Measurement of Implicitly-Priced Services of Banks in the US National Accounts Marshall Reinsdorf US Bureau of Economic Analysis Presented at the 13 th Colloque de l’ACN Paris, June 2, 2010 Why National Accounts include FISIM
Value of output of a market producer is measured by prices. But explicit prices aren’t charged for credit intermediation services. Commercial banks substitute interest rate margins for explicit prices for services to borrowers and depositors. SNA uses the reference rate approach to measure FISIM (financial intermediation services indirectly measured). Without FISIM, bank employees and fixed capital would be shown as producing very little, resulting in negative gross operating surplus. Negative GOS means that banks rely on income attributable to the production of others to pay labor and other costs, so that the industry is, in effect, a “leech on the income stream.”
bea.gov Reference Rate Approach to Measuring FISIM Reference rate r ref represents the opportunity cost of funds both for bank and for its customers. Rate margin above the opportunity cost of funds covers the cost of providing unpriced services to borrowers. Unpriced services to depositors compensate for gap between rate they get and opportunity cost of funds. rA ≡ rate on assets (loans); rD ≡ rate on liabilities (deposits); A ≡ assets included in borrower FISIM; and D ≡ liabilities included in depositor FISIM.
bea.gov Total FISIM < Net interest reported by banks
Description Formula
Borrower FISIM (r A – rref )A
Depositor FISIM (r ref – rD)D
TOTAL FISIM (r A–rref )A + (r ref –rD)D
Net interest reported by bank if A rAA – rDD = r ref (A – D) and D include all interest-bearing + (r A–rref )A + (r ref –rD)D assets and liabilities
“Pure” net interest income of bank rref (A – D) + recorded in national accounts net interest from any items excluded from A and D
bea.gov I. 3 Debates concerning the Definition of FISIM
1. Should FISIM be imputed on assets other than loans and on liabilities other than deposits?
2. Should liquidity provision/transformation count as a service?
3. Should the reward for risk-bearing count as a service?
Warning: Answering “no” to all three questions probably means adopting the “leech on the income stream” view of banks.
bea.gov 1. Should FISIM be limited to loans & deposits?
Premise is that unpriced services can be provided only when there’s a direct connection to a customer. No such connection exists if a bank buys (or issues) bonds, for example. But limiting FISIM to items labeled as loans or deposits is too restrictive. A securitized loan held by the bank continues to provide borrower services. Deposit-like liabilities, such as customer repurchase agreements and sweeps, provide similar services to explicitly identified deposits. In the US, banks have substituted other assets for loans and other liabilities for deposits, so narrow definition would understate the industry’s growth rate. For the US national accounts, this is more a theoretical issue than a practical one: FISIM is imputed on bonds but the amounts are negligible.
bea.gov 2. Should liquidity provision count as a service?
Ready access to funds provides convenience and security. Households and businesses want short maturities on deposits and securities they buy, and long maturities on their borrowings. To accommodate customer’s desire for liquidity, banks must fund long-term, illiquid loans with short-term, easily withdrawn deposits. Diamond and Dybvig (1983) view “liquidity transformation” (funding long-term loans with short-term liabilities) as core function of banks. To satisfy customers’ liquidity needs, banks must manage reserves, maintain a liquid balance sheet, and protect reputation for safety, via risk management and working with troubled borrowers. Maturity-matched reference rates would have effect of excluding liquidity transformation from our measure of the output of banks. Meaning of “maturity” not same for loans/deposits vs. securities.
bea.gov 3. Should reward for risk-bearing count as a service?
Wang, Basu and Fernald (2004) develop a model in which rates on business loans include a risk premium that is not a service. In the model, investments with non-diversifiable risk must have higher expected returns to compensate for disutility of risk-bearing. Each business borrower has an exogenous level of risk and can obtain financing from a variety of sources. The expected value added generated by the borrower’s business must provide investors with compensation for risk-bearing. Bank loans used finance the business must include a risk premium. Value added should be invariant to how the business is financed. Including in FISIM the risk premium part of loan rate violates invariance by reducing measure of borrower’s value added .
bea.gov But is this model a good description of bank lending?
Finance literature models meant to apply to securities markets. Securities are tradable because they have uniform characteristics, and exogenous levels of risk that are not contingent on ownership. Bank loans are idiosyncratic and have levels of risk that partly depend on the effort and skill with which they are managed. Risk is also match-specific: bank often has a long-term relationship with the borrower, a detailed understanding of the borrower’s business, flexibility to renegotiate lending terms, and ability to provide liquidity services to the borrower. Products (or even the business itself) often would not exist without the bank loans. Invariance axiom is inapplicable if no substitute for bank loan exists.
bea.gov II. Implementation of reference rate in the NIPAs
Reference rate approach was implemented in US national income and product accounts (NIPAs) in 2003. Before the change, all FISIM was treated as depositor services, so direct effect was to reclassify some FISIM as borrower services. Broad definition of in-scope assets and liabilities was chosen. Average realized rates calculated from ratios of flow to stocks. Average realized rate on Federal government and agency debt held by banks used as reference rate. At the time, government agency date was perceived as risk free. With these procedures, neither borrower not depositor FISIM had negative estimates.
bea.gov Position of the Reference Rate
Figure 1: Position of the Reference Rate in between the Average Rates Received on Loans and Paid on Interest-Bearing Depo sits 14
12
10
8
6 Percent per year per Percent 4
2
0
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 85 87 89 91 93 95 97 99 01 03 05 07 09 19 19 19 19 19 19 19 19 20 20 20 20 20
bea.gov Effect of Comprehensive Revision of 2003 on Estimates of FISIM in 2001 (billions of $) Estimate using Difference reference rate from approach previous estimate Total implicitly-priced output 186.6 -69.1 Final consumption (GDP) 93.6 -91.9 Persons 78.8 -78.1 Government 5.4 -5.0 Rest of World 9.4 -8.9 Intermediate consumption 93.0 22.8 Financial corporations 7.3 -2.6 Nonfinancial corporations 45.2 3.9 Sole proprietorships and partnerships 20.3 1.5 Landlords, owner-occupiers and NPISHs 20.2 20.1
Decomposition of Difference of -69.1 in Total Imputed Output Decrease in US Increase in Output No FISIM Offices of attributed to Foreign on Own Funds Source Data Foreign Banks Offices of US Banks -19 -13 -13.4 23.7 bea.gov Slowdown of Relative Growth of FISIM
Figure 2: Value Added of Banks and of Financial Cor porations, and Implicitly and Explicitly Priced Bank Services
9.0
Implicitly priced output of commercial banks 8.0 Explicitly priced output of commercial banks Value added of commercial banks 7.0 Value added of financial corporations
6.0
5.0
4.0 Percent of GDP of Percent
3.0
2.0
1.0
0.0
0 0 7 0 9 980 0 1960 1 1 1990 2 bea.gov Slower Growth of Implicitly-Priced Services
Figure 3: Growth of Depositor and Borrower Services (Deflated by the Implicit Price Index for FISIM)
12.5
12
11.5
11
10.5
10 total depositor services
log of Depositor or Borrower Services Services Borrower or Depositor of log total borrower services 9.5 implicitly-priced depositor services
implicitly-priced borrower services 9
4 6 8 0 2 64 66 68 70 72 90 92 94 04 06 bea.gov 9 9 9 9 9 97 97 97 9 9 9 0 0 1960 1962 1 1 1 1 1 1 1 1 198 198 1984 1986 1988 1 1 1 1996 1998 2000 2002 2 2 III. Research in Progress at BEA
Improving measurement of commercial banks is among our research projects in the National Accounts Directorate. Topics include: Methods to reduce volatility of the split between borrower and deposit services; Accounting for expected credit losses (bad debt write-offs); Better measures of volume of FISIM by direct deflation.
bea.gov Accounting for Expected Credit Losses
Ignoring bad debts in national accounts is fine, except when bad debts are expected as part of normal operations. A portion of interest margins on loans is intended to substitute for explicit repayment of principle by borrowers who default. Economic definition of interest is excess of expected receipts from borrowers over the amount of principle borrowed . Some parallels with treatment of expected claims in insurance and with Vanoli’s treatment of interest under high inflation. Should exclude expected bad debt losses from FISIM. Might also exclude from bank income and profits (unlike Wang proposal!) but this would raise borrower’s income and saving.
bea.gov Interest rate and loss rate differentials compared with real estate loans
Figure 6: Charge-offs and Interest Rate Margins, 2001-2009
0.025
0.02
0.015
0.01
0.005 Quarterly Rate (Relative to Real Estate) (Relative Rate Quarterly
0 2001Q1 2001Q2 2001Q3 2001Q4 2002Q1 2002Q2 2002Q3 2002Q4 2003Q1 2003Q2 2003Q3 2003Q4 2004Q1 2004Q2 2004Q3 2004Q4 2005Q1 2005Q2 2005Q3 2005Q4 2006Q1 2006Q2 2006Q3 2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2
-0.005 Quarter
Credit Card Charge-offs Rel. to Real Estate C&I Charge-offs Rel. to Real Estate Credit Card Interest Rel. to Real Estate C&I Interest Rel. to Real Estate bea.gov Experimental Measures of Borrower FISIM (Smoothing Ref. Rate and Deducting Credit Losses)
Figure 4: Borrower Services, Quarterly Imputed Gros s Output
70000
60000
50000
40000
Current $ (M) $ Current 30000
20000
10000
0 1985Q2 1986Q4 1988Q2 1989Q4 1991Q2 1992Q4 1994Q2 1995Q4 199 7Q2 1998Q4 2000Q2 2001Q4 2003Q2 2004Q4 2006Q2 2007Q4 2009Q2 Quarter
Current Method Stabilized Rate Stabilized Rate Net of Expected Charge-Offs bea.gov Concluding Thoughts
Measuring bank output presents hard conceptual and practical challenges!
Theorists should bear in mind that methods have to be simple to be practical.
Definitions of FISIM that result in negative output or negative gross operating surplus are not believable.
Liquidity transformation is a service.
Banks’ willingness to pay for deposits is high, which suggest that they provide substantial amounts of unpriced services to depositors. bea.gov