Economic indicators of financial development

The health of the financial services sector is integral to the overall level of global economic activity. For this reason, the major macroeconomic indicators are also very important pieces of data for the outlook of this sector. Financial services companies rely on high levels of business activity to generate revenue because they act as the intermediary in many economic transactions.

The financial services sector is made up of firms and institutions that provide financial services to commercial and retail customers. This includes banks, investment companies, insurance companies, and real estate firms.

Economic indicators are released through studies, surveys, sector reports, and the data-gathering efforts of government agencies. These indicators have wide-reaching implications for every economic sector. However, the financial services sector is perhaps the most sensitive to large economic aggregates.

Based on this approach some researchers have used one or more indicator to denote the degree of financial development.

Finance ration

The ratio of total issues of primary and secondary claim to national income

Financial Inter-relation ratio

The ratio of financial assets to physical assets in the economy.

Intermediation ratio

The ratio of secondary issue to primary issue, which indicates the extent of development of financial institution as mobilizers of funds relative to real sectors as direct mobilizers of funds. It indicates institutionalization of financial activity in the economy.

The ratio of money to income

Higher the ratio greater the financial development because it indicates the extent of monetization and size of exchange economy in the nation.

• Developed Financial sector is fully integrated domestically as well as internationally. In such system risk adjusted rate of return doesn’t differ significantly in respect of investor as well as saver.
• The lower the transaction and information cost, the higher the financial development.
• A developed financial structure is characterized by presence of strong, active, large sized non-banking financial sector comprising stock market, debt market, insurance companies, pension fund, mutual fund etc.
• The greater the financial development, the greater the openness of the economy reflected in high level of current account openness/convertibility, minimum restriction on foreign ownership of assets and repatriation of earning and absence of parallel foreign exchange market.
• In a developed financial system, private banking not the public sector banking is predominant.

1. Interest Rates

Interest rates are the most significant indicators for banks and other lenders. Banks profit from the difference between the rates they pay depositors and the rates that they charge to borrowers. Banks find it increasingly difficult to pass on interest rate costs to consumers as rates rise. High borrowing costs correspond with fewer loans and more saving. This limits the volume of total profitable activity for lenders.

It is very clear that banks perform best (at least in the short term) when interest rates are lower.

Lower interest rates also turn savers into speculators. It’s more difficult to beat inflation when the rate on a savings account or certificate of deposit (CD) is paying a low rate. Workers will turn more often to equities to try to find ways to counter inflation and grow their nest eggs for retirement. This creates demand for asset management services, brokers, and other money intermediaries.

2. Government Regulation and Fiscal Policy

Government regulation is not necessarily an indicator in the traditional sense; instead, investors should keep an eye toward how regulations and tariffs might impact activity from the financial services sector. Banks, which comprise more than half of the entire sector in the U.S., are heavily influenced by reserve requirements, usury laws, insurance and lending guidelines as well as the possibility of government assistance.

Fiscal policy doesn’t affect banks as directly. Rather, it impacts the banks’ possible customers and trading partners. Consumer confidence tends to rise during expansionary fiscal policy and fall during contractionary fiscal policy. This could translate into fewer investments, trades, and loans.

3. Gross Domestic Product (GDP)

Countries around the world track levels of economic activity through gross domestic product (GDP) calculations. Increases in the level of spending or investments cause GDP to rise, and the financial service sector typically sees increased demand for its goods and services when spending and investment levels go up.

Since GDP is the most common and broadest measure of a region’s economy and it is often considered a lagging indicator the relationship between any one company’s stock and the GDP is tenuous at best. Nevertheless, it is considered a useful benchmark for the overall health of the financial sector.

4. Existing Home Sales

The Existing-Home Sales report is issued monthly by the National Association of Realtors. It provides banks and mortgage lenders with recent data on sales prices, inventory levels, and the total number of homes sold.

This report often impacts prevailing mortgage rates. Investors in financial services and home construction should see upticks when home sales data is rising.