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Financial Accounts in Iceland Methods and Results

Financial Accounts in Iceland Methods and Results. B rief economic background of importance for the financial development in Iceland and for understanding the development of financial accounts What are financial accounts

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Financial Accounts in Iceland Methods and Results

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  1. Financial Accounts in IcelandMethods and Results Brief economic background of importance for the financial development in Iceland and for understanding the development of financial accounts What are financial accounts Compilation and preparation of financial accounts, methodology, valuation, reconciliation, source data, etc. Results and interpretations of financial accounts The use of financial accounts or flow-of-funds accounts for economic analysis

  2. The economic development in Iceland A short background of the Icelandic economy before looking at the development of the financial accounts: In 2003, the Central bank lowered the reserve requirement for the ICE banking system from 4 percent to 2 percent, in accordance with European rules. The lending capacity of banking system was increased by around one GDP. In 2003, the banking system was dominated by three banks; two state owned and one private. The state banks were privatized 2003 and sold to favorable partners who had not much banking experiences. In the parliament spring election 2004, one of the political parties promised to increase the loan-to-value ratio of the State Housing Fund to 90% if it came into power. This promise was introduced in August 2004. Inflationary pressures => policy rate increasing (5.3% May 2004 to 14,3% March 2007) => bank credit growth fuelled by the carry-trade capital inflows attracted by high yields => appreciated ISK krona and falling import prices fuelled private consumption demand. Low international interest rates => Icelandic firms borrowed in foreign currency at low rates Wealth effects, portfolio effects, easy capital, etc.

  3. The Main Price Indices 1995-2013

  4. The GDP in fixed prices (2005) and GDP growth

  5. Relationshipsbetween GFSM 2014and ESA 2010 ESA10 SNA’08 GFSM 2001 Transactions Transactions Revenue account Production account GDP (value added) Expense account Income account Operating balance Saving Non-financial assets Other economic flows Closing balance sheet Capital transfers & Non-financial assets Other economic flows Closing balance sheet Financial assets & liabilities Financial assets & liabilities Net lending / borrowing

  6. Full system of financial accounts Transactions Other economic flows Flows

  7. What are financial accounts

  8. What are financial accounts

  9. The Development of Financial Accounts in Iceland, collaboration & publishing The development started in 2010 with an agreement between the Statistics Iceland and the Central Bank of Iceland The CB collects data for the financial sector and the rest of the world (IIP) Statistic Iceland collects and processes data for other sectors and finalizes the compilation and balancing of the accounts To start with the ESA 1995 (European System of Accounts, 1995) was used Statistic Iceland got 3 years IPA grant (though 2013-2015) from the EU (IPA=Instrument of multi-beneficiary Pre-Accession Assistance) to introduce ESA 2010 Currently, only stock data are published for the whole economy and its sectors Stock and flow data will be published later this year according to ESA 2010

  10. The Development of Financial Accounts in Iceland, methodology The financial accounts are classified by the sectors/subsectors on the financial markets and by the nature of financial instruments (liquidity and legal characteristics) • AF.1 Monetary Gold & Special Drawing Rights • AF.2 Currency and deposits • AF.3 Securities other than Shares • AF.4 Loans • AF.5 Shares and other Equity • AF.6 Insurance technical reserves • AF.7 Financial derivatives • AF.8 Other accounts receivable/payable The Icelandic economy is divided into five main sectors and eight subsectors and the rest of the world is also added, so they are fourteen in total.

  11. The Institutional Sectors in Iceland

  12. The compilation and reconciliation of financial accounts Whom-to-whom basis - debtor and creditor sectors / two sides involvement - show detailed asset and liability positions of both sectors at end of the period - comparing the available data with the counterpart data - considerable difference can exist /same financial instrument - definitions, timing and valuation methods The main matrix depicts two sources of data were available - source data - counterpart data Establish a hierarchy/ranking order of sources Select a “final” amount of each instrument, for the combination of debtor/creditor sectors Sometime needs to make a judgment based on: (1) data revalidation and cross-checks; (2) consultation with experts; and (3) published vs. unpublished data, etc.

  13. Primary data sources • Financial balance sheets • Aggregated tax return statements • A need to ranking data sources

  14. Simplified matrix S: source data C: counterpart data F: final dataUsually Y≠X

  15. Challenges Different valuations • ESA recommends market value • Some methods to approach or estimate the market value • Pricelist/price-register of comparable instruments • Various calculation methods used to approach the market value Calculation of quoted and unquoted shares problematic in the absence of robust stock market Data on loans and securities needs to be disaggregated Work initiated on reducing data discrepancies between IIP and financial sector Need to strengthen data collection of NPISHs - To be disaggregated from the household sector in 2015

  16. Valuation of financial instruments The valuation of financial instruments can vary greatly due to their nature: Gold reserves (F.11) is determined by the gold market SDR´s (F.12) valued in ISK króna at daily rate published by the IMF Currency and deposits (F.2) valued at nominal prices Securities (F.3) are valued at market prices Loans (F.4) are usually valued at nominal prices, the market prices of loans can fluctuate according to their nature and lifetime Valuation of shares and equities (F.5) or the net worth is difficult in Iceland: (1) the stock market or (2) the difference between assets and liabilities. Insurance technical reserves (F.6) valued on marked prices Other accounts receivable/payable (F.8) are usually recorded at nominal value depending on their nature

  17. First issue problems in Iceland Some problems appeared related to data compilation and the methodology that needed be solved: Shortage of financial data on special purpose entities and holding companies Some financial data only available as aggregated data, e.g. securities and sometimes securities and loans not separated Very difficult to draw right picture of the Icelandic economy during the period 2007-2009 due to data problems following the economic crisis (and due to fall of the ISK króna and frequent exchange fluctuations – foreign assets) Inconsistency between source data from foreign entities (S.2) and financial corporations (S.12) – each case scrutinized Discrepancy in National Tax Authority’s source data and depository banks regarding loans to HHs and NFCs during 2008-2009 due to different valuations Discrepancy in data sources of FCs in winding-up process and the bankrupt entities Attempts have been made to harmonize as much as possible the financial data collected by Statistics Iceland and the Central Bank

  18. Financial accounts for one year – stock figures The following figures show some of the latest result and give an idea of what is produced in Iceland.

  19. % of GDP • In 2012, the total financial assets (FA) of the HHs and NPISH was 3,8 billion ISK or 214 of GDP. • It was 185% of GDP in the beginning of the period and its highest proportion was 229% of GDP in 2007, but fell to 197% in 2008 following the crisis. • Pension claims are the largest FA. They were 163% of GDP in 2012 compared with 125% of GDP in 2003. It reached 151% of GDP in 2006, but fell to 131 in 2008. • The currency and deposits were 36% of GDP in 2012, but its peak was 51% in end of 2008. • In end of 2007, the shares and equities were 30% of GDP but fell to 8.6% in 2008 following the crisis. In end of 2012, it was 8.3% of GDP. • The financial liabilities of HHs and NPISHs were 95% of GDP in end of 2012 and had been close to that in the beginning of the period. Its peak was in 2007 reached the level of 115% of GDP. • The liabilities are mostly in form of loans. • The net financial assets position was 119% of GDP in end of 2012 and has not been higher. In 2007, it reached of 114% but fell to 100% in 2008. In the beginning of the period it was 92%.

  20. % of GDP • The financial assets position of NFCs was 345% of GDP in end of 2012. It reached is peak in 2007 when it was 729% of GDP. In the beginning of the period it was 206% of GDP. • Through the period the shares and equity was the biggest asset part. It when up to 446% of GDP in 2007 but fell drastically in 2008 to 203% of GDP and was 125% in end of 2012. • The other part of interest here is the development of the asset position in securities and loans, which is now the biggest financial assets of the NFCs or 146% of GDP. % of GDP • The net financial worth of the NFCs reached its lowest point in 2007 when it was negative by 242% of GDP. In the beginning of the period it was 133% of GDP and in end of 2012 it was 121% of GDP. • Securities and loans is the biggest liabilities part and it reached the highest ratio in 2008 when it was 466% of GDP. It was 296% in end of 2012 and 172% in the beginning of the period. • It is also interesting to see the development of the liabilities in shares and equities which accounted for 416% of GDP in 2007 and fell to 196% of GDP in 2008. It was 123% of GDP in end of 2012.

  21. As shown in this figure, the financial assets position of FCs was 10 times the GDP in 2007 • By excluding the FCs in the winding-up process, the asset position went down to 553% of GDP in 2008. The financial assets of the FCs in the winding-up process was 186% of GDP in 2008. Billion ISK • In end of 2007, the financial liability position was close to 10 times the GDP, so the net financial worth of FCs was positive of 10% of GDP. • Following the crisis, the liability position went up to 1,295% of GDP in 2008, but has reach the level of 1,040% of GDP in 2012. • Around 55% of the liability position is in winding-up process. • The net financial worth was slightly positive up to 2007, but has changed drastically following the crisis.

  22. The financial asset position of depository corporations was 168% of GDP in 2012 and as well in 2003, but had reached its peak in 2007 when it was 704% of GDP. • The great majority of the assets is loans. • The development of the liability position of DFCs is similar to the their assets development. • In 2012, the total liabilities were 167% of GDP compared with 174% in 2003. The highest ratio was 706% of GDP in 2007. • The net financial worth of DFCs was negative by 19% of GDP in 2008. • From 2008 and onward, the largest liability part is currency and deposits. But prior to that, it was securities and loans. • Securities and loans were 405% of GDP in 2007, but 39% in 2012.

  23. % of GDP • The financial asset position of IFCs 146% of GDP in end of 2012 compared with 104% in the beginning of the period. • It was 134% of GDP in 2007, but fell to 116% in 2008. • The largest part of the assets is securities, but in 2005-2007 the shares and equity was larger. % of GDP • The net financial worth of general government was negative by 54% of GDP in 2012 and had been deteriorated since 2007 when it was positive by 1% of GDP. In the beginning of the period it had been negative by 30% of GDP. • The total liability position was 125% of GDP in 2012 compared with 71% in 2003. It was 52% in 2007 and jumped to 100% in 2008. • Most of the liabilities are with the central government.

  24. % of GDP • The financial assets of RoW went from 143% of GDP in 2003 to 625% in 2007, then there was a jump to 945% of GDP in 2008 due to the crisis. It has since been reduced to 738% in 2012. • The bulk of the assets is in form of securities and loans. • Currency and deposits increased drastically in 2007-2008 and has been considerable due to the capital control. % of GDP • The RoW liabilities increased rabidly through 2003-2007 or from 79% of GDP in 2003 to 508% in 2007. • The due to the crisis the liabilities fell drastically and was 272% of GDP in 2012. • The RoW's net financial worth increased slowly from 2003 to 2007, but jumped from 118% of GDP to 660% of GDP between 2007 and 2008 due to crisis and the exchange rate crash.

  25. Money flows between non-MFIs, MFIs and RoW MFI credit to non-MFIs Money holdings Non-MFIs MFIs Financial investments other than money RoW credit to non-MFIs Net lending of non-MFIs Rest of the world Cash flows are received by the sector with a net lending position from sector with a net borrowing position.

  26. Analytical uses of financial accounts Flow of funds provide comprehensive and consistent set of macro-finance information on all sectors of the economy. Integrated with the non-financial accounts, they provide unique overview for analysis of interactions between the real and financial sides of the economy and the assessment of major risks of financial imbalances A detailed flow of funds table can be used in many important areas related to economic policy: • Analyzing and descripting activities and trends in current periods. • In projections of production and assessment of economic policies - How will the central government’s deficit be financed? - How will the major public nonfinancial corporations be financed and by whom? • In modelling of the economy to study economic behavior. • To help to analyse the interrelation between real investment, financial investment and saving. • To assess financial stability • After the crisis the analysts have focused on: financial imbalances, evolution of the balance sheets of financial intermediaries, development in BSs of HHs and NFCs as financial indicators like debt ratios, financial wealth (wealth effects), growth of public debt, etc.

  27. Analytical uses of financial accounts Portfolio shifts between money and other financial assets. Two main sources of changes in the money holdings of non-MFIs • A “credit effect” with the rise in total FAs of non-MFIs due to MFI credit • A “portfolio shift effect” a shift between money and non-monetary FAs in in the total financial assets held by non-MFIs

  28. Analytical uses of financial accounts Banking intermediation - Comparing MFI credit to non-MFIs with total credit to non-MFIs - 2007: MFI’s credit 39% of total financing, loans 73% of total and debt securities 20%

  29. Conclusion FoF is a key framework for the analysis of monetary, financial and economic developments and the interrelations between them. FoFs allow financial intermediation process to be tracted In modelling of the economy to study economic behavior. To help to analyse the interrelation between real investment, financial investment and saving. To assess financial stability After the crisis the analysts have focused on: financial imbalances, evolution of the balance sheets of financial intermediaries, development in BSs of HHs and NFCs as financial indicators like debt ratios, financial wealth (wealth effects), growth of public debt, etc.

  30. Economic theory – an example qi = fi[Rei - Cei, Moi; qij] j = 1,.......,m Sum q1 = sum fi [Rei-Cei, Moi; qij] i=1,.......,n (1) q = f[Re-Ce,Mo,qj] The entrepreneurs‘ expectations of aggregate demand can be broken down to expectations of consumption Cpe, public expenditure Ge, investment Ie, speculation on goods Sge, and export Exe;where p (price structure) is implicit in the expectations. This can formulated in following equation: (2) Re = g[Cpe,Ge,Ie,Sge,Exe] The entrepreneurs’ consumption expectations depend on factors like current consumption [Cp], the consumers taste [SM], the current and expected price structure [p, pe], and the expectations of financing consumption, which depend on factors like current and expected disposable income [Yd,Yde], the current expected interest rates [r,re], the current and expectedconsumers‘ wealth[WI,WIe], and other factors Z like access to borrowing. (3) Cpe = h[Cp,Sm,Yd,Yde,r,re,p,pe,WI,WIe,Z]

  31. Economic theory – an example The entrepreneurs expectations of government expenditures depend on factors like current expenditure [G], the governments intensions and their expectations of financing the expenditure, which depend on the current and expected tax revenues [T,Te], expected net supply of government financial assets and liabilities [sFGe], and other factors [Z] likegovernment creditworthiness and borrowing accessability. This relation is shown in following equation. (4) Ge = j[G,Sm,T,Te,sFGe,Z] The investment demand [I], which can be divided into working capital demand [Iwk] and fixed capital demand [Ifk], depends first and foremost of investors’ expectations of revenue and costs and their motives; or in other words on their planned production q. Such expectations can be both to short and long-term dependent of the nature of the planned investment. The demand for fixed capital is usually determined by long-term expectations. Other important factors for investment decisions are current and expected prices of working and capital goods [pwk,pwke,pfk,pfke], the current and expected wage level [w,we], the current and expected "real-mark" value [rm,rme], and other factors Z like and technology options, new technology, borrowing accessibilityand other operational premises. It is of course the entrepreneurs expectations of investors demand that matter in this context. The relations can be shown by following equations, where q*l stands for the planned long-term production. Iwke = k[q*,pwk,pwke,w,we,r,re,Z] Ifke = f[q*l,pfk,pfke,r,re,rm.rme,Z] (5) Ie= Iwke + Ifke .

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