The development of an economy’s financial markets is closely related to its overall development. Well functioning financial systems provide good and easily accessible information. That lowers transaction costs, which in turn improves resource allocation and boosts economic growth. Both banking systems and stock markets enhance growth, the main factor in poverty reduction. At low levels of economic development commercial banks tend to dominate the financial system, while at higher levels domestic stock markets tend to become more active and efficient relative to domestic banks.
Open economies with sound macroeconomic policies, good legal systems, and shareholder protection attract capital and therefore have larger financial markets. Recent research on stock market development shows that modern communications technology and increased financial integration have resulted in more cross-border capital flows, a stronger presence of financial firms around the world, and the migration of stock exchange activities to international exchanges. Many firms in emerging markets now cross-list on international exchanges, which provides them with lower cost capital and more liquidity-traded shares. However, this also means that exchanges in emerging markets may not have enough financial activity to sustain them, putting pressure on them to rethink their operations.
Data on the stock market are from Standard & Poor’s Emerging Markets Data Base. They include measures of size (market capitalization, number of listed domestic companies) and liquidity (value of shares traded as a percentage of gross domestic product, value of shares traded as a percentage of market capitalization). The comparability of such indicators across countries may be limited by conceptual and statistical weaknesses, such as inaccurate reporting and differences in accounting standards. The percentage change in stock market prices in U.S. dollars for developing economies is from Standard & Poor’s Global Equity Indices (S&P IFCI) and Standard & Poor’s Frontier Broad Market Index (BMI). The percentage change for France, Germany, Japan, the United Kingdom, and the United States is from local stock market prices. The indicator is an important measure of overall performance. Regulatory and institutional factors that can affect investor confidence, such as entry and exit restrictions, the existence of a securities and exchange commission, and the quality of laws to protect investors, may influence the functioning of stock markets but are not included in the table.
Stock market size can be measured in various ways, and each may produce a different ranking of countries. Market capitalization shows the overall size of the stock market in U.S. dollars and as a percentage of GDP. The number of listed domestic companies is another measure of market size. Market size is positively correlated with the ability to mobilize capital and diversify risk.
Market liquidity, the ability to easily buy and sell securities, is measured by dividing the total value of shares traded by GDP. The turnover ratio—the value of shares traded as a percentage of market capitalization—is also a measure of liquidity as well as of transaction costs. (High turnover indicates low transaction costs.) The turnover ratio complements the ratio of value traded to GDP, because the turnover ratio is related to the size of the market and the value traded ratio to the size of the economy. A small, liquid market will have a high turnover ratio but a low value of shares traded ratio. Liquidity is an important attribute of stock markets because, in theory, liquid markets improve the allocation of capital and enhance prospects for long-term economic growth. A more comprehensive measure of liquidity would include trading costs and the time and uncertainty in finding a counterpart in settling trades.
Standard & Poor’s Index Services, the source for all the data in the table, provides regular updates on 21 emerging stock markets and 36 frontier markets. Standard & Poor’s maintains a series of indexes for investors interested in investing in stock markets in developing countries. The S&P/IFCI index, Standard & Poor’s leading emerging markets index, is designed to be sufficiently investable to support index tracking portfolios in emerging market stocks that are legally and practically open to foreign portfolio investment. The S&P/Frontier BMI measures the performance of 36 smaller and less liquid markets. The individual country indexes include all publicly listed equities representing an aggregate of at least 80 percent or more of market capitalization in each market. These indexes are widely used benchmarks for international portfolio management. See www.standardandpoors.com for further information on the indexes.
Because markets included in Standard & Poor’s emerging markets category vary widely in level of development, it is best to look at the entire category to identify the most significant market trends. And it is useful to remember that stock market trends may be distorted by currency conversions, especially when a currency has registered a significant devaluation.
Access to finance
Access to finance can expand opportunities for all with higher levels of access and use of banking services associated with lower financing obstacles for people and businesses. A stable financial system that promotes efficient savings and investment is also crucial for a thriving democracy and market economy.
There are several aspects of access to financial services: availability, cost, and quality of services. The development and growth of credit markets depend on access to timely, reliable, and accurate data on borrowers’ credit experiences. Access to credit can be improved by making it easy to create and enforce collateral agreements and increasing information about potential borrowers’ creditworthiness. Lenders look at a borrower’s credit history and collateral. Where credit registries and effective collateral laws are absent—as in many developing countries—banks make fewer loans. Indicators that cover getting credit include the strength of legal rights index and the depth of credit information index.
The “unbanked” have to resort to informal services to manage their money—saving under the mattress, borrowing from family and friends, or money lenders—that are usually less reliable and more costly than formal banking institutions. Data on financial access include: deposits and loans, and outreach indicators such as the number of branches, automatic teller machines, and point-of-sale terminals
Data on financial access cover 142 countries and present indicators on savings, credit,
and payment services in banks and regulated nonbank financial institutions. Data were collected for commercial banks and regulated nonbank financial institutions such as cooperatives, credit unions, specialized state financial institutions, and microfinance institutions.
Financial stability and efficiency
The size and mobility of international capital flows make it increasingly important to monitor the strength of financial systems. Robust financial systems can increase economic activity and welfare, but instability in the financial system can disrupt financial activity and impose widespread costs on the economy. The ratio of bank capital to assets, a measure of bank solvency and resiliency, shows the extent to which banks can deal with unexpected losses. Capital includes tier 1 capital (paid-up shares and common stock), a common feature in all countries’ banking systems, and total regulatory capital, which includes several types of subordinated debt instruments that need not be repaid if the funds are required to maintain minimum capital levels (tier 2 and tier 3 capital). Total assets include all nonfinancial and financial assets. Data are from internally consistent financial statements.
The ratio of bank nonperforming loans to total gross loans, a measure of bank health and efficiency, helps identify problems with asset quality in the loan portfolio. A high ratio may signal deterioration of the credit portfolio. International guidelines recommend that loans be classified as nonperforming when payments of principal and interest are 90 days or more past due or when future payments are not expected to be received in full. Domestic credit provided by the banking sector as a share of GDP is a measure of banking sector depth and financial sector development in terms of size. In a few countries governments may hold international reserves as deposits in the banking system rather than in the central bank. Since the claims on the central government are a net item (claims on the central government minus central government deposits), this net figure may be negative, resulting in a negative figure of domestic credit provided by the banking sector.
The interest rate spread—the margin between the cost of mobilizing liabilities and the earnings on assets—is a measure of financial sector efficiency in intermediation. A narrow interest rate spread means low transaction costs, which reduces the cost of funds for investment, crucial to economic growth. The risk premium on lending is the spread between the lending rate to the private sector and the “risk-free” government rate. Spreads are expressed as annual averages. A small spread indicates that the market considers its best corporate customers to be low risk. A negative rate indicates that the market considers its best corporate clients to be lower risk than the government.
Data on stock markets are from Standard & Poor’s Global Stock Markets Factbook 2010, which draws on the Emerging Markets Data Base, supplemented by other data from Standard & Poor’s. The firm collects data through an annual survey of the world’s stock exchanges, supplemented by information provided by its network of correspondents and by Reuters. Data on GDP are from the World Bank’s national accounts data files.
Data on getting credit are from the World Bank’s Doing Business project www.doingbusiness.org). Data on financial access and outreach are from the Consultative Group to Assist the Poor and the World Bank Group’s Financial Access 2010. Data on bank capital and nonperforming loans are from the IMF’s Global Financial Stability Report. Data on credit and interest rates are from the IMF’s International Financial Statistics.ons