Financial sector adjustment lending
            : a mid-course analysis
Nearly 100 countries have experienced
            bank insolvencies in the past 20 years. Weakness in the
            financial sectors of many countries is reflected in the size
            of the insolvencies -in many cases, the cost of bailout
            exceeded 15 percent of GDP- and the fact that these crises
            often recur. Because a strong financial sector is important
            for economic growth, the World Bank has increasingly granted
            loans with conditions attached to achieve specific financial
            sector reforms. The Bank often employs financial sector
            adjustment loans (FSALs) or, in poorer countries, credits
            (FSACs). FSALs are generally more comprehensive than other
            types of interventions and tend to concentrate on the reform
            areas most closely linked to the operations of deposit
            banks. Since 1990, their main focus has shifted from
            improving prudential regulations and correcting interest
            rate distortions to privatizing and recapitalizing banks.
            The author examines whether 1) initial conditions in a
            recipient country explain a substantial amount of the
            variation in intervention outcomes (as measured by
            post-intervention financial deepening) and 2) whether the
            changing nature of interventions has had implications for
            their success. He finds that: 1) the decline in
            post-intervention performance since 1990 cannot be
            attributed solely to initial macroeconomic and financial
            sector conditions in the recipient country. 2) When initial
            macroeconomic and financial sector conditions were
            controlled for, certain types of reform, especially those
            dealing with prudential regulations, were associated with
            relatively large increases in the ration of money supply
            (M2) to GDP. Those dealing with recapitalization have also
            been relatively successful, especially when they also
            tackled prudential regulation or banking supervision. Those
            that focused on supervision did not, on average,
            substantially outperform those that did not, on average,
            focus on supervision. And reform focused on bank
            privatization was associated with much less financial
            deepening three years after the intervention. 3) In addition
            to reform aimed at institutional strengthening, the reform
            environment itself had a substantial impact on intervention
            outcomes. Financial deepening was positively associated with
            macroeconomic stability (low inflation) and an initially
            underdeveloped financial sector. 4) As the Bank's
            operational directives suggest, some macroeconomic stability
            is important for the success of financial sector
            interventions, especialy those that incorporate interest
            rate liberalization. While it may be best to move more
            aggressively on financial reform when macroeconomic
            circumstances are favorable, "visible" reform
            (such as privatization or interest rate deregulation) should
            be slowed down rather than abandoned in less fortunate
            circumstances. By contrast, less visible
            institution-building efforts should be continued regardless
            of macroeconomic conditions.