1 The Change in Measuring the Services of Commercial Banks in the US National Accounts Dennis Fixler, Chief Statistician 8 October 2003 Background o Focus on the implicit services that are not explicitly charged-for. o No change in the treatment of explicitly priced services. o Current treatment: value of implicit services measured as net interest (interest paid by business less interest received by business) and allocated to depositors. o View that all implicit services are depositor services ignores the role of banks as financial intermediaries and their provision of credit services.

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

3 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.

4 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 Prices o The form of the price expression depends on the asset liability status of the financial product.

5 p Ai = r Ai – r r. where r r is the reference rate and r Ai is the interest rate for that asset o For some arbitrary liability i the user cost price is p Li = r r – r Li. 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

6 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

7 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.

8 oDefining Assets and Liabilities oThe measure of the imputed output clearly depends on the boundary of the set of assets and liabilities that should be included. oBEA’s measure of imputed bank output reflects all bank assets and liabilities that earn interest or imputed interest. oContrast this to the common view that only deposits and loans should be included. oThe 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.

9 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.

10 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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