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The Change in Measuring the Services of Commercial Banks in the US National Accounts

Dennis Fixler, Chief Statistician8 October 2003

BackgroundoFocus on the implicit services that are not explicitly charged-for.oNo change in the treatment of explicitly priced services.oCurrent treatment: value of implicit services measured as net interest (interest paid by business less interest received by business) and allocated to depositors.oView that all implicit services are depositor services ignores the role of banks as financial intermediaries and their provision of credit services.

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New framework for valuing implicit servicesoFinancial services are output and are packaged as financial products. Financial products associated with financial instruments.oImplicit services are embedded in financial products.oExample: Demand deposit (checking accounts) provide implicit services of record-keeping and safe-keeping.oNew framework based on the concept of the user cost of money; similar to the notion of the user cost of capitaloKey feature is that the imputed price of implicit services is based on an interest rate margin.oBanking, however, is not viewed as a margin industry.oMargin composed of an interest rate (loan or deposit) and a reference or benchmark rate.

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o The reference rate represents an opportunity cost of money. o In the case of loans, it represents the rate banks can earn on

their investments, adjusting for such factors as risk and liquidity. o If banks could charge explicitly for such factors then the interest

rate charged would be lower. o In the case of deposits, it represents the return on an alternative

investment. o For example, depositors could earn an interest rate higher than a

deposit interest rate in an investment product but would forego many of the financial services associated with deposit products.

o The margin between the interest rate and the reference rate provides a price for the implicit services.

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o In the case of loans, the difference represents the value of the services provided by the bank in assuming credit risk. If the borrower were willing to pay for this service explicitly, the loan rate would be the reference rate.

o In the case of depositors, the difference represents the value of such services as access to ATMs, record-keeping, transaction verification (returned checks). If a depositor was willing to explicitly pay for these, then the bank would offer a higher deposit interest rate.

• Expressions for Priceso The form of the price expression depends on the asset

liability status of the financial product.

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• pAi = rAi – rr.• where rr is the reference rate and rAi is the interest rate for

that asseto For some arbitrary liability i the user cost price is

• pLi = rr – rLi .o In principle, a revaluation term should be in both the asset and

liability price expressions. This will not be done pending future discussions about the inclusion of holding gains and losses for financial services.

o Also, the explicit charges should be a part of the user cost price but these will be ignored given the focus on the imputed price and the fact that the explicit prices are accounted for.

• Effect on the measure of imputed output

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o The total value of the imputed output of banks is given by

o The first term of the last line represents the value of implicitly priced services that the bank provides to borrowers.

o The second term shows the value of the implicitly priced services that it provides to depositors and other lenders to the bank.

o Rewrite the equation as

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• Rewrite the equation as

• The first term equals the current NIPA measure of imputed output.

• The second term is the user cost of the own funds used to acquire assets.

• When a bank lends its own funds instead of funds from depositors, it does not need to use a portion of interest that it receives to cover the cost of providing services to depositors, hence less of the interest received from the borrower represents implicit fees for services and more of it represents net interest income earned by the bank.

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o Defining Assets and Liabilitieso The measure of the imputed output clearly depends on the

boundary of the set of assets and liabilities that should be included.

o BEA’s measure of imputed bank output reflects all bank assets and liabilities that earn interest or imputed interest.

o Contrast this to the common view that only deposits and loans should be included.

o The BEA approach allows for substitution by banks between different types of assets, or between different types of liabilities, without directly affecting the measure of imputed output. – For example, loans rose from about one-third of financial

assets in 1951 to about two-thirds of financial assets in 2001, while deposits fell from almost 100 percent of liabilities to about 70 percent of liabilities.

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Computation of Asset and Liability Interest Rates• Decision regarding the use of market rates or book rates; the

creditor approach versus the debtor approach• From a theoretical perspective the use of either market value

or book values can be defended; though there are large differences in the data requirements.

• Use book value data to compute average interest rates. • Average interest rates are calculated as ratios of interest

accrued throughout the year (quarter) to the average value of assets over the course of the year (quarter).

Selection and computation of reference rate• In principle the reference rate should represent rate an

opportunity cost of money that is not tied to any service—in particular credit service and liquidity service.

– BEA selected US Treasury Bond rates.

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o A single rate is not used—a combination of all maturities is proper.

o To compute the book-value reference rate, the interest received from Treasury and Federal agency securities is divided by the average book value of these securities over the period during which the interest was received.

o This method of calculating the reference rate results in a zero value for the implicit borrower services consumed by the Federal Government.

o Letting implicit services for Federal debt equal zero makes GDP invariant to the proportion of Federal debt held by the banking sector.

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Figure 1: Relative Positions of theReference Rate, the Loan Rate, and the Deposit Rate

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1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002

Reference rate

Loan rate

Deposit rate

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Highlights of Table 1: computations of user cost prices and imputed output

Balance Sheet I tem

Avg. Balance 2001 bil. $

Avg. I nt. Rate %

Avg. User Cost Price %

I mputed Output bil.$

Loans 3341. 8.33 2.09 77.3% Balances due from the Federal Reserve, dom. offices

24.8 0 -6.24

-1.5

Other balances due from depository institutions 54.8 0 -6.24 -3.9 Interest-bearing balances due from depository inst. 133.5 4.01 -2.23 -3.4 Federal funds sold and sec. .purch. under agree. to resell 327.3 3.87 -2.37

-8.5

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Balance Sheet I tem

Avg. Balance 2001 bil. $

Avg. I nt. Rate %

Avg. User Cost Price %

I mputed Output bil $

Demand deposits 506.6 0.00 6.24 32.1

Other checkable deposits 155.9 1.96 4.28

6.7 Other checkable deposits

155.9 1.96 4.28 6.7 Savings (including MMDA's)

1522.0 2.19 4.05 61.7 Large time deposits

549.6 5.05 1.19 11.1 Other time deposits

785.3 5.44 0.80 6.3 Federal funds purch. & sec. sold under agreemt. to repurch..

510.7 3.84 2.40 13.0

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o Need an expansion factor (ratio of all banks in US to US chartered banks in US) to account of US offices of foreign banks; that is why imputed output not simply the product of the volume of asset (liability) and the user cost price

o Negative imputed output for assets are offset elsewhere in the Table; a means for preventing interbank services from affecting output to other types of customers.

o For example, adding the negative 8.5 billion dollars for Federal Funds sold to the 13 billion dollars for Federal Funds purchased gives the net output for these types of financial products.

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o Balances due from the Federal Reserve are offset by the measure of implicit services from the Federal Reserve.

o In exchange for the user cost of these balances due banks receive implicit services from the Federal Reserve Banks of equivalent value.

o The total output of the Federal Reserve Banks equals the user cost of their deposit liabilities (including Treasury deposits and international deposits); no output is imputed in connection with assets of Federal Reserve Banks because they consist primarily of Treasury securities, which yield the reference rate of interest.

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Impact on the measures of imputed output of financial services

Table 2 Consumption of Imputed Output of Commercial Banks by Sector and Legal Form of

Organization, 2001 (Billions of dollars)

Based on

User Costs Currently Published

Revision in Level

Total 186.6 255.7 -69.1 Final demand 93.6 185.5 -91.9 Persons 78.8 156.9 -78.1 Federal Government 0.3 0.8 -0.5 State & local governments 5.1 9.6 -4.5 Rest of the world 9.4 18.3 -8.9 I ntermediate demand 93.0 70.2 22.8 Corporate 52.5 51.3 1.7 Financial 7.3 9.9 -2.6 Nonfinancial 45.2 41.3 3.9 Sole Prop. And Partnerships 20.3 18.8 1.5 Farm 1.6 1.0 0.6 Nonfarm 18.6 17.8 0.8 Other Private Business 2.4 0.1 2.3

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o Observe that the reduction in GDP of 91.9 billion dollars derives mainly from the increase in intermediate consumption.

o The increase in intermediate consumption largely due to the borrower services to households (owner occupants) and non profit institutions.

o From 1985Q1 forward, the quarterly methodology for estimating non-seasonally adjusted implicit output is nearly identical to the annual methodology.

o Quarterly data for prior quarters are not readily available; interpolation from annual data.

o Sector consumption of implicit output is determined by using the Flow of Funds data produced by the Federal Reserve. Annual data are used.

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Future Research Topics

o Treatment of off-balance sheet items; derivatives

o Estimation of real implicit output

o Treatment of expected holding gains

o Treatment of credit losses