Financial Services

1. Financial Services UN STATISTICS DIVISION Economic Statistics Branch National Accounts Section UNSD/ECA National accounts workshop November 2005 1

2. Definition of financial corporations • Treatment of own funds • Treatment of SPE and customers • Identifying financial services • Treatment of holding gains and losses • Choice of the reference rate • Treatment of market makers

3. Background Developments in the financial markets have changed the way financial corporations operate Is the 1993 SNA recommendation for calculating output of financial corporation services still relevant?

4. Current SNA –FISIM The total value of FISIM is measured in the System as the total property income receivable by financial intermediaries minus their total interest payable, excluding the value of any property income receivable from the investment of their own funds, as such income does not arise from financial intermediation (par 6.125) 

5. Current SNA - allocation When the output is allocated among different users, one way is to base the allocation on the difference between the actual rates of interest payable and receivable and a "reference" rate of interest.       (a)  For those to whom the intermediaries lend funds: the difference between the interest actually charged on loans, etc. and the interest based on a reference rate;     (b)  For those from whom the intermediaries borrow funds: the difference between the interest based on the reference rate and the interest they actually receive.

6. Current SNA - allocation The reference rate to be used represents the pure cost of borrowing… Alternatively, allocation in proportion to the total financial assets and liabilities …, or other relevant financial variables. Some flexibility is accepted in the way in which the output is allocated.   Some countries preferred to continue to use the convention in the 1968 SNA by recording output of FISIM to intermediate consumption of a nominal industry.  

7. What has changed? Risk management and Liquidity transformation

8. SNA93 focuses on activities of the financial corporations Financial corporations are defined as: “…all resident corporations or quasi-corporations principally engaged in financial intermediation or in auxiliary financial activities which are closely related to financial intermediation” (Paragraph 4.77).

9. Definition of financial corporationsSNA 93 perspective • Definition mainly related to activity (financial intermediation) • Key elements: “Risk taking’’ and “repackaging’’ • No services or composition of assets and liabilities are specified • Ambiguity about the role of own funds

10. Definition of financial corporations Financial corporations consist of all resident corporations and quasi corporations that are principally engaged in providing financial services including insurance and pension funding services to other institutional units. The production of financial services is the result of financial intermediation, risk management, liquidity transformation and/or auxiliary financial activities.

11. Definition of financial corporations Financial intermediation, financial risk management and liquidity transformation are productive activities in which an institutional unit incurs financial liabilities for the purpose of acquiring mainly financial assets. Corporations engaged in these activities obtain funds by taking deposits and issuing bills, bonds or other securities. They use these as well as own funds to acquire mainly financial assets by making advances or loans to others and by purchasing bills, bonds, or other securities.

12. Definition of financial corporations Financial services provided include monitoring services, convenience services, liquidity provision services, risk assumption services, underwriting services and trading services.

13. Definition of financial corporations • Auxiliary financial activities facilitate the provision of financial services • Financial auxiliaries – the units that are primarily engaged in auxiliary financial activities – typically act on behalf of other units and do not put themselves at risk by incurring financial liabilities or by acquiring financial assets.

14. Definition of financial corporations In principle, financial services can be provided as a secondary activity. In practice, however, in many countries, the provision of financial services is so strictly regulated that there may be no other unit providing financial services. By convention, even if financial services are provided by non financial corporations, no indirect charges are imputed. On the other hand, financial services provided for explicit charges are recorded as such.

15. Own fundsSNA 93 perspective • Relates to units that finance themselves exclusively via equity. • SNA (6.134): lending of own funds “ (…) is not financial intermediation as [units] do not channel funds from one group of institutional units to another. Lending as such is not a process of production and the interest received from the lending of own funds cannot be identified with the value of any services produced.”

16. Own funds The 1993 SNA states that lending own funds does not give rise to production. While it is true that units lending own funds do not engage in financial intermediation, with a broader definition of financial services, units lending own funds may provide a financial service.

17. Own funds At a minimum, an incorporated enterprise (thus with a full set of accounts) which, as its main activity, provides loans to a range of clients and incurs the financial risk of the debtor defaulting, should be treated as a financial corporation. Its allocation to the appropriate sub-sector has yet to be determined.

18. Own funds In addition, some unincorporated enterprises which provide loans to a range of clients (other than just family and friends) on a regular business basis may also be treated as providing financial services. The advice of experts from countries where this practice is widespread is needed to specify when and how such units are to be identified and whether they are to be treated as unincorporated enterprises in the household sector or quasi-corporate enterprises in the financial sector.

19. Activities and customers • What about units which : • Are set up to carry out well-specified activities or transactions directly related to a specificpurpose ? • For example: Asset management, corporate treasury services, special purpose vehicle companies Provide financing and asset holding services to one company ? For exampleholding companies and trusts but also Government sector (public-private partnerships, securitization programs, etc)

20. Special Purpose Entities (SPEs): Institutional units? • Ancillary units: • Restriction: “…providing services to the parent corporation” (SNA 93,paragraph 4.40). • “(…) not treated as separate institutional units because they can be regarded as artificial units created to avoid taxes, to minimise liabilities in the event of bankruptcy, or to secure other technical advantages under the tax or corporation legislation in force in a particular country’’ (SNA93,paragraph 4.44).

21. Activities and customers An entity providing financial services to only one unit or a group of units is considered to be a separate institutional unit (and a financial corporation) if it keeps a complete set of accounts and is capable of acquiring assets and incurring liabilities on its own account.

22. Activities and customers A similar entity which does not have a complete set of accounts is treated an institutional unit (and a financial corporation) only if it is resident in a country other than any of the units to which it is providing the services, in accordance with SNA/BPM practice of treating non-resident unincorporated enterprises as quasi-corporations

23. Identifying financial services • Financial services: output provided by financial corporations to customers, either explicitly or implicitly • Financial instruments: means through which financial corporations provide packages of financial services to their customers.

24. Identifying financial services Financial institutions charge for some services explicitly and some implicitly. From an economic perspective, all financial instruments are potentially involved in the production of financial services. Some financial instruments attract only explicit charges but several may attract implicit charges alone or in addition to explicit charges. Deposits and loans attract implicit charges and these instruments are included in the calculations of FISIM. Other instruments may attract FISIM but will not be included unless a clear allocation to users is possible. Thus, in practice, FISIM may be limited by convention to loans and deposits.

25. Treatment of holding gains and losses • Expectations of holding gains provide incentives to engage in productive processes. • Holding gains expectations are part of the decision making process. • Holding gains are components of returns on financial assets.

26. Treatment of holding gains and losses When measuring the implicitly valued output of financial institutions, the question arises of whether expected holding gains and losses of financial institutions on their own account should be included in the measure. There is no question of including holding gains and losses as such in a direct measure of output in the SNA. However, for certain financial instruments, expected price changes constitute an important part of expected returns. In principle, therefore, they could be considered when approximating the value of financial services indirectly measured.

27. Treatment of holding gains and losses Despite this conceptual position, given the empirical difficulties in estimating expected holding gains and losses, it is presently not recommended to include expected holding gains and losses in the measurement of financial services output.

28. The choice of the reference rate • SNA 93: the reference rate “…represents the pure cost of borrowing funds – that is a rate from which the risk premium has been eliminated to the greatest extent possible and which does not include any intermediation services”.

29. The choice of the reference rate The reference rate used in the compilation of FISIM should be a risk-free rate that has no service element in it and that reflects the maturity structure of the financial assets and liabilities to which FISIM applies. It is recommended that a single reference rate be used for transactions in the local currency, but different reference rates may be used for transactions in other currencies.

30. Market makers In practice, virtually all transactions in foreign exchange and securities are carried out via financial corporations. Two prices are quoted for transactions in securities: a bid price and an ask price. The first is the price which the potential buyer is to pay, and the second is the price that the owner receives on sale. The mid-price is by convention taken to be the average of these two prices. The difference between the bid price and the mid price is a margin paid by the buyer to the financial corporation, and the difference between the mid price and the ask price is a margin paid by the seller. The value of securities in the balance sheet is at mid price and excludes theses margins.

31. Market makers Financial corporations buy and sell securities both on their own account and on behalf of clients. Buying and selling on behalf of clients may be on demand, that is in immediate response to an instruction from the client to buy or sell a specific security. Alternatively, a financial corporation may acquire a stock of securities in order to meet future demand immediately. This activity is called market making and may be undertaken by specialised financial corporations or financial corporations providing a wide range of financial services.

32. Quotes, market makers and margins The SNA should measure the margins on the buying and selling of all securities by all financial corporations and attribute these as being paid by the seller and the buyer respectively, regardless of the purpose for which the securities and other instruments are being bought or sold. When there is a delay between the purchase and sale of a security, in order to avoid including holding gains and losses, the margins are calculated on the basis of the prices prevailing at the time the purchase and sale take place.

33. Thank You