1 In the first part of our presentation, Philippe outlined changes in activities of financial corporations and presented a working definition Next question: what are the services rendered by financial corporations? Have they changed as well? And how can they be measured? But first: some terminology

2 Terminology: Production process of financial unit Activities Risk management Liquidity transformation … Other activities Output = Services Liquidity provision service Monitoring service Financial information service … Other services Output-Support = Financial Instruments Deposits Loans Securities … Other instruments Inputs Labour Non-financial goods/services Non-financial capital services Financial capital

3 Identifying financial services (1) Finance literature on ‘theory of financial intermediation’ Monitoring services –Financial corporation assumes costly monitoring of borrowers on behalf of depositors –Financial corporation assumes costly monitoring of depositors on behalf of borrowers Convenience services –Bookkeeping –Safeguarding –Transfer of funds etc.

4 Identifying financial services (2) Liquidity provision services –Depositors: capacity to finance unforeseen expenditure due to withdrawal possibility –Borrowers: credit lines Risk assumption services –Without financial corporations, individual economic agents would bear the full risk of financial operations –Financial corporations assume (parts of) risks of financial operations

5 Identifying financial services (3): Examples of risks

6 Identifying financial services (4) Financial information services –As a separate product (e.g. credit rating agency) –Embedded in portfolio management activities Underwriting services –consulting on issuance of security –securitizaton services Inventory, trading and market making services –Supply of ‘immediacy’ –Market makers bring together buyers and sellers –Remuneration: bid-ask spread

7 Measuring financial services Explicitly priced: value of service = value of commission, fee etc. Implicitly priced: more difficult –Example: depositor buys risk assumption services from financial corporation by accepting interest that is lower than the one paid by the ultimate borrower of his funds No one-to-one correspondence between type of payment and type of service –Example: underwriting services by investment bank: fixed fee combined with margin on price of security

8 Implicitly priced services: an economic rationale for measurement (1) Assume for a moment there are no financial corporations and only loans Loans are granted by non-financial units at rate r L Alternative financial investment at minimum risk at rate rr Total risk (r L -rr)y L Risk is borne by (non-financial) lenders

9 Financial Markets Interest paid Financing Deposit / loan market without financial corporations Non-financial units with surplus of funds Non-financial units with demand for funds

10 Implicitly priced services: an economic rationale for measurement (3) Now let there be a bank that accepts deposits y D at rate r D and lends them all out at rate r L Total risk associated with lending is still (r L -rr)y L But the non-financial unit now only accepts a risk of (r D -rr) y D The differential risk (r L -rr)y L - (r D -rr) y D is borne by financial institution This corresponds to Eurostat FISIM = (rr-r D ) y D + (r L -rr)y L

11 Financial Markets Interest paid Financing Financial corporations AssetsLiabilities r D Interest rate for deposits r L Interest rate for loans Loan (Y L ) Deposit (Y D ) Deposit / loan market with financial corporations Non-financial units with surplus of funds Non-financial units with demand for funds

12 So what? A different rationale has been provided for a well- defined (FISIM) procedure. Is it worth the trouble? Yes, because: –equality in outcome with FISIM only holds for the simple deposit-loan case but the logic of measuring implicitly priced financial services extends directly to a more general case with other assets involved –it emphasises the fact that both sides of the balance sheet are important for the production of a financial service ==> link back to definition

13 Beyond the deposit/loan case Structural shift away from deposit/loan business: different sources of funding and forms of investment Parts of the literature associate (intermediation) services exclusively with deposits and loans. Transactions with other financial instruments are considered merely financial market transactions Following the economic rationale adopted here, this reasoning would not hold: implicitly priced financial services are also identifiable with securities –But we allow for a broader range of sources of funds of financial corporations –And we allow for a broader range of investment possibilities for financial corporations

14 Beyond the deposit/loan case (II) Just as they create markets for deposits, financial units create markets for securities issued by financial corporations. A residual computation similar to the simple deposit/loan case can be envisaged but under the inclusion of other financial assets and liabilities. A number of questions remain to be further discussed by the taskforce, however.

15 Should all securities be included? Discussion point in the Task Force: investment in shares –Can be seen as one instrument by which e.g. risk assumption or liquidity provision services are provided –What about shares held to achieve short-term trading gains? –Shares are not interest-bearing and the most important element of return is price changes –But price changes are holding gains/losses in the SNA and do not constitute compensation for services –Distinction between ‘expected’ and ‘pure’ holding gains as proposed by Moulton and Fixler –Any discussion about holding gains has to consider holding losses

16 What about financial derivatives? Taskforce opinion: they cannot be a priori excluded as carrier of financial services But they constitute off-balance sheet items in commercial accounting A large part of derivatives is traded within the financial sector This reduces their importance from a macro- economic viewpoint unless these intra-sectoral links are international

17 Other points Can we identify the units that buy financial services? Yes, in the case of deposits and loans Things get much more complicated when other securities are involved Volumes and prices - much work left

18 Issues for discussion Is the list of financial services comprehensive? Are important services missing? Beyond the deposit/loan case - a good idea? Is the task force on the right track? Further issues that should be tackled? Others that should not be treated?