Financial Services

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

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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?

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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) 

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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.

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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.  

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What has changed?

• Risk management
• and
• Liquidity transformation

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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).

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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

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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.
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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.

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

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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.
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Own funds SNA 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.

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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.
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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.
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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.
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Activities and customers

• What about units which
• Are set up to carry out well-specified
  activities or transactions directly related to
  a specific purpose ?
• For example Asset management, corporate treasury
  services, special purpose vehicle companies

Provide financing and asset holding services to
one company ? For example holding companies and
trusts but also Government sector (public-private
partnerships, securitization programs, etc)
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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).

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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.
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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
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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.

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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.
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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.

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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.
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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.
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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.

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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.
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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.
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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.
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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.
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• Thank You