ISWGNA Task Force on FISIM AEG New York, April 2012 Contact:

Background Task Force created in late Partly in relation to 2008 SNA research agenda: –The SNA recommends that FISIM should be calculated with respect to a reference rate that contains no service element and reflects the risk and maturity structure of deposits and loans. Different reference rates may be needed for domestic and foreign financial institutions. The assumption behind the FISIM approach is that it is the service element, and not the interest flows, that reflect varying degrees of risk, with riskier clients paying a higher service charge. This assumption has been queried and is being investigated. But also partly in response to volatile (including negative) and difficult to interpret FISIM series in wake of recent financial crisis

Terms of Reference Two meetings: March and July 2011 (merged with European Task Force) with following ToR: 1.How does the composition of the services that FISIM coversparticularly risk management and liquidity transformationaffect the selection of the reference rate and the price and volume breakdown of FISIM. 2.What should be the financial instrument and unit scope of FISIM 3.What are the connections between the recommendations on implementation of FISIM and the definition of income.

Short-term clarification questions How can FISIM be made consistent in international trade? Liquidity transformation, a service or not? Credit-default risk? Compensation for risk- mitigation/purchased insurance or a distributive flow (analogous to insurance). What are the implications for the price and volume measures of FISIM?

International Trade FISIM should be calculated by at least two groups of currencies (national and foreign currency). But recognition that data availability across countries is sparse and, so, there may be a need for international coordination to better estimate the imports/exports of FISIM through counterparty data.

Liquidity Transformation A simple world Loans matched to deposits Assuming no credit-default risk Matched-maturity approach = single reference rate approach

Liquidity Transformation A slightly more complicated world Loans = deposits but not matched (assuming margin rate is the same for all maturities) Matched- maturity (MM) approach is unchanged. But FISIM higher with single reference (SR) rate approach. Liquidity transformation services? Interestingly, if range of instruments is extended MM and SR move closer

Liquidity Transformation Many countries use inter-bank lending rate for RR, which proved troublesome during the crisis, creating volatility and negative component estimates of FISIM. Matched maturity rates should provide greater stability. But the Task Force has tentatively concluded that the removal of LT would result in implausibly low estimates of FISIM. One key argument for a matched approach related to the view that the VA of firms should be indifferent to their means of financing (corporate bond versus a loan – where the term premium for the former is interest but with a loan it is FISIM). But the TF felt this assumed an equivalence between bonds and loans that did not hold, and did not negate the inclusion of LT but rather raised the question about the instrument and institutional scope of FISIM. The TF also recognised that in removing LT from FISIM it would, by default, arise in SNA interest; changing the definition,

Liquidity Transformation However. The TF recognised that, in practice, the use of single reference rate based on short-term maturities had proved problematic. –All other things being equal, does it make sense for the split of FISIM services provided by a bank to depositors and borrowers to change (potentially significantly), from one day to the next, in line with changes in the interbank lending rate, if the bank changes none of the terms and conditions to borrowers or savers and requires no additional funding itself from one day to the next? And so affect GDP? –All other things equal, why should changes in the interbank lending rate necessarily mean differing price movements in FISIM prices for deposits and FISIM prices for borrowers, when the bank's actual costs of production have, to all extents and purposes, remained unchanged?

Liquidity Transformation And, so, the TF have tentatively concluded that the reference rate may be better estimated if it reflects a mix (average) of underlying rates for deposits and loans with different maturities, for example a weighted average of the effective rates for total deposits and loans. –Although this could still lead to some counter-intuitive movements. For example an increase in the term and size of loans would increase the overall reference rate and, so, other things equal increase the value of FISIM services to depositors. But if banks passed the benefits on with higher rates to depositors FISIM for depositors would be unchanged. The TF also considered and still is a Cost of funds approach, which defines the reference rate for an institution based on its interest costs including the implicit costs of its own funds.

Liquidity Transformation Action:- To test the following: –Single reference rate using inter-bank lending rates. –Reference rate calculated using the midpoint of interest rates on deposits and interest rates on loans. –Average reference rate (weighted by the stocks of short-term and long-term loans and deposits) calculated using different rates for the short-term and long-term reference rates. –Matching reference rates using different rates for short-term and long-term deposits and loans With the following criteria –Limited, unexplainable volatility in CP and KP –No sustained periods of negative FISIM –Sensible movements of FISIM over the cycle –Data availability

Credit-default risk The majority of the TF (so far) have concluded that credit-default risk should be removed from FISIM and treated in an analogous way to non-life insurance services. Estimates could be derived using information on CDS, write-offs, provisions. This is currently being tested using an approach developed by Eurostat. Once these results have been completed the TF will review its position, vis-a-vis the feasibility of removing credit- default risk. A secondary issue concerns the accounting treatment of bad debt write-offs. The insurance analogy would mean that households receive a transfer from banks i.r.o of write-offs, increasing saving.

Price and Volumes Direct output approach has merit but is a complex task requiring very detailed data. Task Force expressed a preference for direct deflation methods using a general price index for deflating stocks of loans and deposits. However it was emphasised that the calculation of volume estimates needed to be made by type (maturity) of loan and deposit as the margin varied by maturity.

Next steps Preliminary report with TF. Tests are being conducted by European countries (except the matched-maturity approach) both for reference rate and credit- default risk. ISWGNA TF members conducting similar tests for reference rate. ABS and BEA volunteered to investigate cost of funds approach. Assessment of returns, and subsequent next steps, to be conducted in Q

Issues for the AEG Do the AEG –Support the recommendation on international trade? –Agree with the tentative findings that LT services are part of FISIM And that a single reference rate should be used, reflecting a mix of maturities. Agree with the criteria to determine a reasonable reference rate –Agree that the default risk premium, should, in theory, if not in practice, be treated like non-life insurance services

Posers for the AEG Negative FISIM –Is there such a thing, or is it just an outcome of the approach we use to measure it? –If banks always charged explicit prices for FIS, how would bank interest flows be recorded? –For a fixed rate loan, one could argue that SNA interest=Bank interest irrespective of changes in underlying reference rates? How do we deal with negative FISIM in volume series?