Financial sector development must go beyond improving access to bank credit. Financial systems should develop in a balanced way through both bank and non-bank subsectors, including capital markets, the insurance sector, and other nonbank financial institutions to properly support inclusive growth in Europe and Central Asia, says a new World Bank report.

Risks and Returns: Managing Financial Trade-Offs for Inclusive Growth in Europe and Central Asia, launched today at the National Bank of Poland in Warsaw, notes that financial system in emerging countries in the Europe and Central Asia region is significantly less developed and less diversified than the financial system of their closest benchmark, Western Europe, and many of its middle-income peers.

To achieve sustainable and inclusive growth, the report argues that countries in the region must look at four key dimensions of financial development:

• Stability (e.g. addressing nonperforming loans and decreasing the volatility of private credit)
• Efficiency (e.g. reducing overhead costs and net interest margins on assets)
• Inclusion (e.g. increasing the use of electronic payments and insurance)
• Depth (e.g. developing capital markets and diversifying a country's financial system)

The report points out that throughout the 1990s countries across the Europe and Central Asia region opted for a model of rapid financial development, focused on expanding bank credit often funded by foreign capital. This model helped boost the financial inclusion of firms and households - but was also accompanied by lower financial efficiency and increased vulnerability. Consequently, the region experienced two major banking crises, first in the late 1990s and again after 2008.

Martin Melecky, co-author of the report and a World Bank Lead Economist in the South Asia Region says that they have seen some recovery and that what they are also seeing is that banks alone will be unable to support the kind of inclusive growth needed to drive the region in a long term.

He also said that the weak income growth particularly among people with lower incomes is leading to increased dissatisfaction with the status quo and greater mistrust in the financial sector.

The report stresses the importance for ECA countries to consider certain policy options including tackling the high level of nonperforming loans, setting up the framework for macroprudential policy in ECA countries, strengthening governance frameworks for state-owned banks, increasing the use of electronic payments, and promoting the use of insurance against increasing risks from climate change.