Risk bearing, implicit financial services, and specialization in the financial industry
AbstractWhat is the output of financial institutions? And how can we measure their nominal and, more importantly, real value, especially since many financial services are provided without explicit charges? This paper summarizes the theoretical result that, to correctly impute the nominal value of implicit financial service output, the “user cost of money” framework needs to be extended to take account of the systematic risk in financial instruments. This extension is easy to implement in principle: One can continue using the current imputation procedure, and the only change needed is to adjust the reference rates of interest for risk. ; The paper clarifies why the risk-related income is not part of the output—or equivalently, why risk bearing is not a service—of financial institutions. The paper next argues that, to measure real output, one must first explicitly specify and define the economic services produced by financial firms, a step that is absent from the “user cost of money” theory. Once it is established that only financial services, and not instruments, should be counted as the value added of financial firms, it follows that the quantity of services provided by these institutions is not necessarily in fixed proportion to the volume of instruments. The corollary is that the implicit price of financial services bears no definitive relationship with any reference rate. Instead, price deflators for financial services should be constructed using methods similar to those used for other services.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Boston in its series Public Policy Discussion Paper with number 06-3.
Date of creation: 2005
Date of revision:
Other versions of this item:
- J. Christina Wang & Susanto Basu, 2008. "Risk Bearing, Implicit Financial Services and Specialization in the Financial Industry," NBER Working Papers 14614, National Bureau of Economic Research, Inc.
- E01 - Macroeconomics and Monetary Economics - - General - - - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-04-29 (All new papers)
- NEP-BEC-2006-04-29 (Business Economics)
- NEP-CBA-2006-04-29 (Central Banking)
- NEP-CFN-2006-04-29 (Corporate Finance)
- NEP-FMK-2006-04-29 (Financial Markets)
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