging economies and,more specifically, the achievement of the MillenniumDevelopment Goals.The effects of the crisis on severalemerging markets have been tempered by the soundmacroeconomic policy and external conditions of recent years. However, the effects of financial crises doin general tend to fall disproportionately upon the poor. It is therefore important for countries to craft policy responses with these effects in mind.

We encourage readers to delve into the detail ofPart 2: Country/Economy Profiles and Part 3: DataTables of the Report. In light of the complexity of

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ForewordKEVIN STEINBERG

Chief Operating Officer and Head of the Centre for Global Industries (New York), World Economic Forum USA

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financial systems and of the current problems we face,the richness and breadth of the data paint a balancedpicture of the challenges and opportunities faced by different countries.

By design, this Report necessarily relies on availabledata to proxy for key elements of financial development.It is with a degree of humility that we put forth thisReport given some of the inherent limitations of thesedata, the rapidly changing environment, and the uniquecircumstances of some the economies covered.Yet, in itsattempt to establish a comprehensive framework and ameans for benchmarking, we feel it provides a usefulstarting point from which to ensure a rich and broadperspective at this critical juncture.

Going forwardWe recognize the challenging economic and politicalenvironment into which this Financial DevelopmentReport is being launched. Fortunately, as this is the second edition, it provides us a first-time opportunity tocompare how financial systems are evolving year overyear at a time when understanding these changes couldnot be more important.We therefore welcome ongoingdiscussions and public debate, and anticipate that furtherwork will be both productive and necessary.

On behalf of the World Economic Forum as well as the project team, I extend thanks to all involved increating this Index for their tremendous contributionsto this work. Our Industry Partners have relayed theirenthusiasm not only for using this work as a basis fordiscussions with policymakers, but also for engaging in a broader dialogue about how all stakeholders can ensurethe stability and effectiveness of both national and globalcapital markets.We therefore welcome feedback andreactions from all interested in this work, and inviteyour involvement in our future efforts.

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The Financial Development Report and the FinancialDevelopment Index (FDI) on which it is based providea score and rank for 55 countries according to the levelof their financial development. It analyzes the drivers offinancial system development that support economicgrowth in developed and developing countries to serveas a tool for countries to benchmark themselves andprioritize areas for reform.

The Report defines financial development as the factors,policies, and institutions that lead to effective financial interme-diation and markets, as well as deep and broad access to capitaland financial services. In accordance with this definition,measures of financial development are captured acrossseven pillars:

1. Institutional environment

2. Business environment

3. Financial stability

4. Banking financial services

5. Non-banking financial services

6. Financial markets

7. Financial access

Financial stability is thus an important componentof the FDI, but a breadth of additional factors is alsoconsidered in this assessment of the long-term develop-ment of financial systems.

Although some refinements were made to thisyears FDI, a high-level comparison with last yearsIndex seems to indicate some general trends:

The worlds largest economies exhibited the largestdrop in absolute scores as compared with last year.The size and global nature of these economies mayhave led to greater exposure to the current financialturmoil, as captured in some of the more recentdata in this years FDI.

While the United Kingdom came in 1st and theUnited States came in 3rd, both experienced asharp drop in their overall scores that significantlydecreased the margin with which they lead othercountries in the Index. Financial instability weighedheavily on both, a factor that was offset by strengthin some measures of financial intermediation.

At second place,Australia showed considerablestrength in the rankings. Canada, the smallest of theG-8 countries (by GDP), and countries that aresmaller than it fared better in this years Index,comprising 7 out of the top 10 in overall rank.These include Australia (2nd), Singapore (4th),Hong Kong SAR (5th), Canada (6th), Switzerland(7th), the Netherlands (8th), and Denmark (10th).

Table 1: Top 10 in overall Index ranking

2009 2008 2009 Change rank rank score in score

Economy (1 to 55) (1 to 55) (1 to 7) (2009 vs. 2008)

United Kingdom 1 2 5.28 0.55Australia 2 11 5.13 0.15United States 3 1 5.12 0.73Singapore 4 10 5.03 0.12Hong Kong SAR 5 8 4.97 0.26Canada 6 5 4.96 0.3Switzerland 7 7 4.91 0.32Netherlands 8 9 4.85 0.37Japan 9 4 4.64 0.64Denmark 10 n/a 4.64 n/a

Note: Some refinements have been made to this year's Index that may affectcomparability with the previous year's results.

This years FDI also illustrates some interesting find-ings with respect to developing countries:

Within the FDIs financial stability pillar, a numberof developing countriessuch as Brazil, Chile, andMalaysiaachieve strong scores.

A comparison of commercial financial access andretail financial access measures illustrate that largerenterprises in developing countries appear to enjoyaccess to financial services (such as equity offeringsand private credit) that rivals access seen in devel-oped countries.

However, developing countries did not score nearlyas well in terms of retail financial services providedto individuals (such as savings and demand accounts,micro credit, and point-of-sale financial services)despite the importance of these agents to theeconomies of many developing countries.

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Executive SummaryNOURIEL ROUBINI, New York University and RGE Monitor

JAMES BILODEAU, World Economic Forum USA

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Table 2: Top 20 in the financial stability pillar

2009 rank Economy Score

1 Norway 5.732 Switzerland 5.663 Hong Kong SAR 5.634 Chile 5.625 Singapore 5.616 Saudi Arabia 5.607 Canada 5.578 Kuwait 5.499 Australia 5.48

10 Germany 5.3411 Finland 5.2712 France 5.2713 Malaysia 5.1414 Mexico 5.1315 Brazil 5.1316 Czech Republic 5.0817 United Arab Emirates 5.0718 Sweden 5.0719 Denmark 4.9920 Slovak Republic 4.92

There is necessarily a lag in some of the data usedto calculate the FDI, so it is important not to view it ashaving captured the full effects of the current financialcrisis.As successive iterations of the Report are published,the long-term effects of the crisis on financial systemdevelopment will become increasingly clear. The find-ings with respect to specific countries and variables cov-ered in this Report can be found in the country profilesand data tables contained in Parts 2 and 3.

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Part 1 Findings from the FinancialDevelopment Index

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CHAPTER 1.1

The Financial DevelopmentIndex: Taking Stock ofFinancial System Strength in aTime of CrisisNOURIEL ROUBINI, New York University and RGE Monitor

JAMES BILODEAU, World Economic Forum USA

The global financial crisis that has unfolded over thepast 18 months has underlined the central role thatfinancial systems play in the economic development of countries. In particular, the importance of financialstability as a key aspect of financial systems that hasimplications extending well beyond a countrys borderand deep into the real economy has been made painfullyclear.The sheer scale of the response required by policy-makers to avert a deepening of the crisis has led countriesto rethink the mechanisms for governance and oversightof financial systems at the global and local levels.

As countries continue to examine their response to the current crisis to minimize the possibility of simi-lar occurrences in the future, as well as to ensure theefficacy of their actions, it is crucial to take a longer-termperspective on the role and nature of financial systems.Specifically, it is imperative to consider all the differentfactors that are important in facilitating the central roleof financial systems in furthering economic prosperityfor all participants in the global economy. Empiricalstudies concerning financial development and growthhave generally found that cross-country differences in thelevels of financial development explain a considerableportion of the cross-country differences in growth ratesof economies.1

It is against this backdrop that the second annualFinancial Development Report aims to provide policymakerswith a common framework to identify and discuss thisrange of factors that are central to the development ofglobal financial systems and markets. It provides theFinancial Development Index (FDI), which ranks 55 ofthe worlds leading financial systems against which coun-tries can benchmark themselves and with which theycan establish priorities for financial system improvement.The Financial Development Report is published annually sothat countries can continue to benchmark themselvesagainst their peers and track their progress over time.

In recognition of the diversity of countries coveredin the FDI and the variety of financial activities that arevital to economic growth, the FDI provides a holisticview of financial systems. For the purposes of this Reportand the FDI we have defined financial development as the factors, policies, and institutions that lead to effective financialintermediation and markets, as well as deep and broad access tocapital and financial services. This definition thus spans thefoundational supports of a financial system, includingthe institutional and business environments; the financialintermediaries and markets through which efficient riskdiversification and capital allocation occur; and the resultsof this financial intermediation process, which includethe availability of, and access to, capital.

The FDI relies upon current academic research inboth selecting the factors that are included and in deter-mining its overall structure.This encompasses a variety

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The authors would especially like to thank Ibiye Harry for her extensivecontributions to this chapter and Report.

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of measures intended to capture different dimensions of financial stability that have been highlighted in thecurrent crisis. However, consistent with its purpose ofsupporting the long-term development of financial systems and their central role in economic growth, italso encourages a broad analysis over a theoretical focuson a few specific areas.With this holistic view, decisionmakers can develop a balanced perspective as to which aspects of their countrys financial systemare most important and empirically calibrate this viewrelative to other countries.

Financial development and economic growthA large body of economic literature supports the premisethat, in addition to many other important factors, theperformance and long-run economic growth and welfareof a country are related to its degree of financial devel-opment. Financial development is measured by factorssuch as size, depth, access, and the efficiency and stabilityof a financial system, which includes its markets, inter-mediaries, range of assets, institutions, and regulations.The higher the degree of financial development, thewider the availability of financial services that allow the diversification of risks.This increases the long-rungrowth trajectory of a country and ultimately improvesthe welfare and prosperity of producers and consumersthat have access to financial services.The link betweenfinancial development and economic growth can betraced back to the work of Joseph Schumpeter in theearly 20th century,2 and more recently to RonaldMcKinnon and Edward Shaw.This link is now wellestablished in terms of empirical evidence.3

The current environment has highlighted thepotentially severe impact that financial crises can haveon economies, and in particular on those with fewerresources with which to deal with financial adversity(see Box 1).4 Yet research supports the idea that coun-tries that have experienced occasional financial criseshave, on average, demonstrated higher economic growththan countries that have exhibited more stable financialconditions.5 Thus, although it is important to mitigatethe short-term impact of crises, it is also important toview financial development in terms inclusive of, butbroader than, financial stability.

Economic theory suggests that financial marketsand intermediaries exist mainly because of two types ofmarket frictions: information costs and transaction costs.These frictions lead to the development of financialintermediaries and financial markets, which performmultiple functions, such as facilitating the trading, hedging,diversification, and pooling of risk; providing insuranceservices; allocating savings and resources to the appro-priate investment projects; monitoring managers andpromoting corporate control and governance; mobilizingsavings efficiently; and facilitating the exchange of goodsand services.

Financial intermediation and financial markets contribute directly to increased economic growth andaggregate economic welfare through their effect on capitalaccumulation (the rate of investment) and on techno-logical innovation. First, greater financial developmentleads to greater mobilization of savings and its allocationto the highest-return investment projects.This increasedaccumulation of capital enhances economic growth.Second, by appropriately allocating capital to the rightinvestment projects and promoting sound corporategovernance, financial development increases the rate of technological innovation and productivity growth,further enhancing economic growth and welfare.

Financial markets and intermediation benefit consumers and firms in many other ways that are notdirectly related to economic growth.Access to financialmarkets for consumers and producers can reduce poverty,such as when the poor have access to banking servicesand credit.The importance of microfinance can be seenin this context.This access allows consumers to smoothconsumption over time by borrowing and/or lending andstabilizes consumer welfare in the presence of temporaryshocks to wages and income. By contributing to thediversification of savings and of portfolio choices, it canalso increase the return on savings and ensure higherincome and consumption opportunities. Insurance serv-ices can help mitigate a variety of risks that individualsand firms face, thus allowing better risk sharing of indi-vidual or even macroeconomic risks.

The seven pillars of financial developmentTo understand and measure the degree of financialdevelopment, one must consider all of the different factors that together contribute to the degree of depthand efficiency of the provision of financial services.Conceptually, in thinking about an index that measuresthe degree of financial development, the various aspectsof development can be seen as seven pillars groupedinto three broad categories, as indicated in Figure 1:

1. Factors, policies, and institutions: the foundationalcharacteristics that allow the development of financialintermediaries, markets, instruments, and services.

2. Financial intermediation: the variety, size, depth,and efficiency of the financial intermediaries andmarkets that provide financial services.

3. Financial access: access by individuals and businessesto different forms of capital and financial services.

The seven pillars are organized and described belowaccording to these three categories. (See Appendix A for the detailed structure of the FDI and a list of allindicators).

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Factors, policies, and institutionsThis first category covers those foundational featuresthat support financial intermediation and the optimalprovision of financial services and includes the first threeof the seven pillars: the institutional environment, thebusiness environment, and the degree of financial stability.

First pillar: Institutional environmentThe institutional environment encompasses the laws and regulations that allow the development of deep andefficient financial intermediaries, markets, and services as well as the macroprudential oversight of financial systems.This includes the overall laws, regulations, andsupervision of the financial sector, as well as the qualityof contract enforcement and corporate governance.

Economic theory proposes that a strong institutionalenvironment exists to alleviate information and transactioncosts.6 Much empirical work has tackled issues related to the importance of institutions and their impact oneconomic activity in general.The presence of legal insti-tutions that safeguard the interests of investors is an inte-gral part of financial development.7 Reforms that bolstera countrys legal environment and investor protection arelikely to contribute to a more efficient financial sector.8

Accordingly, we have included variables related to thedegree of judicial independence and judicial efficiency.

Additionally, the current crisis has clearly empha-sized the importance of regulation at the institutionallevel as it relates to financial stability and corresponding

effects on the real economy. Official supervisory powercan be an important component of this oversight, andcan include the ability to declare the insolvency offinancial institutions, restructure them, and undertakeprompt corrective and enforcement actions.9 Therobustness of private monitoring of financial institu-tionsincorporating such elements as the requirementsfor certified auditing, the percentage of banks rated byinternational rating agencies, and the quality of bankaccountingis also an essential aspect of regulation.10

A measure of the effectiveness of regulation of securitiesexchanges is also included.

Better corporate governance is believed to encour-age financial development, which in turn has a positiveimpact on growth.11 Contract enforcement is alsoimportant because it limits the scope for default amongdebtors, which in turn promotes compliance.Variablescapturing these measures as they relate to the formaltransfer of funds from savers to investors are included in the pillar.12 Inadequate investor protection leads to anumber of adverse effects, which can be detrimental toexternal financing and ultimately to the development ofwell-functioning capital markets.13 In general, inadequateenforcement of financial contracts has been found toaugment the process of credit rationing, thus hinderingthe overall process of growth.14

Other important aspects of the institutional envi-ronment are a countrys capital account openness anddomestic financial sector liberalization. Financial liberalization generally permits a greater degree of

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Figure 1: Composition of the Financial Development Index

Source: World Economic Forum

Factors, policies, and institutions

1. Institutional environment

2. Business environment

3. Financial stability

Policymakers

Financial intermediation

4. Banking financial services

5. Non-banking financial services

6. Financial markets

Financial intermediaries

Financial access

7. Financial access

End users of capital

Financial Development Index

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financial depth, which translates into greater financialintermediation among savers and investors.This in turnincreases the monetization of an economy, resulting in amore efficient flow of resources.15 Empirically, however,the impact of capital account liberalization deliversmixed evidence. Several studies have asserted that capitalaccount liberalization has no impact on growth whileothers have found a positive, and statistically significant,impact.16 At the same time, other work asserts that therelationship is undetermined.

Given such ambiguity over the impact of capitalaccount openness, it is best examined within the contextof the legal environment.The better a countrys legal andregulatory environment, the greater the benefits fromcapital account opennessand vice versa.Accordingly,within the FDI we try to capture the relationshipbetween capital account openness and the level of legaland regulatory development and have interacted thevariables used to measure each (see Appendix A).Thepresence of both a robust legal and regulatory systemand capital account openness provides a positive indica-tion of the financial development of a country.We havealso interacted the capital account openness variablewith the level of bond market development because ofresearch that asserts the importance of developingdomestic bond markets in advance of full liberalizationof the capital accounts.17 Assessments of commitment toWTO trade agreements as they relate to financial serv-ices have also been included and interacted in a similar manner.

A similar analysis can be extended to the degree ofliberalization of the domestic financial sector.This degreeof liberalization is based on whether a country exertsinterest rate controls (either ceilings or floors), whethercredit ceilings exist, and whether foreign currencydeposits are allowed. In general, the better a countryslegal and regulatory environment, the greater the impactof domestic financial sector liberalization on a countryseconomic growth.Variables representing each of thesecharacteristics have been interacted to represent thisresult. Recent research supports the importance ofadvanced legal systems and institutions in this respect,holding that the presence of such institutions is as vitalas having both a developed banking sector and equitymarkets.18

Second pillar: Business environmentThe second pillar focuses on the business environmentand considers:

the availability of human capitalthat is, skilledworkers who can be employed by the financial sector and thus provide efficient financial services;

the state of physical capitalthat is, the physicaland technological infrastructure; and

other aspects of the business environment, includingtaxation policy and the costs of doing business forfinancial intermediaries.

Measures taken to facilitate the creation and improvementof human capital have been found to assist the processof economic growth.19 Empirical evidence supports thisrelationship and shows positive correlations betweenhuman capital and the degree of financial development.20

Our proxies for the amount of human capital are relatedto the enrollment levels of tertiary education.We alsoinclude measures that reflect the quality of human capital,such as the degree of staff training, the quality of man-agement schools and math and science education, andthe availability of research and training services.

Another key area is infrastructure.We capture a basicmeasure of the quality of physical infrastructure, whichis important given its role in enhancing the process ofprivate capital accumulation and financial depth incountries by increasing the profitability of investment.21

Our analysis of infrastructure emphasizes measures ofinformation and communication technologies, whichare particularly important to those firms operating within a financial context because of their data-intensivenature.

Another integral aspect of the business environmentis the cost of doing business in a country. Specifically,research has shown that the cost of doing business is avital feature of the efficiency of financial institutions.The different costs of doing business are integral toassessing a countrys business environment as well as thetype of constraints that businesses may be facing.22 Assuch, the better the business environment, the better theperformance of financial institutions and the higher thedegree of financial development.Variables that capturesuch costs include the World Banks measures of the costof starting a business, the cost of registering property,and the cost of closing a business. Indirect or transactioncosts are captured in variables such as time to start abusiness, time to register property, and time to close abusiness.

Our analysis also considers taxes as another keyconstraint that businesses in the financial sector can face.The variables in this subpillar focus on issues related todistortionary and burdensome tax policies, reflectingclearer consensus around the importance of these issues.Because of less clarity in the academic literature aroundthe effects of absolute rates of taxation and issues of datacomparability, we have not included measures related tooverall tax rates.

Third pillar: Financial stabilityThe third pillar addresses the stability of the financialsystem.The severe negative impacts of financial instabilityon economic growth can be profoundly seen in thecurrent financial crisis as well as pervasive past financialcrises.This instability can lead to significant losses to

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investors, resulting in systemic banking crises, systemiccorporate crises, currency crises, and sovereign debt crises.

This pillar tries to capture the risk of three types of crises: currency crises, systemic banking crises, andsovereign debt crises. For the risk of currency crises, weinclude the change in real effective exchange rate, thecurrent account balance, a dollarization vulnerabilityindicator, an external vulnerability indicator, externaldebt to GDP, and net international investment position.The external debt to GDP and net international invest-ment position variables are specifically applied to devel-oping and developed countries, respectively.

The systemic banking crises subpillar combines meas-ures of historic banking system instability, an assessmentof aggregate balance sheet strength, and measures of thepresence of bubbles. Historic instability is captured ina measure of the frequency of banking crises since the1970s; more recent banking crises are given greaterweight. Empirical research has shown that countries thathave gone through systemic banking crises or endured ahigh degree of financial volatility are more susceptible toprofound short-term negative impacts on the degree offinancial intermediation.23 A financial strength indicatorprovides a measure that balances quantitative measuresof balance sheet strength with qualitative assessments ofbanks abilities to meet their obligations to depositors andcreditors. Capital adequacy measures, such as capital-to-asset ratios, have not been included because of researchthat indicates the shortcoming of such measures withrespect to emerging markets.24

The last type of crisis captured within the financialstability pillar is sovereign debt crisis.An importantproxy for the risk of this crisis is sovereign credit ratings;these data were calculated as an average of both localcurrency sovereign credit ratings and foreign currencysovereign credit ratings. Sovereign ratings measure thedegree to which a country is willing and able to pay itsdebt in a timely manner and in full.Thus, a high sover-eign credit rating signifies less likelihood of defaultoccasioned by a sovereign debt crisis. Credit defaultswaps provide a quantitative, market-based indicator ofthe ability of a country to repay its debt. Macroprudentialmeasures such as inflation and GDP growth are alsoincluded, as these also influence the ability of countriesto service their debt.

The greater the risk of these crises, the greater thelikelihood that the different processes of financial inter-mediation will be hampered, precipitating lower economicgrowth rates. However, these effects of financial stabilityon economic growth can be considered in terms of atradeoff between risk and innovation/return. For example,a financial system that is very heavily supervised andregulated may be very stable and never spark a financialcrisis. However, such a controlled system would hamperthe financial development and innovation that increasesreturns, diversifies risks, and better allocates resources tothe highest-return investments. Conversely, a financial

system that is very free and innovative and is very lightly regulated and supervised may eventually becomeunstable and trigger credit booms and asset bubbles that can severely affect growth, returns, and welfare.Although there is some tradeoff between the stability of the financial system and its degree of innovation andsophistication, financial stability remains an importantinput in the process of financial development.

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Box 1: Financial crises and the MillenniumDevelopment Goals

(Please see Chapter 1.3 by Erik Feyen for a full discussion ofthis topic.)

There is no doubt that financial sector developmentcontributes to economic growth and poverty alleviation. Andeven though financial systems can be prone to instability,studies show that countries that have experienced occasion-al financial crises have, on average, grown faster than coun-tries with stable financial conditions because they stimulatedhealthy risk taking by, for example, financing a small compa-ny, a farmer, or R&D activities. However, financial crises canhave devastating effects on the worlds most vulnerable peo-ple. The weakest members of society are often at the highestrisk of falling into a poverty trap, which can lead to long-termdevelopmental and economic losses. The current crisis hasonce again demonstrated that developing countries muststrengthen their safety nets and plan their crisis interventionscenarios to protect the weakest in a timely, targeted, andcost-effective manner.

During normal times, both developed and developingcountries with sound banking and capital markets enjoystronger per capita income growth than countries withoutsuch markets. Research suggests that financial developmentresults in fewer people living in poverty, since the poor indi-rectly benefit from economic growth through increases inemployment opportunities and real wages, as well as frominvestment in core infrastructure.

However, although the poor benefit disproportionatelyfrom financial development, they also tend to suffer dispro-portionately from financial crises. This occurs because theyare less able than wealthier people to insulate themselvesagainst shocks. Even a small shock can force households tosell off productive assets such as land and livestock, econo-mize on food and healthcare, and pull their children out ofschool to make ends meet. Thus, financial crises can endan-ger progress toward attaining the Millennium DevelopmentGoals.

Countries should continue to pursue policies thatencourage financial development and avoid those that leadto excessive long-term intervention in systems or those thatincrease protectionism in the wake of a financial crisis. Well-thought-out safety nets and crisis policies would do much tomitigate the worst effects of a crisis on the poor.

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Excessively unstable financial systemssystems that areprone to repeated and virulent financial crisesare lesslikely to grow and develop. For a full discussion of theimpact of the crisis on emerging market economies, seeBox 2 and the following chapter by Nouriel Roubiniand Ayah El Said.

Financial intermediaries and marketsThe second category of pillars measures the degree ofdevelopment of the financial sector as seen in the differenttypes of intermediaries.These three pillars are bankingfinancial services, non-banking financial services (e.g.,investment banks and insurance firms), and financialmarkets.

Consensus exists on the relationship between thesize and depth of the financial system and the supplyand robustness of financial services that are importantcontributors to economic growth.25 This relationshipoccurs because the size of financial markets is viewed as an important determinant of savings and investment.26

The size (total financial assets within a country) of thefinancial system also matters because the larger it is, thegreater its ability to benefit from economies of scalegiven the significant fixed costs prevailing in financialintermediaries activities.A larger financial system tendsto relieve existing credit constraints.This facilitates bor-rowing by firms and further improves the process of savings mobilization and the channeling of savings toinvestors. Given that a large financial system should allocate capital efficiently and better monitor the use of funds, improved accessibility to financing will tend to amplify the resilience of an economy to shocks.

Thus, a deeper (total financial assets as a percentageof GDP) financial system is an important component of financial development as it contributes to economicgrowth rates across countries.27 Measures of size anddepth have been included in each of the three financialintermediation pillars to capture this factor.

Fourth pillar: Banking financial servicesAlthough the previous pillar captures some of the negativeimpacts that an unstable banking system can have on an economy, banks also play a vital role in supportingeconomic growth.This role is captured in the fourthpillar. Bank-based financial systems emerge to improveacquisition of financial information and to lower trans-action costs, as well as to allocate credit more efficiently.This role is especially important in developing economies.

The efficient allocation of capital in a financial systemgenerally occurs through bank-based systems or market-based financial systems.28 Some research asserts that banksfinance growth more effectively and efficiently thanmarket-based systems, particularly in underdevelopedeconomies where non-bank financial intermediaries aregenerally less sophisticated.29 Research also shows that,compared with other forms of financial intermediation,well-established banks form strong ties with the privatesector, a relationship that enables them to acquire infor-mation about firms more efficiently and to persuade firmsto pay their debts in a timely manner.30 Advocates ofbank-based systems argue that banks that are unimpeded byregulatory restrictions tend to benefit from economiesof scale in the process of collecting information and canthus enhance industrial growth. Banks are also seen askey players in eradicating liquidity risk, which causesthem to increase investments in high-return, illiquid assetsand speed up the process of economic growth.31

One of the key measures of the efficacy of thebanking system captured in this pillar is size.The largerthe banking system, the more capital can be channeledfrom savers to investors.This enhances the process offinancial development, which in turn leads to greatereconomic growth.These measures of size span depositmoney bank assets to GDP, M2 to GDP, and privatecredit to GDP.

Another key aspect of the banking system is its efficiency. Direct measures of efficiency captured in the

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Box 2: The effect of the global financial crisis onemerging markets

(Please see Chapter 1.2 by Nouriel Roubini and Ayah El Saidfor a full discussion of this topic.)

At the onset of the financial crisis, economic and finan-cial fundamentals of emerging market economies were inmuch better shape than they had been in previous episodesof global turmoil. The relative resilience of emerging marketsto external shocks was not only a result of the good policiesimplemented, but also the result of good luck: 200407 was amost favorable period of external conditions for emergingmarkets in a booming global economy.

With the collapse of Lehman Brothers on September 15,2008, the global financial crisis spread swiftly, and thespillover effects were felt in the emerging markets very rap-idly. The crisis was seen to affect emerging markets throughtrade, financial, and commodity channels via the sharp dropin commodity prices. The countries with the least soundmacro and financial fundamentals were affected mostseverely during the crisis.

Policy response to the recession by international organ-izations occurred on a much larger scale than it had in previ-ous crises originating in emerging markets. Better fundamen-tals allowed emerging markets to respond countercyclicallyto the crisis through domestic policy.

Economic recovery in these markets is expected to bemore robust than in that of advanced economies; however,the issue of financial stability will continue to be a priority foremerging markets as they become more cautious about thesequencing of financial sector liberalization, financial deep-ening, and financial development in general.

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Index are aggregate operating ratios such as bank oper-ating cost to assets and the ratio of non-performingloans to total loans.An indirect measure of efficiency ispublic ownership. Publicly owned banks tend to be lessefficient, impeding the processes of credit allocation andchanneling capital, which in turn slows the process offinancial intermediation.

Measures of operating efficiency may provide anincomplete picture of the efficacy of the banking systemif it is not profitable.We have thus also included anaggregate measure of bank profitability. Conversely, ifbanks are highly profitable while performing poorly inthe operating measures, then this may indicate a lack ofcompetition along with undue and high inefficiency.

A third key aspect of the efficacy of the bankingsystem captured by this pillar is the role of financialinformation disclosure within the operation of banks.Policies that induce correct information disclosure andthat authorize private-sector corporate control of banks,as well as motivate private agents to exercise corporatecontrol, tend to encourage bank development, opera-tion, and stability.32 This has a positive effect on theoverall economy.

Fifth pillar: Non-banking financial servicesBecause of inadequate regulation and oversight, certainnon-banking financial services, such as securitization,played a detrimental role in the current financial crisis.However, non-bank financial intermediariessuch asbroker dealers, traditional asset managers, alternativeasset managers, and insurance companiesare still con-sidered both an important complement to banks and apotential substitute for them.Their complementary rolelies in their efforts to fill any vacuum created by com-mercial banks.Their competition with banks allows bothparties to operate more efficiently in meeting marketneeds.Activities of non-bank financial intermediariesinclude their participation in securities markets as wellas the mobilization and allocation of financial resourcesof a longer-term naturefor example, in insuranceactivities.

Empirical research has found that banks as well asnon-bank financial intermediaries are larger, moreactive, and more efficient in advanced economies.33

Advocates of the market-based system (i.e., non-banks)point to the fact that the market-based system is able tofinance innovative and high-risk projects.34 As for theinsurance sector, it can be seen as a tool that eases tradeand commerce by providing ample liability coverage.Insurance also creates liquidity and facilitates the processof building economies of scale in investment, therebyimproving overall financial efficiency.35 And insurancehas been found to mobilize illiquid savings to positivelyaffect growth.36

The degree of development of non-bank financialintermediaries in general has been found to be a good proxyof a countrys overall level of financial development.37

Sixth pillar: Financial marketsThe four major types of financial markets include bondmarkets (both for government and corporate bonds),stock markets where equities are traded, foreign exchangemarkets, and derivatives markets.

Stock market liquidity is statistically significant interms of its positive impact on capital accumulation,productivity growth, and current and future rates ofeconomic growth.38 More generally, economic theorysuggests that stock markets encourage long-run growthby promoting specialization, acquiring and disseminatinginformation, and mobilizing savings in a more efficientway to promote investment.39 Research also shows thatas countries become richer, stock markets become moreactive and efficient relative to banks.40 Bond markets havereceived little empirical attention, but recent researchhas shown that bond markets play an important role infinancial development and the effective allocation ofcapital.41

Derivatives markets are an important aspect of this pillar because they can significantly improve riskmanagement and risk diversification.The developmentof derivatives markets can enhance the confidence ofinternational investors and financial institutions andencourage these agents to participate in them. Derivativesmarkets generally are small in emerging markets.Thestrengthening of the legal and regulatory environmentcan enhance the development of such markets.42

Financial accessThis third and final category is comprised of one pillarthat represents the measures of access to capital andfinancial services.

Seventh pillar: Financial accessThe measures represented in this last pillar span measuresof access to capital through both commercial and retailchannels. Empirically, greater access to financial serviceshas been associated with the usual proxies for financialdevelopment and resulting economic growth.43 Thepresence of financial services per se as reflected by size anddepth does not imply their accessibility by the differenttypes of users within an economy.Thus, the presence ofaccess becomes integral to our analysis.

Measures of commercial access captured includeventure capital availability, access to local equity markets,access to credit, access to loans, and an overall level offinancial market sophistication. Performance in the otherpillars contributes to performance in this subpillar andto the extent of access to financial services by end users.

We have also introduced measures related to retail access to financial services that are provided by the Consultative Group to Assist the Poor and theMicrofinance Information Exchange, Inc.These includemeasures such as the penetration of bank accounts, thenumber of automated teller machines (ATMs) and

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points of sale (POS), and microfinance penetration.These measures capture access to capital by individualsand small enterprises that can be important contributorsto growth in developing countries.

Accessibility, along with the size and depth of thefinancial system as a whole captured in the previous pillars, has a significant effect on a countrys real activity,economic growth, and overall welfare.

Adjustments to the Financial Development Index this yearThe structure of the Financial Development Indexremains largely similar to that used in last years inauguralreport.While there are still seven pillars in the Index,we have improved several of them slightly.The 7th pillarnow focuses specifically on measures of access to finan-cial services and capital, whereas last year it also includedmeasures of size and depth of the overall financial system.We have redistributed these size measures into theappropriate financial intermediation pillars (the 4th, 5th,and 6th pillars, specifically).

As noted previously, we have also expanded ourdefinition of financial access to include a new subpillar ofretail measures that are applicable to individuals and smallenterprises.We considered that this was an importantdimension to add to the Index in consideration of theimportant role that this segment of the economy canplay in developing countries.

We have also made some refinements to the meas-ures within each of the seven pillars to better proxy for the components of financial development we aretrying to capture.Within the 1st pillar (institutionalenvironment), we have combined capital account anddomestic financial sector liberalization measures with anew measure on commitment to the WTO agreementon trade in services to create a single subpillar calledfinancial sector liberalization. We now interact this variablewith bond market development in addition to the legaland regulatory issues score, as noted previously.We havealso added measures related to corruption perceptionsand legal rights.A couple of changes were made to the2nd pillar (business environment) to better align cost ofdoing business measures with financial services compa-nies and to add indirect cost measures related to timerequired to undertake some business-related activities.A measure of absolute tax rates was replaced with avariable to increase the emphasis on distortionary orinefficient tax policies.

Several changes were made to the financial stabilitypillar, in particular the banking stability subpillar.Wenow use a new financial strengths indicator instead of a stability index, have moved some regulatory measuresinto the institutional environment pillar, and added avariable pertaining to the manageability of private debtas an additional indicator of bubbles. Similarly, a man-ageability of public debt measure has been added to the

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Table 1: The Financial Development Index 2009 rankings

20092009 2008 score Change

Country/Economy Rank Rank (17) in score

United Kingdom 1 2 5.28 0.55

Australia 2 11 5.13 +0.15

United States 3 1 5.12 0.73

Singapore 4 10 5.03 0.12

Hong Kong SAR 5 8 4.97 0.26

Canada 6 5 4.96 0.30

Switzerland 7 7 4.91 0.32

Netherlands 8 9 4.85 0.37

Japan 9 4 4.64 0.64

Denmark 10 n/a 4.64 n/a

France 11 6 4.57 0.68

Germany 12 3 4.54 0.74

Belgium 13 17 4.50 0.06

Sweden 14 13 4.48 0.27

Spain 15 12 4.40 0.50

Ireland 16 14 4.39 0.33

Norway 17 15 4.38 0.28

Austria 18 18 4.28 0.27

Finland 19 21 4.24 0.21

United Arab Emirates 20 16 4.21 0.40

Italy 21 22 3.98 0.40

Malaysia 22 20 3.97 0.51

Korea, Rep. 23 19 3.91 0.64

Saudi Arabia 24 27 3.89 0.01

Jordan 25 n/a 3.89 n/a

China 26 24 3.87 0.22

Bahrain 27 28 3.85 0.04

Israel 28 23 3.69 0.45

Panama 29 32 3.63 +0.03

Kuwait 30 26 3.62 0.31

Chile 31 30 3.60 0.19

South Africa 32 25 3.48 0.51

Czech Republic 33 35 3.48 +0.05

Brazil 34 40 3.46 +0.18

Thailand 35 29 3.35 0.48

Egypt 36 37 3.33 +0.01

Slovak Republic 37 42 3.30 +0.05

India 38 31 3.30 0.34

Poland 39 41 3.27 0.00

Russian Federation 40 36 3.16 0.24

Hungary 41 33 3.08 0.45

Peru 42 46 3.07 +0.01

Mexico 43 43 3.06 0.15

Turkey 44 39 3.03 0.27

Vietnam 45 49 3.00 0.03

Colombia 46 44 2.94 0.27

Kazakhstan 47 45 2.93 0.20

Indonesia 48 38 2.90 0.41

Pakistan 49 34 2.85 0.61

Philippines 50 48 2.84 0.19

Argentina 51 47 2.77 0.26

Nigeria 52 50 2.72 0.04

Ukraine 53 51 2.71 0.02

Bangladesh 54 n/a 2.57 n/a

Venezuela 55 52 2.52 0.18

Note: Some refinements have been made to this year's Index that may affectcomparability with the previous year's results.

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risk of sovereign debt crisis subpillar as well as an aggregatemacroprudential indicator and measure of credit defaultswap spreads.The weighting of the banking stabilitysubpillar has also been increased slightly, to 40 percent.

Other changes to variables include the inclusion ofoperational efficiency measures and an aggregate prof-itability indicator to replace an efficiency index in thebanking financial services pillar.We now use a three-yearrunning average for some measures in the non-bankingfinancial services pillar to provide a steadier indicationof trends in non-banking activities (e.g., IPOs and secu-ritizations). Several additional measures have been addedto the financial markets pillar, including the number oflisted companies per 10,000 people.

The Financial Development Index 2009 rankingsThe overall ranking for this years Financial DevelopmentReport can be seen in Table 1, along with the 2008 rank-ing, the Index score, and the change in score from lastyear.As noted above, there were some changes made tothe Index structure and variables this year; yet lookingacross the overall rankings and scores, some generaltrends seem apparent.

Comparison of 2009 and 2008 scores and rankingsThe vast majority of scores have dropped significantlycompared with a year ago. In general, those that droppedthe furthest were in the largest industrialized economies.France (0.68), Germany (0.74), Japan (0.64), theUnited Kingdom (0.55), and the United States (0.73)experienced the largest declines in absolute score.Thesize and global nature of these financial systems mayhave led to greater exposure to the current financial crisis, which was manifested across the different pillars of the Index.

This trend would appear to be consistent across the broader sample of countries covered in the Index.In Figure 2, countries are grouped by the size of theirGDP, and the average GDP for each group is plottedagainst the average change in score from last year. Onesees a general trend that larger economies experienced a sharper drop in overall score than smaller economies.

Of the relatively few countries that experienced an increase, Brazil experienced the largest (+0.18) andAustralia the second largest (+0.15), which would seemconsistent with the relatively robust performance of theirfinancial systems in the face of the extreme instability of the past year. Countries at the bottom of the Index,such as Nigeria and Venezuela, have remained there withlittle improvement.

Thus, for most countries, it was the relative natureof their declines that determined their ranking in theIndex.44 This can be seen in the countries ranked withinthe top 10 of the Indexall of them except Australiaexperienced a decline in their overall score.The UnitedKingdom managed to move into the top spot in the

rankings despite a significant drop in score.The UnitedStates drop in score pulled it down to 3rd from 1st.Two small developed Asian economies, Hong Kong and Singapore, both climbed the rankings to 4th and5th place, respectively, while Japan dropped to 9th placefrom 4th last year.Three smaller European economiesSwitzerland (7th), the Netherlands (8th), and Denmark(10th)along with Canada (6th), round out the top 10.France and Germany both dropped out of the top 10into 11th and 12th place, respectively.

Many countries banded in the middle of the Indexdid not experience significant changes in their relativerank despite the financial turmoil of the past year;however, there were some notable exceptions. Brazilsincrease in overall score moved it up to 34th in theranking from 40th, while Pakistan experienced one of the most severe drops; it fell 15 places down to 49thfrom 34th, which probably reflects the political and economic instability confronted by the country and theresulting impact on its financial system. Indonesia andSouth Africa also experienced significant declines.Therewas no improvement in score for countries at the bottom of the Index such as Nigeria, Ukraine, andVenezuela.

Financial stability and the Financial Development IndexIn Table 2, the rankings and scores are provided for eachof the FDI pillars that have been described previously inthis chapter.A look across country rankings and scoresin each of these pillars reveals a degree of heterogeneity

-0.7 -0.6 -0.5 -0.4 -0.3 -0.2 -0.10.0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Top 5 by GDP

6th10th by GDP

31st40th by GDP21st30th by GDP

11th20th by GDP

41st55th by GDP

Figure 2: Change in overall Index scores by GDP tier

Note: The graph shows the change in overall Index score grouped by GDP(US$ billions); GDP values shown are average for each tier. Some refine-ments have been made to this year's Index that may affect comparabilitywith the previous year's results.

Change in FDI score from 2008 to 2009

2008

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Country/Economy Rank Score

United Kingdom 1 5.28Australia 2 5.13United States 3 5.12Singapore 4 5.03Hong Kong SAR 5 4.97Canada 6 4.96Switzerland 7 4.91Netherlands 8 4.85Japan 9 4.64Denmark 10 4.64France 11 4.57Germany 12 4.54Belgium 13 4.50Sweden 14 4.48Spain 15 4.40Ireland 16 4.39Norway 17 4.38Austria 18 4.28Finland 19 4.24United Arab Emirates 20 4.21Italy 21 3.98Malaysia 22 3.97Korea, Rep. 23 3.91Saudi Arabia 24 3.89Jordan 25 3.89China 26 3.87Bahrain 27 3.85Israel 28 3.69Panama 29 3.63Kuwait 30 3.62Chile 31 3.60South Africa 32 3.48Czech Republic 33 3.48Brazil 34 3.46Thailand 35 3.35Egypt 36 3.33Slovak Republic 37 3.30India 38 3.30Poland 39 3.27Russian Federation 40 3.16Hungary 41 3.08Peru 42 3.07Mexico 43 3.06Turkey 44 3.03Vietnam 45 3.00Colombia 46 2.94Kazakhstan 47 2.93Indonesia 48 2.90Pakistan 49 2.85Philippines 50 2.84Argentina 51 2.77Nigeria 52 2.72Ukraine 53 2.71Bangladesh 54 2.57Venezuela 55 2.52

1st pillar: Institutional environment


Singapore 1 6.17Denmark 2 5.97Norway 3 5.89Sweden 4 5.87Netherlands 5 5.82Austria 6 5.71Switzerland 7 5.70Finland 8 5.67Germany 9 5.66Hong Kong SAR 10 5.65United States 11 5.63Canada 12 5.62Ireland 13 5.61Australia 14 5.56United Kingdom 15 5.54Belgium 16 5.54Japan 17 5.43France 18 5.35Spain 19 5.12Bahrain 20 5.05United Arab Emirates 21 5.05Malaysia 22 4.86Jordan 23 4.73Israel 24 4.68Saudi Arabia 25 4.60Panama 26 4.51South Africa 27 4.41Hungary 28 4.41Czech Republic 29 4.31Chile 30 4.29Korea, Rep. 31 4.26Italy 32 4.22Thailand 33 4.08Slovak Republic 34 4.08China 35 4.07Kuwait 36 3.94Poland 37 3.90Egypt 38 3.87Nigeria 39 3.83Peru 40 3.70Vietnam 41 3.70Brazil 42 3.64Philippines 43 3.62Mexico 44 3.59Indonesia 45 3.54Turkey 46 3.50Kazakhstan 47 3.39India 48 3.38Colombia 49 3.30Argentina 50 3.23Ukraine 51 3.08Pakistan 52 3.03Russian Federation 53 3.01Venezuela 54 2.50Bangladesh 55 2.47

2nd pillar: Business environment


Denmark 1 6.15Singapore 2 6.05Norway 3 5.98Canada 4 5.94Sweden 5 5.93Finland 6 5.88Switzerland 7 5.84Netherlands 8 5.84Hong Kong SAR 9 5.82United States 10 5.70Australia 11 5.68United Kingdom 12 5.63Germany 13 5.60Ireland 14 5.48Japan 15 5.45Korea, Rep. 16 5.35Austria 17 5.29Bahrain 18 5.24United Arab Emirates 19 5.19France 20 5.09Belgium 21 5.08Italy 22 4.94Spain 23 4.92Saudi Arabia 24 4.88Chile 25 4.84Hungary 26 4.68Israel 27 4.60Slovak Republic 28 4.56Kuwait 29 4.51Malaysia 30 4.49Thailand 31 4.43Turkey 32 4.37Poland 33 4.34Russian Federation 34 4.21Czech Republic 35 4.19South Africa 36 4.15Jordan 37 4.12Colombia 38 4.11Panama 39 4.09China 40 4.09Kazakhstan 41 4.05Peru 42 3.95Mexico 43 3.90Argentina 44 3.81Ukraine 45 3.73Egypt 46 3.70Brazil 47 3.63India 48 3.51Vietnam 49 3.44Pakistan 50 3.42Philippines 51 3.36Indonesia 52 3.26Nigeria 53 2.95Venezuela 54 2.92Bangladesh 55 2.71

3rd pillar: Financial stability


Norway 1 5.73Switzerland 2 5.66Hong Kong SAR 3 5.63Chile 4 5.62Singapore 5 5.61Saudi Arabia 6 5.60Canada 7 5.57Kuwait 8 5.49Australia 9 5.48Germany 10 5.34Finland 11 5.27France 12 5.27Malaysia 13 5.14Mexico 14 5.13Brazil 15 5.13Czech Republic 16 5.08United Arab Emirates 17 5.07Sweden 18 5.07Denmark 19 4.99Slovak Republic 20 4.92Netherlands 21 4.91Peru 22 4.90China 23 4.83Austria 24 4.81Colombia 25 4.80Poland 26 4.78Israel 27 4.76Korea, Rep. 28 4.73Nigeria 29 4.71Bangladesh 30 4.69South Africa 31 4.67Spain 32 4.66Belgium 33 4.66Japan 34 4.57Panama 35 4.57Thailand 36 4.57United Kingdom 37 4.57United States 38 4.56Russian Federation 39 4.50Bahrain 40 4.49Ireland 41 4.48Venezuela 42 4.44Indonesia 43 4.44Italy 44 4.44Egypt 45 4.27India 46 4.23Philippines 47 4.12Pakistan 48 4.10Vietnam 49 3.82Jordan 50 3.79Turkey 51 3.79Hungary 52 3.70Argentina 53 3.68Kazakhstan 54 3.50Ukraine 55 3.19

Table 2: Financial Development Index 2009

FACTORS, POLICIES, AND INSTITUTIONSOVERALL INDEX

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4th pillar: Banking financial services


Hong Kong SAR 1 5.39United Kingdom 2 5.32Japan 3 5.15Spain 4 5.07Australia 5 5.01Ireland 6 4.98Netherlands 7 4.90Canada 8 4.83Belgium 9 4.79China 10 4.77Singapore 11 4.68Malaysia 12 4.66Sweden 13 4.61Switzerland 14 4.56Jordan 15 4.42Norway 16 4.34Denmark 17 4.34Austria 18 4.24Germany 19 4.23United States 20 4.21United Arab Emirates 21 4.17Korea, Rep. 22 4.16France 23 4.05Panama 24 4.05Italy 25 4.01Israel 26 3.97Czech Republic 27 3.85Kuwait 28 3.79Finland 29 3.78South Africa 30 3.75Saudi Arabia 31 3.58Bahrain 32 3.57Slovak Republic 33 3.50Thailand 34 3.49Brazil 35 3.46Chile 36 3.43Vietnam 37 3.29Poland 38 3.17India 39 3.12Egypt 40 3.09Turkey 41 2.96Argentina 42 2.78Peru 43 2.77Indonesia 44 2.63Philippines 45 2.63Pakistan 46 2.62Colombia 47 2.57Kazakhstan 48 2.52Venezuela 49 2.49Nigeria 50 2.45Bangladesh 51 2.44Ukraine 52 2.38Hungary 53 2.37Mexico 54 2.37Russian Federation 55 1.80

5th pillar: Non-banking financial services


United Kingdom 1 6.36United States 2 5.93Australia 3 4.36Russian Federation 4 4.13Netherlands 5 4.10Japan 6 4.03Canada 7 3.99France 8 3.98Hong Kong SAR 9 3.74Germany 10 3.52Singapore 11 3.37China 12 3.31Spain 13 3.25Ireland 14 3.21Brazil 15 3.20Switzerland 16 3.19India 17 3.12Korea, Rep. 18 3.02Italy 19 2.82Kazakhstan 20 2.81Denmark 21 2.80Sweden 22 2.67Jordan 23 2.58Belgium 24 2.48Malaysia 25 2.44United Arab Emirates 26 2.40Ukraine 27 2.39Argentina 28 2.28Norway 29 2.26Finland 30 2.26Egypt 31 2.16South Africa 32 2.13Bahrain 33 2.10Saudi Arabia 34 2.03Mexico 35 2.01Indonesia 36 1.96Israel 37 1.89Austria 38 1.87Chile 39 1.87Turkey 40 1.83Philippines 41 1.81Vietnam 42 1.73Poland 43 1.73Colombia 44 1.65Peru 45 1.60Panama 46 1.59Thailand 47 1.58Venezuela 48 1.52Hungary 49 1.48Czech Republic 50 1.41Pakistan 51 1.40Nigeria 52 1.26Slovak Republic 53 1.23Kuwait 54 1.13Bangladesh 55 1.03

6th pillar: Financial markets


United States 1 5.65United Kingdom 2 5.52Singapore 3 5.10Switzerland 4 4.96Japan 5 4.81Australia 6 4.63Germany 7 4.45France 8 4.42Hong Kong SAR 9 4.40Netherlands 10 4.22Belgium 11 4.21Canada 12 4.02Jordan 13 3.85Spain 14 3.81Italy 15 3.74Sweden 16 3.64Denmark 17 3.62Kuwait 18 3.53Finland 19 3.37Korea, Rep. 20 3.35United Arab Emirates 21 3.07India 22 2.96Austria 23 2.96Ireland 24 2.91Pakistan 25 2.75China 26 2.74Norway 27 2.73Panama 28 2.64Malaysia 29 2.47South Africa 30 2.38Saudi Arabia 31 2.33Israel 32 2.28Czech Republic 33 2.05Egypt 34 2.04Hungary 35 1.98Thailand 36 1.96Brazil 37 1.86Poland 38 1.84Bahrain 39 1.77Philippines 40 1.77Russian Federation 41 1.76Turkey 42 1.75Vietnam 43 1.71Bangladesh 44 1.67Venezuela 45 1.65Slovak Republic 46 1.52Chile 47 1.50Mexico 48 1.47Argentina 49 1.43Peru 50 1.42Kazakhstan 51 1.38Indonesia 52 1.35Nigeria 53 1.34Ukraine 54 1.33Colombia 55 1.27

7th Pillar: Financial access


Australia 1 5.19Austria 2 5.11Canada 3 4.75Belgium 4 4.73Bahrain 5 4.73Denmark 6 4.59United Arab Emirates 7 4.55Switzerland 8 4.47Singapore 9 4.22Saudi Arabia 10 4.21Egypt 11 4.19United States 12 4.19Hong Kong SAR 13 4.19Netherlands 14 4.16Ireland 15 4.04United Kingdom 16 4.02Panama 17 3.99Spain 18 3.95France 19 3.86Jordan 20 3.72Italy 21 3.72Malaysia 22 3.71Norway 23 3.69Israel 24 3.67Chile 25 3.63Sweden 26 3.59Czech Republic 27 3.46Finland 28 3.44Thailand 29 3.33China 30 3.31Brazil 31 3.31Vietnam 32 3.30Slovak Republic 33 3.29Poland 34 3.14Peru 35 3.14Indonesia 36 3.11Japan 37 3.03Turkey 38 3.01Kuwait 39 2.98Bangladesh 40 2.97Germany 41 2.96Hungary 42 2.95Mexico 43 2.95Colombia 44 2.90Ukraine 45 2.90Kazakhstan 46 2.89South Africa 47 2.89India 48 2.76Russian Federation 49 2.73Pakistan 50 2.66Philippines 51 2.54Korea, Rep. 52 2.50Nigeria 53 2.46Argentina 54 2.22Venezuela 55 2.14

Table 2: Financial Development Index 2009 (contd.)

FINANCIAL INTERMEDIATION FINANCIAL ACCESS

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in performance in the different dimensions of financialsystems represented. In Table 3 this finding is also appar-ent, as economies that are ranked in the top three spotsin each pillar do not necessarily achieve a strong overallscore or high scores in other pillars.

A country such as Norway achieves very strongperformance across the more foundational pillars relatedto institutional environment, business environment, andfinancial stability, yet is not as strong across the threefinancial intermediation pillars and the financial accesspillar.Austria achieves a first-place showing in financialaccess, yet has scores that are not as strong in other pillarswith an overall ranking of 18th place in the Index.

Thus a strong performance in one or even severalof the pillars does not necessarily translate to a strongperformance for a country in the overall ranking.Thishas important implications for how the Index should beviewed in the context of the current global financialcrisis. Given the degree to which the current crisis hascompromised the functioning of financial systems,changed assumptions behind financial system governance,and impacted the lives of many who have felt its effectin the real economy, it may be tempting to construe theIndex as a proxy for how stable or unstable countriesfinancial systems are. It may also be tempting to viewthe Index as an indicator of how favorable an economyis for investment.These views are both inaccurate as theIndex is both broader and longer term in scope: it looksat many different and often complex factors that supportthe long-term development of the financial systems itassesses. Financial stability is only part of the assessment ofhow well financial systems in these countries contributeto overall economic growth through the diversificationof risks and the efficient allocation of capital to thosewho most need it.

Consistent with the origins of the current financialcrisis in the United Kingdom and the United States,these countries show very low scores in the financialstability pillar (37th and 38th, respectively), driven

particularly by low scores in banking system and currencystability.At the same time, there is evidence of contin-ued strength across the financial intermediation pillarsthat capture such measures as the depth and efficiency oftheir banking systems (the United States is weaker thanthe United Kingdom here) the provision of importantnon-banking financial services such as IPOs, M&Aactivity, and insurance; and the size and activity of theirfinancial markets.

If one believes that financial stability should take amore prominent role in the Index than factors such asfinancial intermediation, what would that mean for theperformance of countries like the United States andUnited Kingdom within the Index? Table 4 illustrates howthe scores of the United States and the United Kingdomwould be affected by increased weighting of the financialstability pillar.All pillars are currently weighted equallyin the Index, which implies a weighting of approximately14 percent for each.As the weighting of the financialstability pillar is increased, first by 20 percent and thenby 40 percent, one sees that the rankings for the UnitedStates and the United Kingdom stay the same. It is onlywhen the weighting is increased by 60 percent (to anabsolute weighting of 23 percent) that the ranking ofthe United States drops by one place.When the weight-ing of the pillar is increased by 80 percent (representingan absolute weighting of over 25 percent of the totalIndex), the United Kingdom still remains in the topposition while the United States is still within the top 5.

Thus, even when increased weighting lends a greaterimportance to financial stability, this appears to be offsetby the other relative strengths of the financial systems inthese two countries.

Financial stability and access in developing countriesThis years Index points up some interesting findingswith respect to financial stability and access to financialservices in the developing economies covered. First, therankings and scores within the financial stability pillar

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Table 3: Countries ranked within the top three of each Index pillar

Financial Number of 4. Banking 5. Non-bankingDevelopment times ranked 1. Institutional 2. Business 3. Financial financial financial 6. Financial 7. Financial

Country/Economy Index 2009 rank in top three environment environment stability services services markets access

Australia 2 2 3 1Austria 18 1 2Canada 6 1 3Denmark 10 2 2 1 Hong Kong SAR 5 2 3 1 Japan 9 1 3 Norway 17 3 3 3 1 Singapore 4 3 1 2 3 Switzerland 7 1 2 United Kingdom 1 3 2 1 2 United States 3 2 2 1

FINANCIAL DEVELOPMENT INDEX PILLARS

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illustrate the degree to which the financial systems inmany developing countries have been able to weatherthe current crisis.Table 5 presents the top 20 performersin this pillar.A number of developing economies arerepresented hereamong them Chile, Malaysia, Mexico,Brazil, and the Czech and Slovak Republics.

Many developing economies entered the recentdownturn with much stronger macroeconomic and

financial fundamentals than they had in previous financialcrises.This included lower liability dollarization, lowerfiscal and private debt, and a better aggregate balancesheet for the financial services sector. For many countries,such as Brazil, this was the result of effective macro-economic and financial policy in the wake of past crises as well as generally favorable economic conditions thatincluded higher commodity prices and strong capital in-flows in the period preceding the crisis.

For some developing countries, which perform relatively well in this pillar but poorly in others, thisresult may represent the relative lack of integration anddevelopment of their financial intermediaries, whichlimited their exposure to the global financial turmoil.Asdescribed previously, in some instances financial stabilitymay imply a tradeoff with healthy risk-taking or theefficient allocation of capital to the highest-returninvestments.

The measures of retail access to financial services,new to the financial access pillar this year, illustrate somepotentially interesting findings with respect to developingcountries. Figure 3 shows average scores with respect to commercial and retail access for developing anddeveloped countries. Commercial access measuresinclude access to equity markets, private credit, and foreign investment that is generally more applicable tolarger enterprises.The retail access measures include themarket penetration of bank accounts, number of bankbranches,ATMs, and the penetration of microfinancemeasures that are more applicable to individuals andsmall businesses. On average, one sees that developing

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Table 4: Financial stability pillar: Sensitivity analysis

ORIGINAL WEIGHT

Pillar Weight (%)

1 14.292 14.293 14.294 14.295 14.296 14.297 14.29


United Kingdom 1 5.28Australia 2 5.13United States 3 5.12Singapore 4 5.03Hong Kong SAR 5 4.97

1.20 x ORIGINAL WEIGHT

Pillar Weight (%)

1 13.812 13.813 17.144 13.815 13.816 13.817 13.81




Pillar Weight (%)

1 12.862 12.863 22.864 12.865 12.866 12.867 12.86


United Kingdom 1 5.21Australia 2 5.17Singapore 3 5.09United States 4 5.07Hong Kong SAR 5 5.04


Pillar Weight (%)

1 13.332 13.333 20.004 13.335 13.336 13.337 13.33




Pillar Weight (%)

1 12.382 12.383 25.714 12.385 12.386 12.387 12.38


United Kingdom 1 5.18Australia 2 5.18Singapore 3 5.11Hong Kong SAR 4 5.06United States 5 5.05

Table 5: Financial stability: Top 20 economies

2009 rank Economy Score

1 Norway 5.732 Switzerland 5.663 Hong Kong SAR 5.634 Chile 5.625 Singapore 5.616 Saudi Arabia 5.607 Canada 5.578 Kuwait 5.499 Australia 5.48

10 Germany 5.3411 Finland 5.2712 France 5.2713 Malaysia 5.1414 Mexico 5.1315 Brazil 5.1316 Czech Republic 5.0817 United Arab Emirates 5.0718 Sweden 5.0719 Denmark 4.9920 Slovak Republic 4.92

Note: Highlighted countries are developing countries as defined by MoodysStatistical Handbook (November 2008). Some refinements have been madeto this year's Index that may affec

The Financial Development Report 2009

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