Stripping out the compensation for bearing risk to better reflect the service component of the financial sector could be achieved in different ways. One possibility would be to adjust FISIM using provisions as an indicator of expected losses. A broader adjustment for risk, as has been suggested by several commentators, would be to move away from the risk-free rate as the reference rate within FISIM. 3 For example, a paper prepared for the OECD Working Party on National Accounts (Mink (2008)) suggested that the FISIM calculation should use reference rates that match the maturity and credit risk of loans and deposits. This would also eliminate an inconsistency within the current National Accounts framework. Measured financial intermediation output increases if a bank bears the risk of lending to a company. But gross output is unchanged if a household holds a bond issued by the same company and thus bears the same risk. To see how such a mechanism would work, consider the following simple example. A bank lends £ to a corporate borrower at 7% per annum for one-year. The risk-free rate is 5%. The bank correctly assesses the credit risk of the corporate to be A-rated. The market spread for A-rated credits at a maturity of one-year is 1% over the risk-free rate. Current FISIM would estimate bank output as £ (Table 2). Risk-adjusted FISIM, though, would estimate banks’ output as £ An adjustment of FISIM along these lines could potentially be material.
The lack of a breakdown between client and proprietary sources of revenues is problematic when making sense of investment banking activities, both in the run-up to and during the crisis. In the run-up to crisis, FICC and equity-related activity contributed significantly to revenues, partly on the back of proprietary trading in assets whose prices were rising rapidly. Some of these gains then dissolved when asset prices, in particular for FICC, went into reverse during 2008. The story of 2009/10 is of a strong recovery in FICC and equity revenues. The source of this revenue recovery is, however, different to the boom. Instead of proprietary risk-taking, increased revenues appear instead to have been driven by market-making activities on behalf of clients. These were boosted by a bulge in client activity and wider bid-ask spreads, against a backdrop of lower levels of competition (Chart 38). It is an open question whether these returns to market-making will persist. In some respects, returns to M&A and advisory activities represent even more of a puzzle. For a start, it is well known that most M&A activity is value-destroying (for example, Palia (1995)). Advisory fees of 0.5–1.5% are typically taken, even though these activities are essentially risk-less. And in total under-writing fees are often around 3–4% in Europe and higher still in the US, having risen during the course of the crisis. The level and persistence of these fees is also something of a puzzle.