Financial Corporations Leonidas Akritidis National Accounts in Practice – Advanced course Luxembourg, 3-12 October 2016 THE CONTRACTOR IS ACTING UNDER A FRAMEWORK CONTRACT CONCLUDED WITH THE COMMISSION

Content Definition of Financial Corporations (FC) Sub-sectors of FC, units and source data Special treatment of: Insurance Corporations and Pension Funds Investment Funds Market Makers FISIM

Institutional Sectors Domestic Economy S.1 Rest of the World S.2 Non-Financial Corporations S.11 Financial Corporations S.12 General Government S.13 Households S.14 Non-Profit Institutions Serving Households S.15 Monetary financial institutions S.121 Deposit taking Co. S.122 MMF S.123 Non-MMF S.124 Other financial intermediaries S.125 Financial auxiliaries S.126 Captive financial & money lenders S.127 Insurance corporations S.128 Pension funds S.129

Institutional Sectors

Sequence of Accounts Typical source data Non-Financial Account (NFA) Current Accounts Non-Financial Account (NFA) *admin/surveys Source data:, e.g. ->Profits and loss accounts, ->Income statements -> Income and expenditure -> Non-financial balances Accumu- Accounts lation Financial Account (FA), e.g. *Financial assets/aiab. balances

Sub-Sectors of FC Financial corporations sector (S.12) Consists of institutional units which are independent legal entities and market producers, and whose principal activity is the production of financial services. Such institutional units comprise all corporations and quasi-corporations which are principally engaged in: Financial intermediation (financial intermediaries); and/or Auxiliary financial activities (financial auxiliaries).

Sub-Sectors of FC Financial intermediation is a process of channelling funds between parties with a surplus and those with a lack of funds. In the financial intermediation process, assets and liabilities of financial intermediaries are transformed or repackaged, e.g. in relation to maturity, scale, risk, etc. Auxiliary financial activities are activities related to financial intermediation but which do not involve financial intermediation themselves, e.g. head offices, brokers, fund managers

Sub-Sectors of FC S.121: Central Bank The principal function is to issue currency, to maintain the internal and external value of the currency and to hold all or part of the international reserves of the country Source data: -> Accounts of the central banks

Sub-Sectors of FC S.122: Deposit-taking corporations, except the central bank The deposit-taking corporations except the central bank subsector (S.122) includes all financial corporations and quasi-corporations which are principally engaged in financial intermediation and whose business is to receive deposits from institutional units and to grant loans and/or to make investments in securities e.g. Banks, Building Societies

Sub-Sectors of FC S.122: Deposit-taking corporations, except the central bank Source data: -> administrative or surveys based on the central authority list of units with banking licence, e.g. www.bankofengland.co.uk\

Data sources: e.g. -> Profits and loss accounts, -> Income statements -> Income and expenditure

Source data: Assets and Liabilities balances

Sub-Sectors of FC S.122: Deposit-taking corporations, except the central bank Non-financial account, main items: Output (P.1):FISIM (-> more later ! ! !) , imputed market makers spread (-> more later ! ! !), Fees and commisions Acrued interest (D.41) adjuted for FISIM Financial Account, main items: Assets: loans (AF.4) and debt securities (AF.3) Liabilities: deposits (AF.2) incl. inter-bank

Institutional Sectors S.123: Money market funds (MMF) Their business is to issue investment fund shares or units as close substitutes for deposits and to make investments primarily in money market fund shares/units, short-term debt securities, and/or deposits e.g. -> UCI/UCITS, Unit Trusts S.124: Non- Money market funds (Non-MMF) Their business is to issue investment fund shares or units which are not close substitutes for deposits and to make investments primarily in financial assets other than short-term financial assets and in non-financial assets (usually real estate) e.g. -> Hedge Funds, Real Estate Investment Funds

Institutional Sectors S.123: Money market funds (MMF) and S.124: Non- Money market funds (Non-MMF) Non-financial Account Output calculated as sum of costs interest (D.41) receivable investment income attributable to shareholders (D.443) payable Financial Account, main items: Assets: deposits (AF.2) and securities (AF.3) Liabilities: investment fund shares (AF.52) -> more later ! ! !

Institutional Sectors S.125: Other Financial Intermediaries They are principally engaged in financial intermediation by incurring liabilities in forms other than currency, deposits, or investment fund shares, or in relation to insurance, pension and standardised guarantee schemes e.g. -> financial vehicle corporations (FVC) security and derivative dealers financial leasing Specialised Mortgage/Credit Lenders Factoring Venture and development capital companies Export/import financing companies

Sub-Sectors of FC S.125: Other Financial Intermediaries Non-financial account, main items: Output (P.1):FISIM, imputed market makers spread, Fees and commisions Acrued interest (D.41) adjuted for FISIM Financial Account, main items: Assets: loans (AF.4) and debt securities (AF.3) Liabilities: deposits (AF.2) incl. inter-bank

Institutional Sectors S.126: Financial auxiliaries Not intermediaries ! ! ! Insurance, securities, interment brokers, Financial consultants Corporations providing infrastructure for financial markets Head Offices of financial corporations Regulatory and Supervisory Authorities Managers of pension funds, mutual funds Corporations providing stock exchange and insurance exchange payment institutions (facilitating payments between buyer and seller) e.g.->

Sub-Sectors of FC S.126: Financial auxiliaries Non-financial account, main items: Output (P.1): fees and commissions Accrued interest (D.41) payable Dividends (D.421) receivable and payable Financial Account, main items: Assets: shares (AF.5) Liabilities: shares (AF.5)

Sub-Sectors of FC S.127: Captive financial institutions Neither intermediaries nor Auxiliaries ! ! ! Trusts, estates, agencies accounts or 'brass plate' companies Holding companies SPEs that qualify as institutional units and raise funds in open markets Corporations engaged in lending to students or for foreign trade, pawnshops e.g.->

Institutional Sectors S.127: Captive financial institutions Non-financial Account Output calculated as sum of costs interest (D.41) dividends (D.421) Financial Account, main items: Assets: loans (AF.4) and shares (AF.5) Liabilities: loans (AF.4) and shares (AF.5)

Sub-Sectors of FC S.128: Insurance corporations Insurance corporations are engaged in financial intermediation as a consequence of the pooling of risks mainly in the form of direct insurance or reinsurance -> more later ! ! !

Sub-Sectors of FC S.128: Pension finds Pension funds are engaged in financial intermediation as the consequence of the pooling of social risks and needs of the insured persons (social insurance). -> more later ! ! !

Insurance Corporations and Pension Funds

Insurers maximise provisions by investing and getting a return Sales are not a reference for insurers output, thus their output is calculated as premiums less claims Insurers maximise provisions by investing and getting a return Return on investment premiums investment

However, the provisions belong to the policyholders Thus, we need to send the money to their owners…and feed it back to the insurer as a supplement to output premiums investment Return on investment premium supplements

The output of life insurance services are calculated as [gross] premiums earned + [gross] premium supplements - [gross] benefits due ± changes in technical reserves (provisions) * * Holding gains (realised and not-realised) must be eliminated

Important: Life Insurance Premiums earned = 100 Premium supplements = 20 Benefits due = 65 Change in technical reserves = 50 Holding gains = 10 Output ?

Important: Life Insurance Premiums earned = 100 Premium supplements = 20 Benefits due = 65 Change in technical reserves = 50 Holding gains = 10 Output = 15

The output of non-life insurance services are calculated as [gross] premiums earned + [gross] premium supplements - [gross] adjusted claims incurred* * Adjusted non-file claims incurred can be calculated: a) based on past experience (expectation approach), or ; b) as claims due less changes in equalisation provisions less changes to own funds (accounting approach) Catastrophic losses must be eliminated and recorded as capital transfers

Important: Non-life Insurance Allocation of output is based on share paid by each customer In case of non-life, for each insurer-customer relation, we split the premiums payment into A production flow (P.1 output) A distributive flow (D.71 net premiums) There is a second distributive flow (D.72 claims) and correspond other capital transfers recording catastrophic losses (D.99)

Important: Non-life Insurance Premiums + supplements = 100 Claims incurred = 150 Adjusted claims incurred = 70 Output (P.1) = Consumption = 30 Net Premiums (D.71) = premiums – P.1 = 70 Claims (D.72) = 150 Catastrophic losses (D.99) = 80

Direct insurance and reinsurance services

Focus on pension schemes Pensions in Social insurance Social Security pensions Other employment-related pension schemes Defined contributions schemes (DC) Defined benefit schemes (DB)

Social Security Treated on payable basis, thus Social Contributions recorded as they are payable (from households) Social benefits recorded as they are payable (to households)

Other employment-related schemes Treated as saving schemes Including funded schemes for government and public corporation employees

Imputations; only db schemes Imputed contribution by the employer = ? Actuarial increase in pension entitlements 15 Less employers actual contribution 10 Less employees contribution 1.5 Plus costs of operating the scheme 0.5

Imputations; only db schemes Imputed contribution by the employer = 4 Actuarial increase in pension entitlements 15 Less employers actual contribution 10 Less employees contribution 1.5 Plus costs of operating the scheme 0.5

What is D8? Recall that social benefits and social contributions are entered before “disposable income”, thus if no further adjustment disposable income and saving would be fully affected by the balance However we take the view that for occupational and funded government sponsored pension schemes the increase in the household’s net equity should be included in saving (households own pension reserves)…

Investment Funds

Investment Funds (S.123 & S.124) Financial Markets, Real Estate, etc Manager Fund managing services Fees Investment Funds (S.123 & S.124) currency – (A)F.21 (Share)holders of investment fund shares funds shares -(A)F.521 & (A)F.522 Fees (sales, redemption, etc) D.4431 & D.4432 payable rerouted = D.4432, but recorded in financial accounts more (A)F.521 & (A)F.522 Fees payable Other services D.41 & D.42 receivable Investing in financial and non-financial assets Rerouted retained earnings = D.4432 Services to investment fund is usually provided by external companies, e.g.: - accountancy - custodian - distribution - legal - other admin. Financial Markets, Real Estate, etc

Compiling D.443 Investment income attributable to collective investment fund shareholders (D.443), including mutual funds and unit trusts, is composed of two separate items: Dividends attributable to collective investment fund shareholders (D.4431) are recorded in exactly the same manner as dividends for individual corporations; Retained earnings attributable to collective investment fund shareholders (D.4432) are recorded using the same principles as those described for foreign direct investment enterprises but is calculated excluding any reinvested earnings on foreign direct investment. The remaining retained earnings are attributed to the investment fund shareholders leaving the investment fund with no saving, and are re-injected into the fund by the investment fund shareholders in a transaction recorded in the financial account. (see next slide)

Compiling D.4432 2008 SNA, 26.63: Retained earnings (RE) are equal to the net operating surplus of the enterprise plus all property income earned less all property income payable (before calculating reinvested earnings) plus current transfers receivable less current transfers payable and less the item for the adjustment for the change in pension entitlements. Thus: RE = B.2 + net D.4 + net D.7 – D.8 paid Hence, in case of S.123 & S.124, taking only the relevant components given in b, we get: D.4432 = B.2 + D.41rec + D.42rec- D.4431paid This would lead to confirm the statement in 2008 SNA 7.139 that retained earnings is deemed to be remitted to that investor and then reinvested, in which case the saving of the enterprise must be zero.

Market Makers

Indirect measures of Financial Corporations Market Makers When a financial institution offers a security for sale, a service charge is levied. The purchase price (the ask price) is equal to the estimated market value of the security plus a margin. Another charge is levied when a security is sold, the price offered to the seller (the bid price) being equal to the market value minus a margin.

F inancial I ntermediation S ervices I ndirectly M easured

Financial Intermediaries (S. 122 + S Financial Intermediaries (S.122 + S.125) provide services for which they charge implicitly via interest margin. They pay lower rates of interest (interest payable) to those that lend them money and charge higher rates of interest (interest receivable) to those who borrow from them. In this situation, the National Accounts must use an indirect measure, called F I S I M . Interest receivable € Interest Margin Interest payable time 47 t

FISIM allocation Reference rate = 2% Rate on loan Stock on Loan of 200 € Interest receivable by FI of 6.5 % So FISIM on Loan = 200 € x (6. 5% - 2 %) = 9 € Stock of Deposit of 200 € Interest payable by FI of 1.5 % FISIM on Deposit= 200 € x (2% - 1.5%) = 1 € Total FISIM output = 10 € Rate on loan % Ref rate Margin loan Rate on dep. Margin deposit time t

FISIM allocation: by sectors

FISIM allocation: by sectors

FISIM allocation: by sectors

FISIM allocation: by sectors

FISIM allocation: in the Sector Accounts, household sector % time Rate on loan t Margin deposit loan

Calculation and allocation of FISIM in practice To calculate FISIM output and allocate it into user sectors, we need: Matrix of stocks of deposits / loans of FIs by sectors Matrix of interest paid / received by FIs to/from sectors

Example 55

Example (in €) (in €) rr= 30€/1000€ = 3% (in %) FISIM

Example (in €) (in €) rL= 150€/3000€ = 5% (in %) FISIM 57

Example FISIM D to S.11= (- + rr) * Stock D= 1 % * 600 € = 6 € (in €) (in €) (in %) FISIM D to S.11= (- + rr) * Stock D= 1 % * 600 € = 6 € FISIM L to S.11= ( - ) * Stock L= 2 % * 3000 € = 60 € 58

Example Solution to the example above: FISIML = 60 € to non-financial enterprise (S11) FISIMD = 24 € to households (S14) FISIMD = 6 € to non-financial enterprise (S11) Total FISIM output = 90 €

Exercise (FISIM)