Financial systems and development

ecome the rule because historical cost accounting tion (which decreases the mobilization of resources
becomes virtually meaningless under such condi- and the availability of finance for investment).
tions. Market valuation can be equally trouble- As financial systems develop, different institusome
for assets with drastic, cyclical changes in tions evolve to take over some activities formerly
value (for example, some types of securities, raw performed by banks and to provide new services.
materials, and commercial real estate).
All these institutions, old and new, are integrated
Efforts have recently been made to harmonize in an increasingly complex financial system. This
accounting and auditing practices internationally complexity limits the ability of creditors to exercise
through the International Accounting Standards effective control and calls for prudential regulation
Committee and, in a more far-reaching way, and supervision.
within the European Community. The result is a
convergence of the Anglo-Saxon and continental Regulation of banks
approaches, with greater standardization of financial
statement formats on the one hand and a Bank supervisors in many developing countries fogreater
use of the concept of fair market value on cus on compliance with monetary policy regulathe
other.
tions, foreign exchange controls, and economic
In developing countries accounting and auditing policy regulations such as those for allocating
practices are sometimes weak, and financial laws credit. They pay relatively little attention to the
and regulations do not demand accurate and prudential aspects of financial monitoring. For extimely
financial reports. Developing an effective ample, in many countries supervisors make no inaccounting
and auditing profession is essential for dependent assessment of the quality of assets and
building efficient financial markets, and projects to give scant regard to accounting procedures and
do this have recently been introduced in Indonesia management controls. Together with macroecoand
Madagascar, for example. Training and educa- nomic instability and the lack of adequate legtion
are the main requirements, but appropriate islation, this is one of the main causes of bank
regulation and regulatory bodies are also needed. insolvency.
Timely accounts are very important for financial Governments in developing countries are preocinstitutions.
Annual or quarterly accounting might cupied with faster economic growth; they see
be sufficient for most nonfinancial firms, but finan- banks as an instrument for promoting the desired
cial institutions can lose their risk capital virtually investments, Often, however, these investments
overnight if, say, they hold large open positions in are the most risky from a bank's point of view, so
foreign exchange or futures and options contracts. the volume of credit extended to them remains less
Internal and external financial reporting therefore than the governments would like. The governneeds
to be much more frequent, with certain ment reaction is often to force the banks to extend
kinds of information available to management credit to priority sectors. This policy has been purdaily.
sued without adequate attention to the risks involved.
With the benefit of prudential regulation
Prudential regulation of financial
and supervision, however, governments can obinstitutions
and markets
tain information about the consequences of their
policies while there is still time to modify them.
Procedures for settling private disputes are set The goal of bank supervision, then, is to proforth
in most company laws, commercial codes, mote a safe, stable, and efficient financial system.
and special banking acts, but the development of a The main task is to prevent bank failures, but this
sound financial system requires additional mea- does not mean that financial institutions should
sures. Prudential supervision by government au- not be allowed to fail. Bank supervisors must try to
thorities is warranted for banks and some other identify problems at an early stage and intervene
financial institutions and markets. Banks hold an before the situation gets out of hand. For this reaimportant
part of the money supply, create money, son they have to be organized in such a way that
are the main means of implementing monetary they are constantly aware of developments.
policy, administer the payments system, and intermediate
between savings and investments. Prob- ORGANIZATION. In many developing countries
lems in one bank can quickly spread through the supervision tends to rely predominantly on analyentire
financial system. Bank failures have mone- sis of bank reports or on bank inspections. Off-site
tary and macroeconomic consequences, disrupt supervision cannot assess risk adequately, and inthe
payments system, and lead to disintermedia- spections tend to be too infrequent. Effective su-
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