Service output of bank holding companies in the 1990s and the role of risk

This paper constructs a new measure of output for Bank Holding Companies (BHCs) over the period 1986 to 1999. This flow measure of bank value added follows from a unified model of bank operation that integrates theories of production, financial intermediation, and asset pricing. The primary contribution of the model is to demonstrate how one should account for risk when measuring the value added of bank services. One key implication is that the risk-related return on the funds banks borrow and lend should be excluded from the nominal value of the services banks produce, since the model recognizes that these funds are simply a particular kind of intermediate input. The new output measure is thus conceptually different from the existing ones even in terms of the nominal value. This paper focuses on deriving the nominal value of bank services according to the new measure, since no adequate data are available for compiling more accurate price indices for the services. Comparisons show that the new measure differs noticeably from the two existing ones. First, it is about 25% smaller than the measure stipulated in System of National Accounts 1993, and it is two orders of magnitude smaller than the measure used in virtually all the empirical studies of individual banking organizations. Second, the new measure exhibits quite different time series properties--in particular, it is more cyclical. This new model-based measure of bank output carries significant implications for the measurement of banking output in the National Income Accounts, providing the theoretical basis for a new approach that is consistent with basic principles. This paper can be regarded as a first attempt to resolve the host of data limitations on the implementation of the new measure. Better data and more accurate price indices for bank services will be needed before the new measure can become practical for National Income Accounting.