Chapter One Introduction

1.1 The primary purpose of the Compilation Guide on Financial Soundness Indicators (Guide) is to provide guidance on the concepts and definitions, and sources and techniques, for the compilation and dissemination of the Financial Soundness Indicators (FSIs) identified by the IMF’s Executive Board (see Table 1.1). The Guide is intended to encourage compilation of FSIs and promote cross-country comparability of these data, as well as assist compilers and users of FSI data, for the purpose of supporting national and international surveillance of financial systems.

Table 1.1.

Financial Soundness Indicators: The Core and Encouraged Sets¹

Table 1.1.

Financial Soundness Indicators: The Core and Encouraged Sets¹

		Core Set
Deposit-takers
	Capital adequacy	Regulatory capital to risk-weighted assets Regulatory Tier 1 capital to risk-weighted assets Nonperforming loans net of provisions to capital
	Asset quality	Nonperforming loans to total gross loans Sectoral distribution of loans to total loans
	Earnings and profitability	Return on assets Return on equity Interest margin to gross income Noninterest expenses to gross income
	Liquidity	Liquid assets to total assets (liquid asset ratio) Liquid assets to short-term liabilities
	Sensitivity to market risk	Net open position in foreign exchange to capital
		Encouraged Set
Deposit-takers		Capital to assets Large exposures to capital Geographical distribution of loans to total loans Gross asset position in financial derivatives to capital Gross liability position in financial derivatives to capital Trading income to total income Personnel expenses to noninterest expenses Spread between reference lending and deposit rates Spread between highest and lowest interbank rate Customer deposits to total (noninterbank) loans Foreign-currency-denominated loans to total loans Foreign-currency-denominated liabilities to total liabilities Net open position in equities to capital
Other financial corporations		Assets to total financial system assets Assets to GDP
Nonfinancial corporations sector		Total debt to equity Return on equity Earnings to interest and principal expenses Net foreign exchange exposure to equity Number of applications for protection from creditors
Households		Household debt to GDP Household debt service and principal payments to income
Market liquidity		Average bid-ask spread in the securities market2 Average daily turnover ratio in the securities market2
Real estate markets		Real estate prices Residential real estate loans to total loan Commercial real estate loans to total loans

View Table

Table 1.1.

Financial Soundness Indicators: The Core and Encouraged Sets¹

		Core Set
Deposit-takers
	Capital adequacy	Regulatory capital to risk-weighted assets Regulatory Tier 1 capital to risk-weighted assets Nonperforming loans net of provisions to capital
	Asset quality	Nonperforming loans to total gross loans Sectoral distribution of loans to total loans
	Earnings and profitability	Return on assets Return on equity Interest margin to gross income Noninterest expenses to gross income
	Liquidity	Liquid assets to total assets (liquid asset ratio) Liquid assets to short-term liabilities
	Sensitivity to market risk	Net open position in foreign exchange to capital
		Encouraged Set
Deposit-takers		Capital to assets Large exposures to capital Geographical distribution of loans to total loans Gross asset position in financial derivatives to capital Gross liability position in financial derivatives to capital Trading income to total income Personnel expenses to noninterest expenses Spread between reference lending and deposit rates Spread between highest and lowest interbank rate Customer deposits to total (noninterbank) loans Foreign-currency-denominated loans to total loans Foreign-currency-denominated liabilities to total liabilities Net open position in equities to capital
Other financial corporations		Assets to total financial system assets Assets to GDP
Nonfinancial corporations sector		Total debt to equity Return on equity Earnings to interest and principal expenses Net foreign exchange exposure to equity Number of applications for protection from creditors
Households		Household debt to GDP Household debt service and principal payments to income
Market liquidity		Average bid-ask spread in the securities market2 Average daily turnover ratio in the securities market2
Real estate markets		Real estate prices Residential real estate loans to total loan Commercial real estate loans to total loans

1.2 FSIs are indicators of the current financial health and soundness of the financial institutions in a country, and of their corporate and household counterparts. They include both aggregated individual institution data and indicators that are representative of the markets in which the financial institutions operate. FSIs are calculated and disseminated for the purpose of supporting macroprudential analysis. This is the assessment and surveillance of the strengths and vulnerabilities of financial systems, with the objective of enhancing financial stability and, in particular, limiting the likelihood of failure of the financial system.

1.3 FSIs are a new body of economic statistics that reflect an amalgam of influences. This is evident from the conceptual framework described ahead. On the one hand, there are concepts drawn from prudential and commercial measurement frameworks, which have been developed to monitor individual entities. Other concepts are drawn from macroeconomic measurement frameworks, which have been developed to monitor aggregate activity in the economy. Given the flexibility provided by the Guide, these frameworks can be drawn upon to develop the data set out in the Guide. Advice is also provided on reconciling the data relevant for the Guide with these frameworks. However, some new data sources may need to be developed. In this regard, the Guide serves as a benchmark or reference point for future development work, and as a reference document for technical assistance to support the compilation efforts.

1.4 While the international community through the IMF Executive Board considers that fostering comparability of FSI data is a medium term objective, in discussions during the preparation of this Guide many commentators stressed the need for flexibility in the application of the guidance set out ahead. So, as experience is gathered on compiling this new set of macro statistics, users should be aware that data sourced from national prudential and commercial measurement frameworks will vary across countries, so limiting crosscountry comparability of data. Looking ahead, the work of the Basel Committee on Banking Supervision (BCBS) on revising its Capital Accord to be more risk-sensitive could affect the calculation of FSIs primarily sourced from supervisory data, and subsequent editions of the Guide could accommodate such revisions.

1.5 It is also recognized that the compilation of FSI data is likely to require a relatively high level of technically skilled staff at the compiling agencies.

Background

1.6 By allocating funds for viable investment projects and providing payment services, healthy and robust financial systems help increase economic activity and welfare. However, experience has shown that financial systems are prone to instability and crisis that have the potential to disrupt financial activity and impose huge and widespread costs on the economy. With the liberalization of financial markets and the greater recognition of the importance of systemic effects of financial sector weakness, policy makers and others are paying increasing attention to the stability of national financial systems. So the long-established surveillance of individual institutions is being supplemented by the monitoring of risks to the stability of national financial systems arising from the collective behavior of individual institutions. This work is known as macroprudential analysis.

1.7 The traditional focus of prudential data reporting and analysis is on the microprudential objective of limiting the likelihood of failure of individual institutions. Macroprudential analysis has a somewhat different set of data requirements due to its focus on identifying risks emerging in the financial system as a whole. For instance, while increased lending to the real estate market, or to the corporate sector, may be profitable to a bank in the short term, if such lending is mirrored in other banks, the resultant sharp expansion of the banking sector’s exposure to real estate, or the corporate sector’s debt to equity ratio might raise concerns from a macroprudential viewpoint. In such instances, risks considered exogenous to any one institution, are endogenous to the financial system.³

1.8 Further, the magnitude and mobility of international capital flows has made it increasingly important to monitor the strength of financial systems and their resilience to capital flow volatility. The financial sector is often the conduit between global financial markets and domestic borrowers and, as such, is sensitive to external capital markets conditions, as well as domestic developments. Moreover, weaknesses in domestic banks can have a pervasive influence on consumer and investor confidence, capital flows, and public finances, as well as on domestic financial intermediation.

1.9 Attention also needs to be given to balance sheet and profitability indicators of nonfinancial corporations. Financial weaknesses such as a high leverage ratio and/or low profitability of these corporations can directly affect the strength of the financial sector because of their impact on asset quality. Also, financially weak corporations can render an economy more susceptible, and less resilient, to external shocks. Governments also play an important role.⁴

1.10 The recognition of the importance of macroprudential analysis has increased the need for supporting data. This consideration led the IMF to undertake in 2000 a survey of its member countries and of regional and international agencies to identify those indicators considered to be most relevant to the macroprudential work of national and regional authorities, both as compilers and users of data. A summary of the results is presented in Appendix I. Also, in 1999, the IMF and the World Bank launched the Financial Sector Assessment Program (FSAP), designed to identify financial system strengths and vulnerabilities and to help to develop appropriate policy responses. This work has involved the use of FSIs, drawing upon available data sources in countries.

1.11 Using the results of the survey of member countries, the experience from FSAPs, and discussions with international agencies interested in this work, a list of key FSIs was developed and presented to the IMF’s Executive Board in June 2001. From this meeting, the list of core and encouraged FSIs set out in Table 1.1 was agreed (agreed FSIs), based on various selection criteria.⁵ The list was modified by the Board in January 2004.⁶ To help prioritize future work, the core set is considered relevant for all countries, while the encouraged set might be developed as country circumstances require. At the same time, the Board encouraged the IMF’s staff to produce the Compilation Guide to help compilers develop the agreed indicators, and undertake further development work in this field.

1.12 The Guide is a comprehensive document that explains not just how to compile the core and encouraged FSIs but also sets out the conceptual frameworks from which the data series required to calculate the FSIs could be drawn. A summary of the guidance for compiling each FSI is provided in Appendix II. Also, in the process of consultation, some associated data series have been suggested that assist in the interpretation of FSIs, such as information on the structure of a country’s financial system. However, in reading the Guide compilers should be aware that in terms of data requirements the priority is the core set of FSIs, followed by the encouraged FSIs. Also, while as far as possible the Guide draws on existing data systems, compiling FSIs most likely will add to the statistical burden. The extent of any additional costs will depend on a number of factors including the amount of data already available, the structure of the financial system, and the time horizon over which the data are developed.

Some key aspects of the Guide

1.13 From the work undertaken, it is clear that the range and type of FSIs compiled and disseminated differ among countries, but that given their pivotal role in all national economies, FSIs for the deposit-takers—particularly the core set—are considered central to any analysis of the current health and soundness of a national financial system. This is reflected in the Guide. Also, because of the importance of the credit quality of their assets to the profitability and soundness of deposit-takers, information on their main customers—particularly the corporate and household sectors—is relevant for such analysis. The need for FSIs for other financial corporations will vary depending upon their importance within the economy.

1.14 FSIs need to cover several aspects of financial health and soundness. In a financial system, capital strength is important for all types of institutions, especially as a “cushion” against unexpected losses. In monitoring the financial soundness of financial institutions, important considerations are also the quality and composition of their assets, and exposures to financial risk. Information on income and expenses is also critical—without sufficient income generation, no entity is financially healthy or sound. For nonfinancial corporations, the focus is on their liabilities and their ability to meet their financial obligations as they fall due. In short, FSIs are intended for use in monitoring the development of positions (and exposures) and flows that could indicate increased financial sector vulnerability and to help assess the potential resilience of the sector to adverse circumstances.

1.15 Because most FSIs are in the form of ratios, definitions are required for the underlying series used to calculate FSIs. Further, in considering the definitions for these individual series, it is apparent that many are derivable from information contained in balance sheets and income statements. So for all sectors including deposit-takers and nonfinancial corporations, the Guide starts from the presumption that, as far as possible, the underlying series should be drawn from internally consistent financial statements that encompass an income and expense statement and a balance sheet. Calculating FSI ratios from data series derived from internally consistent financial statements enhances the analytical usefulness of the indicators, and contributes to the quality control of published data due to the well-established inter-linkages between financial statement items.

1.16 In developing guidance on definitions, the Guide draws upon the System of National Accounts 1993 (1993 SNA) (see Commission of the European Communities and others, 1993) and related manuals,⁷ and the international accounting standards (IASs), developed by the International Accounting Standards Board (IASB). Both these international measurement systems have developed their guidance within the context of internally consistent financial statement frameworks. For deposit-takers, the work of the BCBS is also drawn upon. While there are many similarities between the international measurement systems, the conceptual approach in the Guide allows for flexibility in order to accommodate differences between them and meet the needs of macroprudential analysis. Further, Appendix IV explains how the guidance in the 1993 SNA and IAS corresponds with the requirements of the Guide. The Guide also provides methodological guidance on measurement issues that are new at the international, or even national level, such as for real estate prices and certain financial market information.

1.17 Despite the reliance to the extent possible on existing measurement systems, the needs of macroprudential analysis are different from those the existing systems are addressing, and this is reflected in the framework developed.

1.18 For deposit-takers, macroprudential analysis monitors the profitability, capital strength, quality and composition of assets, and exposures to financial risks faced by the sector as a whole. Supervisors have similar interests but at the level of the individual institution. Further, some supervisors adapt accounting guidance to meet the needs of individual institutions, whereas the consistent application of accounting rules across all entities in the sector is essential to avoid asymmetries in the macro-based data.

1.19 The sector focus and the consistent application of accounting rules are applicable for other macro-based data such as the national accounts, monetary aggregates, and the Bank for International Settlement’s (BIS’s) international banking statistics (IBS). However, there are differences in analytical focus. National accounts data are focused on production, income and its distribution and use, and the financial claims and liabilities generated. Compared with these datasets, the FSI framework focuses more on capital strength and profitability making essential the avoidance of double counting capital, and activity based on that capital, at the sector level. So, macroprudential analysis favors consolidation of group accounts, whereas national accounts data focus on the gross output and activity of individual entities within groups. Further, the build up of claims and liabilities among deposit-takers is of macroprudential interest, not least to monitor the potential for contagion, whereas monetary aggregates focus on deposit-takers’ claims and liabilities vis-à-vis other sectors and so eliminate such intra-sectoral positions.

1.20 Furthermore, it is worth noting that compared with other measurement systems, the extent of institutional coverage for macroprudential purposes is not clearly determined. While the Guide requires the compilation of FSIs on a consolidated group basis to support soundness analysis, this can involve consolidating the activities of branches and subsidiaries with those of the parent entity regardless of location—more akin to the commercial accounting and supervisory approaches for individual entities. Data on domestically located operations might be separately distinguished if authorities believe it would contribute materially to their financial stability analysis (e.g., in order to illustrate the linkage with other macroeconomic information). Chapter 5 discusses these approaches in more detail.

1.21 More generally, the Guide recognizes that the analysis of FSIs must take into account country specific circumstances.⁸ Most relevant to any assessment is the structure of a country’s financial system, for instance, the number of deposit-takers, extent of cross-border ownership, the extent of government ownership, relative size of other financial institutions, and extent to which security markets are used to raise capital. All these factors can influence the interpretation of FSIs. So, guidance is provided on the types of information on financial system structure that could be disseminated, both to help provide context for the analysis of FSIs—including through peer group and dispersion analysis—and to provide information relevant for policy makers and other users. Also important is the strength of a country’s financial infrastructure, such as the level of development of financial markets and payment systems. The Guide provides some advice on the type of information on the structure of the financial system that could be disseminated.

1.22 Also, in developing the framework for use in compiling data, consultations with experts raised some points that go beyond the requirements of the agreed FSIs. First, the framework developed should be flexible to allow for future growth as analytical needs evolve; the idea of developing sectoral financial statements for macroprudential purposes is consistent with this concern. Second, some additional series were recommended to be included that meet specific financial soundness needs, such as information on contingent liabilities and the value of assets transferred to special purpose entities; these ideas are included in Appendix III. Third, as far as possible, the framework should draw on and take account of the related statistical needs of international and regional agencies; Fund staff has consulted with other agencies in the process of producing this Guide.

1.23 The Guide recognizes the importance of disseminating FSI data for use by market participants, policy analysts in foreign countries, and other users. The dissemination of data on a frequent basis allows new developments to be identified at an early stage and facilitates comparisons and analysis of data over time. Also, it is vital that any dissemination of data be supplemented with the provision of metadata (information about data) so that users can understand the methodology underlying the available information. Chapter 12 discusses these issues in more detail.

1.24 Finally, experience demonstrates that FSIs are only one input into macroprudential analysis. Also relevant are indicators that provide a broader picture of economic and financial circumstances, such as asset prices, credit growth, Gross Domestic Product (GDP) growth (including its components), inflation, and the external position; the institutional and regulatory framework for an economy, in particular through assessments of compliance with international financial sector standards; the outcome of stress tests;⁹ and, as mentioned above, the structure of the financial system and strength of the financial infrastructure. More generally, FSI data can potentially complement the use of early warning systems and contribute to crisis prevention.

1.25 Stress testing, in particular, is a tool that when used in combination with FSIs can enhance their usefulness in several ways. First, estimated FSIs are typically the output of stress tests and, in some cases, an “intermediate” input also. For example, the impact of a macroeconomic shock is usually measured as the impact on the capital ratio FSIs. Second, stress tests can provide information on the linkages between different FSIs—in stress tests that make use of banks’ credit risk models, the “shock” is worked through nonperforming loans (NPLs), providing a direct measure of the linkage between changes in the NPL-based FSIs and the capital ratio FSIs. Further, stress tests provide a complementary, but more direct, way to assess certain types of risks that are hard to measure precisely using FSIs, including the risk of interbank contagion.

Structure of the Guide

1.26 The Guide is presented in four parts. They are (1) conceptual framework—covering Chapters 2 to 5, (2) specification of FSIs—covering Chapters 6 to 9, (3) compilation and dissemination of FSIs—covering Chapters 10 to 12, and (4) analysis of FSIs—Chapters 13 to 15. There are also a number of appendices.

1.27 The Guide is provided to encourage compilation and dissemination of the FSIs agreed by the Executive Board. Part II provides specific guidance on how to calculate the individual FSIs in the list, but before a compiler is in a position to use such guidance, certain definitional issues need to be addressed: the definition of each sector, the accounting principles underlying data compilation, the definitions of the individual series that are used to calculate the ratios, and the scope of coverage within the sector. These are the issues covered in Part I. In Part III, the Guide provides advice on practical compilation and dissemination issues that are likely to face the compiler as they put together this body of data, while Part IV provides information on the analytical use of FSIs.

1.28 More specifically, chapters of each part address the following issues:

Conceptual framework

• Chapter 2 identifies and defines the main institutions and markets that typically constitute a financial system.

• Chapter 3 provides accounting principles for FSIs.

• Chapter 4 provides an accounting framework and sectoral financial statements from which the series required to calculate FSIs could be identified and defined.

• Chapter 5 explains how data can be aggregated and consolidated.

Specification of financial soundness indicators

• Chapter 6 defines each of the agreed indicators for deposit-takers.

• Chapter 7 defines each of the agreed indicators for other sectors.

• Chapter 8 defines the indicators for financial markets.

• Chapter 9 provides advice on the compilation of data on real estate prices.

Compilation and dissemination of financial soundness indicators

• Chapters 10 and 11 provide an overview of the compilation of FSIs.

• Chapter 12 presents a framework for the dissemination of FSIs.

Analysis of financial soundness indicators

• Chapter 13 discusses FSIs and macroprudential analysis.

• Chapter 14 looks at the analytical use of specific FSIs.

• Chapter 15 discusses peer group and descriptive statistics.

Appendices

1.29 Appendix I summarizes the survey of countries conducted in 2000 to understand more about countries’ needs for, and compilation practices relating to, FSIs. Appendix II summarizes in tabular form the detailed information on each agreed FSI contained in the Guide. Appendix III provides additional definitions of FSIs and related data series. Appendix IV provides information on how to derive FSI series from both the national accounts and commercial accounting frameworks. Appendix V provides a set of numerical examples. Appendix VI discusses provisioning, interest rate risk, and stress testing issues on which at the time of drafting there was not an international consensus or best practice to draw upon. Finally, Appendix VII provides a glossary of terms.

Terminology

1.30 Different methodologies can use different terms for the same item or instrument. So it is necessary to note that the terms used by the Guide are consistent with those used in the agreed list of FSIs. So whereas supervisors might use phrases such as “allowance” and “impaired assets,” the Guide uses the phrases “provision” and “nonperforming loans,” respectively. Other terms are drawn from the 1993 SNA—particularly for those items in the sector accounts that the 1993 SNA also covers—and from supervisory sources. In a few instances, the text notes alternative terms for the same item/instrument at the appropriate point in the text.

Chapter Two Overview of the Financial System

Introduction

2.1 As noted in Chapter 1, FSIs are calculated and disseminated for the purpose of assisting in the assessment and monitoring of the strengths and vulnerabilities of financial systems. Such assessments need to take account of country specific factors, not least the structure of the financial system. Simply stated, whether an economy has a few or many banks, has diverse financial intermediaries or not, has deep and liquid securities market or not, and whether the financial intermediaries have international operations or not, matters to any assessment. This chapter identifies and defines the main types of players and markets that typically constitute a financial system.

What is a financial system?

2.2 A financial system consists of institutional units¹⁰ and markets that interact, typically in a complex manner, for the purpose of mobilizing funds for investment, and providing facilities, including payment systems, for the financing of commercial activity. The role of financial institutions within the system is primarily to intermediate between those that provide funds and those that need funds, and typically involves transforming and managing risk. Particularly for a deposit-taker, this risk arises from its role in maturity transformation, where liabilities are typically short term, (e.g., demand deposits), while its assets have a longer maturity and are often illiquid (e.g., loans). Financial markets provide a forum within which financial claims can be traded under established rules of conduct, and can facilitate the management and transformation of risk. They also play an important role in identifying market prices (“price discovery”).

2.3 Within a financial system, the role of deposit-takers is central. They often provide a convenient location for the placement and borrowing of funds and, as such, are a source of liquid assets and funds to the rest of the economy. They also provide payments services that are relied upon by all other entities for the conduct of their business. Thus, failures of deposit-takers can have a significant impact on the activities of all other financial and nonfinancial entities and on the confidence in, and the functioning of, the financial system as a whole. This makes the analysis of the health and soundness of deposit-takers central to any assessment of financial system stability.

Financial corporations¹¹

Deposit-takers ¹²

2.4 The term “bank” is widely used to denote those financial institutions whose principal activity is to take deposits and on-lend or otherwise invest these funds on their own account. In many countries, “banks” are defined under banking or similar regulatory legislation for supervisory purposes. In the Guide, banks and other deposit-takers (other than central banks) are included within an institutional sector that is known as “deposit-takers.” Deposit-takers are defined as those units that engage in financial intermediation as a principal activity—that is, channel funds from lenders to borrowers by intermediating between them through their own account—and

• have liabilities in the form of deposits payable on demand, transferable by check, or otherwise used for making payments; or

• have liabilities in the form of instruments that may not be readily transferable, such as short term certificates of deposit, but that are close substitutes for deposits in mobilizing financial resources and included in measures of money broadly defined.

2.5 Commercial banks, which typically take deposits and are central to the payment system, fall under the definition of deposit-takers. These banks, which participate in a common clearing system, may be known as deposit money corporations. Other types of institutions that may be covered by the definition include institutions described as savings banks (including trustee savings banks, as well as savings and loan associations), development banks, credit unions or cooperatives, investment banks, mortgage banks and building societies, where their particular specialization distinguishes them from commercial banks, and micro-finance institutions that take deposits. Government-controlled banks (e.g. post office savings banks, and rural or housing banks) are also deposit-takers if they are institutional units separate from the government and they meet the definition of a deposit- taker outlined in paragraph 2.6. This list is not exhaustive and classification as a deposit-taker depends on the function of the corporation, and not on its name.

2.6 Within an economy, the definition of deposit-takers should encompass a group of institutions that meet the definition of banks and similar institutions, under banking or other legislation, because like the statistical definition for deposit-takers, a common legal criterion for a bank is the taking of deposits. If some institutions are banks in a legal sense but not deposit-takers as described above, in following the Guide they should still be classified as “deposit-takers,” but in any associated description of the FSI data the status of these institutions should be explained, with some indication of their importance to the data disseminated.

2.7 Conversely, if there are any other groups of institutions that meet the Guide's definition of a deposit-taker, but are not banks or similar institutions under the legislative approach, they should be separately identified so their importance to the information disseminated can be judged.

2.8 As noted in Chapter 1 and described in more detail in Chapter 5, to meet analytical needs, deposit-takers can be grouped on the basis of common characteristics. Two types of reporting populations are particularly identified in the Guide: domestically incorporated and controlled deposit-takers, including any foreign branches and subsidiaries, and all domestically located deposit-takers.

Special cases

2.9 Holding corporations are entities that control a group of subsidiary corporations and whose principal activity is owning and directing the group rather than engaging in deposit-taking. As the Guide's focus is the health and soundness of deposit-takers as a sector, in principle the Guide considers that holding corporations should be excluded from the deposit-taking sector, even if the business of the subsidiaries it owns is primarily deposit-taking. Rather such holding corporations should be classified as other financial corporations. It is acknowledged that this approach may not be consistent with 1993 SNA, but is consistent with present supervisory guidance.¹³ Nonetheless, there may be interest in information on financial conglomerates headed by holding corporations, as discussed in Appendix III.

2.10 In the Guide, it is recommended that money market funds should not be classified as deposit-takers, but be separately identified as investment funds within other financial corporations (see ahead), because the nature and regulation of their business is different from that of deposit-takers, although their liabilities can be included in broad money. A similar treatment is recommended for any other institution that engages primarily in securities activity, and issues liabilities that are included in broad money but are not deposits.

2.11 There is little international conformity of law or practice in the area of banking regulation governing the treatment of banks in distress, with official efforts to rehabilitate banks differing both in their time horizon and nature, from the enforcement of banking law and restricting new business, to the receivership and liquidation of banks.¹⁴ In the Guide, it is recommended that financial institutions in distress that otherwise meet the definition of a deposit-taker continue to be included in the deposit-taking reporting population for calculating FSIs. Their assets and liabilities exist in the deposit-taking system and the costs of resolution may be significant. Accordingly, until a deposit-taker is liquidated—all assets and liabilities are redeemed and/or written down and the entity ceases to exist—or all deposit liabilities removed from its balance sheet—through either repayment or transfer to another entity—its balance sheet and income statement continue to be included in the data used for calculating FSIs for the deposit-taking sector.

2.12 If banks in distress hold significant positions, data both including and excluding these deposit-takers might be considered, particularly if the liquidation process is very lengthy.¹⁵ In any associated description of the FSI data, the importance of banks in distress to the data disseminated could be indicated.

Central bank

2.13 The central bank is the national financial institution that exercises control over key aspects of the financial system and carries out such activities as issuing currency, managing international reserves, and providing credit to deposit-takers. Central banks are excluded from the reporting population for compiling FSIs.

Other financial corporations

2.14 Other financial corporations are those financial corporations that are primarily engaged in financial intermediation or in auxiliary financial activities that are closely related to financial intermediation but are not classified as deposit-takers.¹⁶ Their importance within a financial system varies by country. Other financial corporations include insurance corporations, pension funds, other financial intermediaries, and financial auxiliaries. Other financial intermediaries include securities dealers, investment funds (including money market funds), and others, such as finance companies and leasing companies. Moreover, included as other financial intermediaries are special asset management companies created for the purpose of managing nonperforming assets that have been transferred from another financial corporation(s), typically deposit-takers.¹⁷ In addition, acting as agents rather than as principals, are other financial auxiliaries, such as market makers. Detailed descriptions of all these types of financial corporations are provided in Appendix VII: Glossary of Terms.

Nonfinancial corporations

2.15 As customers, the performance of nonfinancial corporations is important to the health and soundness of financial corporations. Nonfinancial corporations are institutional entities whose principal activity is the production of goods or nonfinancial services for sale at prices that are economically significant.¹⁸ They include nonfinancial corporations; nonfinancial quasi-corporations;¹⁹ and nonprofit institutions that are producers of goods or nonfinancial services for sale at prices that are economically significant. They can be controlled by the government sector.

Households

2.16 Households are also customers of financial corporations. They are defined as small groups of persons who share the same living accommodation, pool some or all of their income and wealth, and consume certain types of goods and services (e.g., housing and food) collectively. Unattached individuals are also considered households. Households may engage in any kind of economic activity, including production.

Nonprofit institutions serving households (NPISHs)

2.17 NPISHs are mainly engaged in providing goods and services to households or the community at large free of charge or at prices that are not economically significant (and thus are classified as nonmarket producers), except those that are controlled and mainly financed by government units, which are classified as part of the general government sector (see paragraph 2.18). NPISHs are mainly financed from contributions, subscriptions from members, or earnings on holdings of real or financial assets. They are customers of financial corporations, although experience suggests that their impact on the financial stability of the economy is limited. Examples of NPISHs include consumer associations, trade unions, and charities financed by voluntary transfers.

General government

2.18 General government units exercise legislative, judicial, or executive authority over other institutional units within a specified area. Governments have authority to impose taxes, to borrow, to allocate goods and services to the community at large or to individuals, and to redistribute income. They affect and can be affected by the activities of financial corporations. The general government sector consists of departments, branches, agencies, foundations, institutes, nonmarket nonprofit institutions controlled and mainly financed by government, and other publicly controlled organizations engaging in nonmarket activities. Various units of general government may operate at the central, state, or local government level.

Public sector

2.19 The public sector includes the general government, central bank, and those entities in the deposit-taking and other sectors that are public corporations. A public corporation is defined as a nonfinancial or financial corporation that is subject to control by government units, with control over a corporation defined as the ability to determine general corporate policy by choosing appropriate directors, if necessary. A fuller discussion of control is provided in paragraph 5.7.

Financial markets

2.20 A financial market can be defined as a market in which entities can trade financial claims under some established rules of conduct. There are various types of financial markets depending on the nature of the claims being traded. They include money markets, bond markets, equity markets, derivatives markets, commodity markets, and the foreign exchange market.

2.21 The money market is the market that involves the short-term lending and borrowing of funds among a range of participants. The typical instruments traded in a money market have a short maturity and include treasury bills, central bank bills, certificates of deposit, bankers’ acceptances, and commercial paper. They also include borrowing through repurchase agreements and similar arrangements. It is the market that can provide short-term liquidity to governments and financial and nonfinancial corporations. An active money market allows entities to manage their liquidity in an efficient manner, by facilitating investment of excess holdings of cash in interest-bearing assets, which can be drawn upon when needed, and by providing a source of funds for those short of liquidity, or who wish to finance short-term positions in other markets.

2.22 One specific money market is the interbank market, which is the market in which banks lend to each other. This market allows banks with excess liquidity to lend these funds to banks with a shortage of funds, often overnight and usually on an unsecured basis. An efficient interbank market improves the functioning of the financial system by enabling the central bank to add or drain liquidity from the system more effectively and banks to redistribute their individual excesses and shortages of liquidity among themselves without causing undue interest-rate volatility. If funds do not flow freely among banks in the interbank market, this impedes liquidity management by individual banks, posing a risk to financial stability, and could result in the central bank having to supply liquidity to banks on a case-by-case basis, complicating the management of monetary policy.

2.23 The bond market is the market in longer-term debt instruments issued by governments, and financial and nonfinancial corporations. The bond market allows a borrower to obtain long-term funds through the issuance of debt securities, while providing investors with an opportunity to purchase and sell these securities. For borrowers, such a market provides an alternative to bank lending as a form of long-term finance and in the instance of asset-backed securities, whose income payments and principal repayments are dependent upon a pool of assets such as loans, allows a lender to, in effect, convert illiquid assets into tradable securities.²⁰ An active bond market also allows credit risks to be spread over a wide range of investors, reducing the potential for concentration of credit risk to develop, and providing borrowers with up-to-date information on the market views of their credit-worthiness. Bonds also provide an investment opportunity for those investors that have a long-term investment horizon, such as pension funds with long-term liabilities.

2.24 The equity market is where equity securities are traded. An active equity market can be an important source of capital to the issuer for use in business, and allows the investor to benefit from the future growth of the business through dividend payments and/or an increase in the value of the equity claim. The market value of the equity security can also fall. Turnover serves as an indicator of liquidity in equity markets.

2.25 Financial derivatives markets are different from money, bond, and equity markets in that the instruments—such as swaps and options—are used to trade financial risks such as arising from foreign exchange and interest rates, to those more able or willing to bear them. Credit risk can also be traded, through credit derivatives. The value of derivative instruments depends on the price of the underlying item—the reference price. These markets can broaden financial market activity in that, for instance, investors can, in a derivatives market, trade away financial risk inherent in a security, such as exchange rate risk, that otherwise would have deterred them from purchasing the security. However, financial derivatives can be used to take on risk, and thus can pose a threat to financial stability if significant losses are incurred.

2.26 In financial markets, liquidity is important, because it allows investors to manage their portfolios and risks more efficiently, which tends to reduce the cost of borrowing. There are several dimensions to market liquidity, including tightness, depth, immediacy, and resilience. Tightness is a market's ability to match supply and demand efficiently and can be measured by the bid-ask spread. Market depth relates to the ability of a market to absorb large trade volumes without a significant impact on prices, and can be approximated by the amounts traded over a period of time (turnover) and quote sizes. Immediacy is the speed with which orders can be executed and settled, and resilience is the speed with which price fluctuations arising from imbalances in trades are dissipated.

Payment system

2.27 A payment system consists of a set of instruments, banking procedures, and typically interbank fund transfer systems that ensure the circulation of money. The payment system is a channel through which shocks can be transmitted across financial systems and markets. A robust payment system is a key requirement in maintaining and promoting financial stability. So, a broad international consensus has developed on the need to strengthen payment systems by promoting internationally accepted standards and practices for their design and operation.²¹

Real estate markets

2.28 Experience has shown that real estate markets can be an important source of financial instability. Real estate markets allow the trading of claims on, and investments in, real estate and can also involve markets associated with the financing of real estate. In the Guide, real estate is defined to include both land and buildings (including other structures used as dwellings, e.g., houseboats). Because land is a more-or-less fixed resource, as are buildings in the short-term, traditionally real estate has lent itself to speculative activity—when demand and prices significantly increase in a short period—and, often associated with this, large financing flows. In addition, for households, changes in the value of the real estate they own can have a significant effect on their economic behavior.

Chapter Three Accounting Principles for Financial Soundness Indicators

Introduction

3.1 To compile both position and flow data for use in calculating FSIs a consistent set of accounting principles is required. This chapter provides guidance on accounting principles that could be employed, drawing on existing international standards and taking account of the analytical needs of FSI data. But it is recognized that at this time, in practice, there is no full-fledged adherence to internationally agreed prudential, accounting, and statistical standards by all countries. So, in disseminating any information, countries are encouraged to disclose the basis of accounting that is used to compile FSI data series, along with the critical assumptions made.

Definition of flows and positions

3.2 In the Guide, flow data include transactions in goods, services, income, transfers, nonfinancial and financial assets; holding gains and losses arising from price or exchange rate movements; and other changes in the volume of assets, such as losses from extraordinary events. Under certain circumstances, potential costs can also be included. Position data are the value of outstanding stocks of nonfinancial and financial assets, and liabilities.²²

Time of recognition of flows and positions

3.3 The guiding principle in the Guide is that flows and positions should be recorded using the accrual basis of accounting. On this basis, flows are recognized when economic value is created, transformed, exchanged, transferred, or extinguished. In other words, under accrual accounting, revenue and gains are recognized in the period when they are earned, and expenses and losses when they are incurred, rather than when cash is received or disbursed. Existing actual assets and liabilities are recognized, but contingent positions are not.

3.4 The accrual approach to recording is adopted because by matching the time of recognition with the time of resource flows and the time of gains and losses in value, the economic consequences of transactions and events on the current health and soundness of the reporting entities is best observed. Moreover, this method has the advantage of capturing all types of resource flows regardless of whether or not cash has been exchanged.

3.5 Whether assets and liabilities exist and are outstanding is determined at any moment in time by the principle of ownership.²³ So for debt instruments, the creditor owns a claim on the debtor, and the debtor has an obligation to the creditor.²⁴

3.6 When a transaction occurs in assets, the position should be recorded on the date of the change of ownership (the value date), when both creditor and debtor have entered the claim and liability, respectively, in their books. If an existing asset is sold by one entity to another, the first entity derecognizes and the second entity recognizes the asset on the date of the change of ownership. The date of recording may actually be specified to ensure matching entries in the books of both parties. If no precise date can be fixed on which the change in ownership occurs, the date on which the creditor receives payment in cash or in some other asset is decisive. When a service is rendered, interest accrues, or an event occurs that creates a transfer claim (such as taxation), a financial claim is created and exists until payment is made or forgiven. Service charges, like interest, can accrue continuously. After dividends are declared payable, they are recorded as liabilities/assets until paid.

3.7 The Guide recommends that interest costs accrue continuously on debt instruments, matching the cost of funds with the provision of funds and increasing the principal amount outstanding until the interest is paid.²⁵ The preference of the Guide is that interest should accrue at the rate—effective yield—agreed at the time of the issuance of the debt instrument. For example, for a loan this is the contractual rate of interest. Thus, for fixed-rate instruments, the effective yield is the rate of interest that equates the future payments to the issue price. For variable-rate instruments, the yield will vary overtime in line with the terms of the contract. No adjustment should be made to interest income for any gains or losses arising from financial derivatives contracts, as these are recognized as gains and losses on financial instruments (see paragraph 4.22). These recommendations for the accrual of interest are largely consistent with the approach in the related international statistical and accounting standards.²⁶ However, it is recognized that for data compiled under IASs, when an instrument is traded, interest accrues for the new creditor at the effective yield at the time of acquisition of the instrument and not the effective yield at the time of issuance of the instrument.²⁷

3.8 For interest costs that accrue in a recording period, these transactions should be recorded as an expense (income) in that period. For position data, there are three measurement possibilities: (1) interest costs that accrue are paid within the reporting period, in which instance there is no impact on end-period positions; (2) they are not paid, because they are not yet payable, for example, interest is paid each six months on a loan or debt security, and the position is measured after the first three months of this period—in which instance, the positions increase by the amount of interest that has accrued during the three-month period; or, (3) they are not paid when due, in which instance, the positions increase by the amount of interest costs that has accrued during the period (excluding any specific provisions against such interest—see also paragraph 4.19). The Guide recommends including interest costs that have accrued and are not yet payable as part of the value of the underlying instruments.

3.9 For bonds issued on discount or on a zero-coupon basis, the difference between the issue price and the value at maturity is treated as interest, and recorded as accruing over the life of the bond. As calculated interest income exceeds any coupon payments for these instruments, the difference is included in the outstanding principal amount of the asset. For instruments issued at a premium, coupon payments will exceed calculated interest income, with the difference reducing the principal amount outstanding.

Arrears

3.10 When principal or interest payments are not made when due, such as on a loan, arrears are created. Arrears should continue to be recorded from their creation, which is when payments are not made,²⁸ until they are extinguished, such as when they are repaid, rescheduled, or forgiven by the creditor. Arrears should continue to be recorded in the underlying instrument (excluding any provisions for accrual of interest on nonperforming assets—see also paragraph 4.19).

3.11 If debt payments are guaranteed by a third party (guarantor) and the debtor defaults, the debtor records an arrear until the creditor invokes the contract conditions permitting the guarantee to be exercised. Once exercised, the debtor no longer records an arrear as the debt is attributed to the guarantor. In other words, the arrear of the debtor is extinguished as though repaid. Depending upon the contractual arrangements, in the event of a guarantee being exercised, the debt is not classified as arrears of the guarantor but instead is classified as a short-term debt liability until any grace period for payment ends.

Contingencies

3.12 Many types of contractual financial arrangements between institutional units give rise to conditional requirements either to make payments or provide items of economic value.²⁹ In this context, “conditional” means that the claim only becomes effective if a stipulated condition or conditions arise. These arrangements are referred to as contingent items and are not recognized as financial assets (or liabilities) in the Guide, because they are not actual claims (or obligations). Nonetheless, such arrangements represent potential exposures to risks.

3.13 The types of contingent arrangements for which data could be collected on the basis of the maximum potential exposures³⁰ are described ahead:

3.14 Loan and other payment guarantees are commitments to make payments to third parties when another party, such as a client of the guarantor, fails to perform some contractual obligations. These are contingent liabilities because payment is only required if the client fails to perform and until such time no liability is recorded on balance sheet of the guarantor. The common type of risk assumed by a deposit-taking guarantor is commercial risk or financial performance risk of the borrower.

3.15 Included under payment guarantees are letters of credits (LoC). Irrevocable and stand-by LoCs are guarantees to make payment upon nonperformance by the client provided all the conditions in the letter have been met. LoCs are an important mechanism for international trade. Revocable LoCs allow the terms of the letter to be changed without prior approval of the beneficiary. Also included are performance bonds that normally cover only part of the contract value but in effect guarantee a buyer of goods, such as an importer, that the seller, such as an exporter, will meet the terms of the contract.

3.16 Lines of credit and credit commitments, including undisbursed loan commitments, are contingencies that provide a guarantee that undrawn funds will be available in the future, but no financial liability/asset exists until such funds are actually advanced.

3.17 Included under credit commitments are unutilized back-up facilities such as note issuance facilities (NIFs) that provide guarantees that parties will be able to sell short-term debt securities (notes) that they issue and that the financial corporations providing the facility will purchase any notes not sold in the market. Other note guarantee facilities providing contingent credit or back-up purchase facilities are revolving underwriting facilities (RUFs), multiple options facilities, and global note facilities (GNFs). Both banks and nonbank financial institutions provide such back-up purchase facilities.

3.18 Also, potential costs—such as potential losses of deposit-takers on financial assets in general or costs of nonfinancial corporations associated with product warranties—are not recognized in the Guide as liabilities on balance sheet as no clear legal claim/liability exists. However, if such potential costs can be valued reliably, they are included as an expense in the income statement (e.g., as a provision) as such an approach provides a better measure of current financial health. It is preferred that the amounts so provisioned be included as a general reserve in capital and reserves,³¹ consistent with prudential regulation but not with IASs (see also Box 4.3).

3.19 If such costs are subsequently realized there is no impact on net income because the costs have already been recognized,³² but general reserves (and so capital and reserves) decline. Also, there is either a decline in the value of assets—through say a settlement of the expense, or a decline in the value of an instrument—or a liability is recognized on balance sheet. Overestimation of potential costs could be reversed in subsequent periods, increasing income, such as through a lower amount of provisioning.

Valuation

3.20 The Guide prefers valuation methods that can provide the most realistic assessment at any moment in time of the value of an instrument or item.³³ This approach supports macroprudential analysis by facilitating the compilation of more reliable measures of capital strength and profitability than provided by other approaches.

3.21 Crucial in determining the valuation approach to adopt is whether, or not, a market exists for the instrument or for similar instruments (or items) that can allow a reliable measure of value to be established. ³⁴ When an instrument is tradable the expectation is that it should be valued at market or fair value (approximation of market value). For nontradable instruments, the Guide acknowledges that nominal value³⁵ (supported by appropriate provisioning policies) may provide a more realistic assessment of value than the application of fair value. For such instruments, application of fair value when a significant degree of subjectivity is involved could diminish the reliability of data for macroprudential analysis. For transactions, the market value is the amount of money that willing buyers pay to acquire something from willing sellers.

3.22 It is recognized that the use of market or fair value can introduce fluctuations into the valuation of assets and liabilities that may prove temporary. Nonetheless, at any moment in time, the opportunity costs facing the creditor and debtor, as reflected in the market or fair value, provide the most relevant, but not perfect, basis for assessing financial soundness. In this light, an institution that owns securities that have fallen significantly in value but which are valued on the balance sheet on an historic cost basis will be overstating its capital strength—and so its financial soundness—because the institution cannot realize the value for the assets recorded on the balance sheet. Moreover, an institution that holds assets on an historic cost basis and has a weak capital position and low profitability has an incentive to sell those assets that show a significant gain in the market and hold those that do not, thereby boosting profits and capital while the overall quality of assets held deteriorates.

3.23 Information on the trends in market prices overtime is of analytical value in its own right, not least in allowing the price risk associated with the end-period observation to be assessed. Given this, it might be appropriate to monitor period-average, and end-period market prices for representative assets and liabilities of the reporting population. Data on average period market prices could also help indicate unusual outlier observations in end-period market price data.

Transactions

3.24 Transactions are generally valued at the actual prices agreed by the transactors, including sales of instruments classified as nontradable such as loans. Market price equivalents might be needed when no actual market price is set or where the value is far from the prevailing market value—for instance, for transactions between related entities. In such instance, a customary approach is to construct market prices by analogy with known market prices for the same or similar items established under conditions that are considered essentially the same. Any difference from such an estimated price and the transaction price could be classified as a subsidy from one party to the other (see also paragraph 4.30).

Positions

3.25 The market value of an asset or liability on the balance sheet is a measure of what the financial and nonfinancial asset or liability is worth in the market at the reference date of the balance sheet.

3.26 The market value for a traded instrument at a reference date should be determined by the market price for that instrument prevailing on the date to which the position relates. Such a price is the best indication of the value that economic agents currently attribute to specific financial claims. The ideal source of a market price for a traded instrument is an organized exchange or other financial market (e.g., an over-the-counter, or off-exchange market) in which the instrument is traded in considerable volume and the market price is listed at regular intervals. If the markets are closed on the reference date, the market price that should be used is that prevailing on the closest preceding date when the market was open. In some financial markets, the market price quoted for traded debt securities does not take account of interest costs that have accrued but are not yet payable; but in determining market value, these interest costs need to be included.

3.27 When specific assets are not traded in organized exchanges or other financial markets but are tradable, various approaches can be taken to estimate the market value. The preferred approach in the Guide is to estimate the present value of the instrument by discounting the expected stream of future benefits associated with the asset at an appropriate market rate of interest.³⁶ Both the 1993 SNA and IASs support this approach. ³⁷

3.28 The method requires that (1) the future cash flows are known with certainty or can be reliably estimated, and (2) a market interest rate or series of market interest rates are observable (such as through reference to a similar instrument(s) traded in organized markets).

3.29 Other approaches to estimating market or fair value can include using market prices that are observable for similar assets that are traded; using a market-related price reported for accounting or regulatory purposes; and for nonfinancial assets, accumulating and revaluing acquisitions less disposals of the asset in question over its lifetime, including taking account of depreciation (consumption of fixed capital)³⁸ or amortization costs. If used, these methods should be applied consistently both over time and, where relevant, in debtors and creditors’ financial statements.

3.30 For some financial instruments, such as loans, currency and deposits, and trade credit, because of their nontraded nature and the difficulty of reliably pricing such instruments at fair value, nominal value may provide the most realistic measure of value. Such instruments may be predominant in the balance sheet of deposit-takers. Nonetheless, for nontraded instruments, particularly loans, recorded at nominal value, the creditor (but not the debtor) should reduce the balance sheet value of the asset for expected losses by making specific provisions or otherwise writing down the value of the asset. Provisioning is discussed in more detail in Chapter 4 in the section on deposit-takers.³⁹

3.31 If an instrument that is considered to be nontradable is sold or transferred to another entity, in the absence of market or fair valuation the transaction value should be the basis for any subsequent balance sheet valuation. So, for instance, if a deposit-taker sold a portfolio of loans that are not tradable to another deposit-taker at a heavily discounted price, the initial balance sheet value for the purchaser should be the purchase price. The seller would record as a loss in the income statement, under gains and losses on financial instruments, the difference between the value on the balance sheet (after deduction of specific provisions) at the end of the previous period and the sale value.

3.32 As markets and valuation techniques develop, the likelihood could increase of estimating fair values for nontraded instruments that provide for a more realistic measure of value than nominal value—such as using information from credit derivatives linked to the credit risk of individual entities. In such instances, compilers are encouraged to compile information on market or fair values of nontraded instruments initially as supplementary information so that the implications of market (fair) valuation for such instruments can be assessed.

3.33 The value of a share and other equity investment in an associate and unconsolidated subsidiary is equal to the investor’s proportionate share, in terms of ownership of the equity capital, of the value of the capital and reserves of the associate/subsidiary. Any equity investment by an associate or unconsolidated subsidiary in the parent investor (known as a reverse equity investment) is similarly valued. In practice, balance sheet values of these entities are generally utilized to determine the value of this investment. If the investor sells equity such that they no longer retain an associate stake but still retain some equity in the other entity, the remaining investment is valued in the same manner as for any other equity investment. On the other hand, if the investor adds to an equity investment such that an associate or subsidiary stake is created, the whole investment is valued on a proportionate basis.

Residence

3.34 In the Guide, residence (or location) is a relevant concept as the location of a deposit-taker, and in some instances that of its parent, determines the extent to which data should be collected. The same holds true for other types of entities. The residence of a parent deposit-taker determines the residence of the deposit-taking group. When such deposit-takers have international operations, it is essential that account is also taken of the activity of their foreign branches and subsidiaries through consolidation of their domestic and foreign operations. Domestically located deposit-takers are those resident in the economy—a host country concept consistent with the approach taken in economic statistics.

3.35 The concept of residence is not based on nationality or legal criteria, but rather on whether an institutional unit has a center of economic interest—dwelling, place of production, or other premises—in the economic territory of the country in question, from where it intends to engage (indefinitely or for a year or more) in economic activities and transactions on a significant scale. So, corporations (or quasi-corporations) are residents of a country in which they are ordinarily located. This concept is central to the compilation of national accounts data.

3.36 The economic territory of a country covers geographic territory administered by a government within which persons, goods, and capital circulate freely, and includes free trade zones, entreports, bonded warehouses or factories that are physically located within a country’s boundaries. This territory is not always based strictly on physical or political borders, although there is usually a close correspondence.⁴⁰ In recording the geographic distribution of assets, claims of deposit-takers or other lending entities are attributed to economies on the basis of the residence of the entity on which they have a claim.

Some specific aspects of residence

3.37 A branch or subsidiary is resident in the economy in which it is ordinarily located, because it engages in economic activity and transactions from that location, rather than necessarily the economy in which its parent is located.

3.38 The residence of offshore units is attributed to the economies in which they are located. For instance, in some countries, deposit-takers, including branches of foreign banks, are licensed to take deposits from and lend primarily, or even only, to residents of other economies, and are treated as “offshore banks.” These banks usually face different exchange or other regulatory requirements and may not be required to provide the same amount of information to supervisors as “onshore” banks. Nonetheless, they are resident in the economy in which they are located.

3.39 Similar issues can arise with “brassplate companies,” “shell companies,” or “special purpose entities’’ (SPEs). These entities may have little physical presence in the economy in which they are legally incorporated or legally domiciled (e.g., registered or licensed), and any substantive work of the entity may be conducted in another economy. In such circumstances, there might be debate as to where the center of economic interest for such entities lies. The Guide attributes residence to the economy in which the entity, which has the liabilities on its balance sheet—and, therefore, on whom a creditor has a claim—is legally incorporated, or in the absence of legal incorporation, is legally domiciled.

3.40 However, “brass plate companies,” “shell companies,” or SPEs, if deposit-takers, should be included in the cross-border consolidated information of the parent deposit-taking entity.

3.41 A household is resident in the country in which its members maintain regular residence. The situation differs for military personnel and civil servants (including diplomats) employed abroad in government enclaves such as military bases and embassies, and for students and medical patients abroad, who remain members of households in their home countries.

3.42 The ownership of land and structures within the economic territory of a country is not deemed to be sufficient in itself for the owner to have a center of economic interest in that country. When an owner of land or buildings in an economy is a resident of another economy, he/she is classified as a nonresident from the viewpoint of the first economy.

3.43 Unless agents take positions between the borrower and the creditor bank on to their own balance sheets, the debtor/creditor relationship is between the lending bank and the borrowing entity, with the agent merely facilitating the transaction by bringing the borrower and lender together.

Domestic and foreign currencies, unit of account, and exchange rate conversion

3.44 The extent to which assets and liabilities on the balance sheets of corporations are denominated in foreign currencies and the degree to which currency risks are matched, is important for financial stability analysis because of the potential impact on the domestic currency value of assets and liabilities from movements in foreign exchange rates.

3.45 Domestic currency is the one which is legal tender in the economy and issued by the monetary authority for that economy or for the common currency area to which the economy belongs.⁴¹ Any currencies that do not meet this definition are foreign currencies to that economy. Under this definition, an economy that uses as its legal tender a currency issued by a monetary authority of another economy—such as U.S. dollars—or of a currency area to which it does not belong should classify the currency as a foreign one, even though domestic transactions are settled in it.

3.46 In the Guide, the currency composition of assets and liabilities is primarily determined by characteristics of the future payment(s). Foreign currency instruments are those payable in a currency other than the domestic currency. A subcategory of foreign currency instruments comprises those payable in a foreign currency but with the amounts to be paid linked to a domestic currency (domestic-currency-linked instrument). Foreign-currency-linked instruments are those payable in domestic currency but with the amounts to be paid linked to a foreign currency. Domestic currency instruments are those instruments payable in the domestic currency and not linked to a foreign currency. In the unusual instance of debt instruments with interest payments to be paid in a foreign currency but principal payments to be paid in a domestic currency, or vice versa, only the present value of the payments to be paid in a foreign currency need be classified as a foreign currency instrument.

3.47 From the perspective of the national compiler, the domestic currency unit is the obvious choice in which to calculate FSIs. Such data are compatible with the national accounts and most of the economy’s other economic and monetary statistics, which are expressed in that unit. However, if the value of the domestic currency is subject to significant fluctuation relative to other currencies, a statement denominated in domestic currency could be of diminished analytical value, because valuation changes could make period-to-period comparisons less meaningful.

3.48 The calculation of FSIs can be complicated by the fact that transactions, other flows, and positions may be expressed initially in a variety of currencies or in other standards of value. Their conversion into a reference unit of account is a requisite for the construction of a consistent and analytically meaningful set of FSI statistics. The most appropriate exchange rate to be used for conversion of position data denominated in foreign currencies into the unit of account is the market (spot) exchange rate prevailing on the reference date to which the position relates. The midpoint between buying and selling rates is preferred to ensure consistency of approach among the reporting population. For conversion of an instrument in a multiple rate system,⁴² the rate on the reference date for the actual exchange rate applicable to the specific liabilities or assets should be used. Transactions and other flows in foreign currencies should be converted at the market exchange rate—the midpoint between buying and selling rates is preferred—prevailing at the moment when the transaction occurs. If this information is not available, the average rates for the shortest period applicable should be used. If only information on aggregated transactions over a period is available, then the average exchange rate over this period is a suitable proxy.

Maturity

3.49 Maturity is relevant for financial stability analysis both from a liquidity viewpoint (e.g., in calculating the value of liabilities falling due in the short-term) and from an asset/liability mismatch perspective (e.g., in estimating the effect of changes in interest rates on profitability). In the Guide, short-term is defined as a maturity of one year or less⁴³ and long-term as a maturity of more than one year (or no stated maturity).

3.50 One approach is to determine the maturity classification of financial instruments on the basis of the time until repayments of principal (and interest) are due—known as remaining maturity (and sometimes referred to as residual maturity).⁴⁴ Another approach uses the maturity at issuance—known as original maturity—thus indicating whether the funds were raised in the short-term or long-term markets.

3.51 Yet another approach to maturity is to calculate the duration of assets and liabilities. Duration is the weighted average term to maturity of a financial instrument and can be used as a measure of the sensitivity of the value of financial assets to changes in interest rates, rather than of maturity as such.

3.52 For a given portfolio of financial assets and liabilities the magnitude of gains or losses arising from potential interest rate changes can be estimated using duration analysis, and compared with capital and reserves.

3.53 The longer the duration of a portfolio, the greater the gains (or losses) for any given change in interest rates. Therefore, if despite the matching of the maturities of financial assets and liabilities, the timing of the cash flows on assets and liabilities is not perfectly matched, that is the duration of assets and liabilities differ, corporations can be open to gains (or losses) as interest rates change. ⁴⁵

3.54 For fixed-rate instruments, the time period until the receipt/payment of each cash flow, such as six months, is weighted by the present value of that cash flow as a proportion of the present value of total cash flows over the life of the instrument. So, the more cash flows are concentrated toward the early part of an instrument’s life, the shorter the duration relative to maturity. Duration equals remaining maturity only for zero-coupon instruments. In the Guide, the preferred approach is that the discount rate used to calculate present value of each payment is the current yield to maturity of the instrument.

3.55 For a floating-rate instrument, its duration is the time until the next interest rate reset date rather than the time until the receipt/payment of each cash flow.

3.56 Depending upon the analytical need, the instrument coverage of duration measures can vary. Shares and other equity are typically excluded from the calculation.

• where,

• D_i = Duration measured in years for instrument i

• CF_t = Cash flow to be received on the financial instrument at end of period t

• N = Last period in which the cash flow is received—maturity of instrument

• DF_t = Discount factor = 1/(1+R)^t where R is the yield or current level of interest rates in the market

• $\sum _{t-1}^N$ = summation sign for addition of all terms for t=1 to t=N

• PV_t = Present value of the cash flow due at the end of the period t, which equals CF_t x DF_t

Chapter Four Accounting Framework and Sectoral Financial Statements

Introduction

4.1 Fundamental to understanding the financial condition of deposit-takers, other corporations, and households is information from the traditional financial statements on income and expense, and the stock of assets and liabilities—the balance sheet. Data series obtained from such statements can be used to calculate many of the FSI ratios for corporations and households.

4.2 This chapter begins by outlining the traditional accounting framework for which financial statements are drawn, before presenting detailed sectoral financial statements and defining the line-item series. The guidance is provided in order to assist in the compilation of the component series required to calculate the FSI ratios. It draws upon the relevant conceptual advice for other economic statistics, IASs and supervisory guidance, and takes account of macroprudential requirements.

4.3 In addition to data reported by individual institutions, some data are required to make adjustments at the sector level primarily to eliminate transactions and positions among institutions within the same sector. While sector-level data are discussed in more detail in Chapter 5, where appropriate the series required for sector-level adjustments are noted in footnotes in this chapter. ⁴⁶

4.4 It is recognized that countries have different accounting systems and will rely on national sources of data to compile FSIs. For instance, to compile data on a domestically controlled cross-border consolidated basis compilers may rely on supervisory-based data. Some data series may not be collected, and others may not meet the definitions suggested in the Guide. In such circumstances, the data that most closely approximate the principles in the Guide should be used. In determining the need to collect new data, and hence an increased resource cost, authorities must make a judgment as to the likely impact and importance of the additional data series for compiling and monitoring FSI data.

4.5 In comments made on an earlier draft of the Guide, many compilers urged that flexibility be given to countries to take account of the differences in the readiness to adopt international standards. It was acknowledged that such flexibility may make comparison difficult between countries that have different criteria for recording information, increasing the importance of disseminating metadata (information about data). Such information could potentially give greater transparency to provisioning and loan classification methods.

4.6 Given these concerns, why does the Guide provide sectoral accounts and detailed definitions? First, such an approach supports compilation efforts at the national level by specifying how the series required to calculate FSIs are to be defined. Second, by providing a consistent framework that draws on relevant international standards, and takes account of analytical needs, a benchmark is provided for use by national compilers, even if their own national standards differ. Such a benchmark can be used as a reference when disseminating metadata. Third, such an approach helps foster greater comparability of data across countries—a medium-term objective in line with the views of the IMF Executive Board. In this regard, the definitions provided in this chapter can help guide the future development of sectoral financial data to be used to calculate FSIs.

Accounting framework

4.7 Outlined ahead are the key elements of financial statements.

Income and expense statement

4.8 This statement includes income and expenses related to the operations of the entity. After expenses have been deducted along with any dividends paid or payable to shareholders, any remaining income is transferred to the capital and reserves as retained earnings. As noted in Chapter 3, in the Guide income and expenses are recorded on an accrual rather than a cash basis. As defined in the Guide, net income before dividends measures the increase or decrease in value during the period that arises from the activities of the deposit-taking sector.

Balance sheet

4.9 The balance sheet is the statement of assets, liabilities, and capital at the end of each accounting period:

• Assets include both financial⁴⁷ and nonfinancial assets.

• Liabilities include debt liabilities and financial derivatives.

• The difference between the value of assets and liabilities is known in the Guide as capital and reserves.⁴⁸ This represents the “cushion” to absorb any losses arising from the income and expense statement, or for other reasons. If liabilities exceed assets, then the entity is technically insolvent.

4.10 Some liabilities and assets of corporations are contingent on a certain event(s) occurring and are recorded off balance sheet (see paragraph 3.12). As noted in Chapter 3, such items require monitoring to assess the full financial risk exposure of the corporation.

4.11 Measures of profitability and capital depend on the accounting definitions adopted. For instance, if valuation gains and losses on assets are recorded in the income and expense statement, they will affect the recorded profitability of corporations. Alternatively, if some assets or liabilities are off—rather than on—balance sheet, this will affect measured capital. In developing the guidance on definitions set out ahead, to a varying extent three sources of accounting definitions are drawn upon. These are described in Box 4.1.

Box 4.2

The Basel Capital Adequacy Ratio

The Basel capital adequacy ratio was adopted in 1988 by the Basel Committee on Banking Supervision (BCBS) as a benchmark to evaluate whether banks operating in the Group of Ten (G-10) countries have sufficient capital to survive likely economic shocks. The ratio calls for minimum levels of capital to (1) provide a cushion against losses due to default arising from both on- and off-balance sheet exposures, (2) demonstrate that bank owners are willing to put their own funds at risk, (3) provide quickly available resources free of transaction and liquidation costs, (4) provide for normal expansion and business finance, (5) level the playing field by requiring universal application of the standard, and (6) encourage less risky lending.

The original Basel capital ratio, along with subsequent amendments, requires international banks to have a specific measure of capital greater than or equal to 8 percent of a specific measure of assets weighted by their estimated credit risk. The ratio is an analytical construct with complex definitions of the numerator (capital) and the denominator (risk-weighted assets) that cannot be derived directly from standard financial statements. The formula states that a banking enterprise must have capital on a worldwide consolidated basis equal to 8 percent or more of its risk-weighted assets, which includes off-balance sheet positions.

where: capital = (Tier 1 capital - goodwill) + (Tier 2 capital) + (Tier 3 capital) - adjustments

Tier 1 capital, or “core capital” consists of equity capital and disclosed reserves that are

$$Risk-basedcapitaladequacyratio=\frac{capitalx100}{Risk-weightedassets}\ge 8$$

considered freely available to meet claims against the bank.

Tier 2 capital consists of financial instruments and reserves that are available to absorb losses, but which might lack permanency, have uncertain values, might entail costs if sold, or which otherwise lack the full loss-absorption capacity of Tier 1 capital items.

Tier 3 capital consists of subordinated debt with an original maturity of at least two years for use, if needed, against market risk exposures associated with fluctuations in the market value of assets held. Neither interest nor principal on its debt may be paid if such payments mean that the bank falls below or remains below its minimum capital requirement.

Goodwill is subtracted because the value of goodwill may fall during crises, and various adjustments are made to capital to prevent possible double counting of value.

Risk-weighted assets, the denominator, are the weighted total of each class of assets and off-balance-sheet asset exposures, with weights related to the credit risk associated with each type of asset. In the example below, the market value of assets is 940, but the value of risk-weighted assets is 615.

Example of Estimation of Risk-Weighted Assets

Example of Estimation of Risk-Weighted Assets

Type of Asset	Value of Holdings	Risk-Weight	Risk-Weighted Assets
U.S. Treasury bonds	200	%0	0
Mortgage loans	250	50%	125
Corporation bonds	120	100%	120
Consumer loans	370	100%	370
Total	940	--	615

View Table

Example of Estimation of Risk-Weighted Assets

Type of Asset	Value of Holdings	Risk-Weight	Risk-Weighted Assets
U.S. Treasury bonds	200	%0	0
Mortgage loans	250	50%	125
Corporation bonds	120	100%	120
Consumer loans	370	100%	370
Total	940	--	615

Capital adequacy ratios are often not directly comparable between countries because national supervisors have some leeway in defining weights and adjustments and, even more importantly, national practice may vary in the valuation of assets, recognizing loan losses and provisioning, which can significantly affect the ratio. Also, an aggregate measure of capital adequacy potentially disguises information on individual institutions, and thus for macroprudential analysis, it is useful to supplement the aggregate ratio with information on the dispersion of ratios for individual institutions or subsectors of the banking system.

Recent developments regarding the ratio include attempts to refine the weighting system. In particular, the Basel Committee has a proposal to revamp the standard to permit greater differentiation between assets based on their risk, including the possibility of using—under specified conditions—internal model-based measures of risk exposures.

4.12 Appendix IV provides a detailed reconciliation of the definitions set out in this chapter with those in both national and commercial accounting—the basic data sources most likely to be drawn upon. This appendix supplements the main text, and can be drawn upon for additional guidance.

Sectoral financial statements

4.13 Sectoral financial statements are set out ahead on an institutional sector basis. While the income and expense statements and the balance sheets for the specific sectors have a considerable degree of overlap in terms of line-item series identified (particularly the balance sheets) there are significant differences in presentation between the sectors. These differences have implications for the calculation of FSIs. For instance, the net interest margin is an important FSI series for deposit-takers, but not for the household sector, for which gross disposable income is a more relevant measure. The deposit-taking sector is presented first, because of its central role in the financial system and the wider range of series from the sectoral financial statements required to calculate FSIs for deposit-takers.

4.14 The line-item series in the financial statements for which definitions are provided are those required to calculate the FSIs set out in Chapters 6 and 7, either directly, or as important building blocks in calculating the required aggregates. The advantage of defining these series within the framework of a financial statement is the accounting rigor that is imposed—the series are defined so as to ensure that the integrity of a double-entry recording system is maintained, while promoting a consistency of approach in the classification and coverage of transactions and positions. The conceptual guidance for the calculation of financial market FSIs is provided in Chapter 8.

4.15 Unless stated otherwise, each series presented below is defined only once, even if it appears in other sectoral financial statements. Most of the definitions are provided in the section covering the deposit-takers’ financial statement. It is recognized that there may need to be a degree of flexibility in interpreting this guidance when compiling data. When disseminating data, compilers are encouraged to document any significant differences between national practice and the guidance provided below.

Deposit-takers

Income and expense

4.16 The sectoral financial statement for deposit-takers is set out in Table 4.1.

Table 4.1.

Deposit-Takers

¹To understand the interconnections among deposit-takers, separate identification of income and claims on other deposit-takers in the reporting population is encouraged.

²Interbank loans and deposits comprise those loans to or deposits from any other deposit-taker (resident or nonresident).

³If gross loans data are only available including the accrual of interest on NPLs, any provisions for accrued interest on NPLs should be included in this line item, and if significant, separately identified.

⁴Funds contributed by owners plus retained earnings (including appropriations from retained earnings to reserves). Purchased goodwill is excluded. Only compiled if Tier 1 data are not available.

⁵While individual country circumstances will vary, data on the distribution of lending by regional groupings of countries is encouraged, with additional country information where relevant (see paragraph 6.62).

Table 4.1.

Deposit-Takers

Income and Expense Statement		Balance Sheet
1.	Interest income1 (i) Gross interest income (ii) Less provisions for accrued interest on nonperforming assets	14.	Total assets (= 15+16 = 31)
		15.	Nonfinancial Assets
		16.	Financial assets (=17 to 22)
2.	Interest expense1	17.	Currency and deposits1
3.	Net interest income (= 1 minus 2)	18.	Loans (after specific provisions) (i) Gross loans1 (i.i) Interbank loans2 (i.i.i) Resident (i.i.ii) Nonresident (i.ii) Noninterbank loans (i.ii.i) Central bank (i.ii.ii) General government (i.ii.iii) Other financial corporations (i.ii.iv) Nonfinancial corporations (i.ii.v) Other domestic sectors (i.ii.vi) Nonresidents (ii) Specific provisions 3
4.	Noninterest income (i) Fees and commissions receivable1 (ii) Gains or losses on financial instruments (iii) Pro-rated earnings (iv) Other income1
5.	Gross income (= 3 + 4)
6.	Noninterest expenses (i) Personnel costs (ii) Other expenses
7.	Provisions (net) (i) Loan loss provisions (ii) Other financial asset provisions	19.	Debt securities1
		20.	Shares and other equity
		21.	Financial derivatives1
		22.	Other assets1
8.	Net income (Before extraordinary items and taxes) (= 5 minus (6 + 7))	23.	Liabilities (= 28 +29)
		24.	Currency and deposits (i) Customer deposits (ii) Interbank deposits2 (ii.i) Resident (ii.ii) Nonresident (iii) Other currency and deposits
9.	Extraordinary items
10.	Income tax
11	Net income after tax (= 8 minus (9 +10))
12.	Dividends payable	25.
			Loans
13.	Retained earnings (= 11 minus 12)	26.	Debt securities
		27.	Other liabilities
		28.	Debt (= 24+25+26+27)
		29.	Financial derivatives
		30.	Capital and reserves (i) o/w narrow capital and reserves 4
		31.	Balance sheet total (=23+30 = 14)
Memorandum series
Other series required to calculate the agreed FSIs
Supervisory series
32.	Tier 1 capital
33.	Tier 2 capital
34.	Tier 3 capital
35.	Supervisory deductions
36.	Total regulatory capital (item 32 to item 34 minus item 35)
37.	Risk-weighted assets
38.	Number of large exposures
Series that provide a further analysis of the balance sheet
39.	Liquid assets (core)
40.	Liquid assets (broad measure)
41.	Short-term liabilities
42.	Nonperforming loans
43.	Residential real estate loans
44.	Commercial real estate loans
45.	Geographic distribution of loans 5
46.	Foreign currency loans
47.	Foreign currency liabilities
48.	Net open position in equities
49.	Net open position in foreign currency for on-balance-sheet items
Balance-sheet-related series
50.	Total net open position in foreign currency
51.	Exposures of largest deposit-takers to largest entities in the economy
52.	Exposures to affiliated entities and other “connected” counterpartie

¹To understand the interconnections among deposit-takers, separate identification of income and claims on other deposit-takers in the reporting population is encouraged.

²Interbank loans and deposits comprise those loans to or deposits from any other deposit-taker (resident or nonresident).

³If gross loans data are only available including the accrual of interest on NPLs, any provisions for accrued interest on NPLs should be included in this line item, and if significant, separately identified.

⁴Funds contributed by owners plus retained earnings (including appropriations from retained earnings to reserves). Purchased goodwill is excluded. Only compiled if Tier 1 data are not available.

⁵While individual country circumstances will vary, data on the distribution of lending by regional groupings of countries is encouraged, with additional country information where relevant (see paragraph 6.62).

View Table

Table 4.1.

Deposit-Takers

Income and Expense Statement		Balance Sheet
1.	Interest income1 (i) Gross interest income (ii) Less provisions for accrued interest on nonperforming assets	14.	Total assets (= 15+16 = 31)
		15.	Nonfinancial Assets
		16.	Financial assets (=17 to 22)
2.	Interest expense1	17.	Currency and deposits1
3.	Net interest income (= 1 minus 2)	18.	Loans (after specific provisions) (i) Gross loans1 (i.i) Interbank loans2 (i.i.i) Resident (i.i.ii) Nonresident (i.ii) Noninterbank loans (i.ii.i) Central bank (i.ii.ii) General government (i.ii.iii) Other financial corporations (i.ii.iv) Nonfinancial corporations (i.ii.v) Other domestic sectors (i.ii.vi) Nonresidents (ii) Specific provisions 3
4.	Noninterest income (i) Fees and commissions receivable1 (ii) Gains or losses on financial instruments (iii) Pro-rated earnings (iv) Other income1
5.	Gross income (= 3 + 4)
6.	Noninterest expenses (i) Personnel costs (ii) Other expenses
7.	Provisions (net) (i) Loan loss provisions (ii) Other financial asset provisions	19.	Debt securities1
		20.	Shares and other equity
		21.	Financial derivatives1
		22.	Other assets1
8.	Net income (Before extraordinary items and taxes) (= 5 minus (6 + 7))	23.	Liabilities (= 28 +29)
		24.	Currency and deposits (i) Customer deposits (ii) Interbank deposits2 (ii.i) Resident (ii.ii) Nonresident (iii) Other currency and deposits
9.	Extraordinary items
10.	Income tax
11	Net income after tax (= 8 minus (9 +10))
12.	Dividends payable	25.
			Loans
13.	Retained earnings (= 11 minus 12)	26.	Debt securities
		27.	Other liabilities
		28.	Debt (= 24+25+26+27)
		29.	Financial derivatives
		30.	Capital and reserves (i) o/w narrow capital and reserves 4
		31.	Balance sheet total (=23+30 = 14)
Memorandum series
Other series required to calculate the agreed FSIs
Supervisory series
32.	Tier 1 capital
33.	Tier 2 capital
34.	Tier 3 capital
35.	Supervisory deductions
36.	Total regulatory capital (item 32 to item 34 minus item 35)
37.	Risk-weighted assets
38.	Number of large exposures
Series that provide a further analysis of the balance sheet
39.	Liquid assets (core)
40.	Liquid assets (broad measure)
41.	Short-term liabilities
42.	Nonperforming loans
43.	Residential real estate loans
44.	Commercial real estate loans
45.	Geographic distribution of loans 5
46.	Foreign currency loans
47.	Foreign currency liabilities
48.	Net open position in equities
49.	Net open position in foreign currency for on-balance-sheet items
Balance-sheet-related series
50.	Total net open position in foreign currency
51.	Exposures of largest deposit-takers to largest entities in the economy
52.	Exposures to affiliated entities and other “connected” counterpartie

¹To understand the interconnections among deposit-takers, separate identification of income and claims on other deposit-takers in the reporting population is encouraged.

²Interbank loans and deposits comprise those loans to or deposits from any other deposit-taker (resident or nonresident).

³If gross loans data are only available including the accrual of interest on NPLs, any provisions for accrued interest on NPLs should be included in this line item, and if significant, separately identified.

⁴Funds contributed by owners plus retained earnings (including appropriations from retained earnings to reserves). Purchased goodwill is excluded. Only compiled if Tier 1 data are not available.

⁵While individual country circumstances will vary, data on the distribution of lending by regional groupings of countries is encouraged, with additional country information where relevant (see paragraph 6.62).

4.17 For deposit-takers the main source of revenue and expense is interest. Interest income is a form of income that accrues on debt instruments such as deposits, loans, debt securities, and other accounts receivable. For the borrower it is the cost (known as an interest cost) of the use of another entity’s funds. As explained in Chapter 3 (paragraph 3.7) in the Guide, interest is recorded as accruing continuously. As can be seen in Table 4.1, the difference between interest expense and interest income is known net interest income.

4.18 A specific issue arises as to whether interest should accrue on nonperforming assets, and if so should this affect the net interest income line. The Guide recommends that interest income should not include the accrual of interest on nonperforming assets, because otherwise net interest income would be overstated relative to the actual interest earning capacity of the deposit-taker⁴⁹

4.19 But, to ensure consistency of approach between debtors and creditors, Table 4.1 includes the line-items for gross interest income, including interest accrual on nonperforming assets, and provisions for interest accrual on nonperforming assets. The latter should be deducted from the former to eliminate the interest accruing on nonperforming assets in the interest income line.^{50 51} If the debtor subsequently pays interest on nonperforming assets to the deposit-taker, interest income should increase through an adjustment to the provision in the period payments are received and, if significant, referred to in any accompanying explanatory documentation.⁵² If any interest accrued before an asset was classified as nonperforming, given that such accrual would increase the value of the asset, a specific loan loss provision would be appropriate (see paragraph 4.32). If data are only available on interest income excluding interest accrual on nonperforming assets, then only the interest income line (line 1 in Table 4.1) should be reported. Appendix V provides numerical examples of how to record interest on NPLs.

4.20 Noninterest income is all other income received by the deposit-taker. Included are fees and commissions from the provision of services, gains and losses on financial instruments, ⁵³ and other income. Net interest income together with noninterest income is equal to gross income.

4.21 Fees and commissions are for services such as payment services; intermediary services (e.g., those associated with lines of credit, and letters of credit), services related to transactions in securities (e.g., brokerage fees, placements and underwriting of new issues, arrangement of swaps and other financial derivatives, security lending), and services related to asset management (e.g., portfolio management, safe-custody).⁵⁴ National practice might require that fees and commissions payable to other deposit-takers in the reporting population be included as a negative income item rather than included as an expense.

4.22 Gains and losses on financial instruments are those arising during the period under review. The Guide encourages the inclusion in this item of realized and unrealized gains and losses arising during each period on all financial instruments (financial assets and liabilities, in domestic and foreign currencies) valued at market or fair value in the balance sheet, ⁵⁵ including investment account securities, but excluding equity in associates, subsidiaries, and any reverse equity investments.^{56 57} Gains and losses on foreign exchange instruments and on financial derivative instruments, such as interest rate swaps, are also included. Gains and losses on financial instruments exclude any interest included in the net interest income account as accrued for that instrument in the reporting period, as such amounts have been already accounted for in the income account as interest income.

4.23 In contrast, gains and losses in deposit-takers’ accounts have traditionally covered gains and losses recorded on assets and liabilities held for a short period as deposit-takers seek to take advantage of short-term fluctuations in market prices. Coverage varies among the various accounting standards, but typically includes realized and unrealized gains/losses during the period on securities and derivatives held in the so-called dealing account.⁵⁸ They include gains and losses arising from on-selling of securities acquired under security repurchase agreements, securities lending, and sell/buyback arrangements (see paragraph 4.48); any gains/losses realized during the period on sales of securities held in the investment account; and gains or losses arising from the holding, sale, and purchase of foreign exchange instruments (except for equity investments in associates and subsidiaries), including foreign exchange derivative contracts.

4.24 However, the Guide encourages the wider coverage of gains and losses on financial instruments outlined in paragraph 4.22 so that:

(1) Net income reflects current health and not past developments. In other words, changes in the value of financial instruments that can be reliably measured are recorded in sector income in the period they arise.⁵⁹ Experience has demonstrated that the build-up of hidden gains and losses that remain unrecorded in the income statement until they are realized can be misleading for macroprudential analysis.

(2) Return on capital is reliably observed. Capital is employed by deposit-takers to generate net income primarily through activity in financial instruments. Excluding unrealized gains and losses in financial instruments, whose value can be reliably measured, obscures in any one period the extent to which capital is efficiently employed. While immediate recognition of gains and losses might generate greater period-to-period volatility in the return on capital data than nonrecognition, understanding the causes of such volatility and observing the trend overtime provides a more robust basis for macroprudential analysis.

(3) The relative importance of gains and losses on those financial assets and liabilities valued at market or fair value can be monitored. Experience has shown that gains and losses on financial instruments can be a more volatile element in deposit-takers’ earnings than other income items, perhaps reflecting potentially greater risk-taking. Identification of the size and sensitivity of deposit-taker’s income and capital to changes in market conditions is best observed by time series data that captures the gains and losses on an ongoing basis.

(4) To avoid asymmetric reporting of gains and losses at the sector-wide level. If individual deposit-takers record gains and losses on the same instrument at different times this will lead to inconsistent measures of net income at the sector level.⁶⁰

4.25 Appendix V provides numerical examples of how to record gains and losses on financial instruments.

4.26 It is acknowledged that coverage of gains and losses as set out in paragraph 4.22 may not be feasible for reporters at the time of writing, and that data collection systems may need to be developed.

4.27 For those financial instruments for which gains and losses can only be recorded when realized, the gain or loss should be measured as the difference between the transaction value and the market value recorded on the balance sheet at the end of the previous period. Any unrealized gains or losses that developed over previous periods and which are included in the valuation adjustment should be transferred to retained earnings. In other words, so as not to distort measures of current health, or create adverse selection-type incentives described in paragraph 3.22, net income should not reflect the realization of gains or losses that have developed in the balance sheet valuation of financial instruments and been retained over a number of reporting periods. In addition, all gains or losses in the reporting period—that is, since the previous end-period—that are realized on any other financial assets (except for those related to associate, subsidiary, and reverse equity investments, which are all recorded directly in capital and reserves) should also be included within the gains and losses on financial instruments line. This includes losses on loan sales. If these gains and losses are significant in any one period, compilers are encouraged to provide additional information so that their importance to the data disseminated can be judged.

4.28 Pro-rated earnings cover the share—on the basis of the share of equity owned—of net income after tax⁶¹ from associates, and unconsolidated subsidiaries ⁶² and reverse equity investments, and, for domestic-based data, foreign branches.⁶³

4.29 Other income covers (1) dividends declared payable by other corporations or cooperatives in which deposit-takers have an equity stake,⁶⁴ (2) gains or losses on sales of fixed assets in the current period (measured as the difference between the sale value and the balance sheet value at the previous end-period),⁶⁵ (3) rental and royalty income receivable (including on buildings, other structures, and equipment; from land and subsoil assets; and from other produced and nonproduced assets), and (4) any amounts receivable by deposit-takers arising from compensation for damage or injury.

4.30 Noninterest expenses cover all expenses other than interest expenses, including fees and commissions. They include operating expenses relating to the ordinary banking business (other than interest expenses) such as (1) personnel (or staff) costs (see ahead); (2) expenses for property and equipment—ordinary and regular maintenance and repair,⁶⁶ rentals paid on building, other structures and equipment (and related depreciation),⁶⁷ and rents paid on land; (3) other expenditures related to the operations—including purchases of goods and services, (e.g., advertising costs, staff training service expenses, and fees for other services provided), and royalties paid for the use of other produced or nonproduced assets (excluding those expenses classified as personnel costs (see ahead)); and (4) taxes other than income taxes—such as taxes on the ownership or use of land and buildings or on labor employed (including, payroll and other employee related taxes payable by the employer)—less any subsidies received such as from general government, related to operating activity. Also included are any fines and penalties imposed on deposit-takers, such as by courts of law, and any amounts payable by deposit-takers as compensation to other institutional units for injury and damage. For deposit-takers, operating expenses also include any premiums paid to a deposit insurance fund.

4.31 Personnel costs include the total remuneration, in cash or in kind, payable by the enterprise in return for work done by employees during the accounting period. Included are wages and salaries, including paid annual leave and paid sick leave, profit sharing and bonuses, allowances for housing and cars, as well as free or subsidized goods and services provided (except those required for employees to carry out their work); and social security contributions, for such items such as medical care and pensions.⁶⁸ Also included are unfunded employee social insurance benefits such as the continued payment of normal or reduced wages during periods of absence from work as a result of ill health and accidents, redundancy payments, and so on.

4.32 Loan loss provisions are net new allowances that deposit-takers make in the period against bad or impaired loans, based on their judgment as to the likelihood of losses.⁶⁹ General provisions are provisions not attributed to specific assets but the amount of losses that experience suggests may be in a portfolio of loans. Such provisions are sometimes calculated as a percentage of total assets. Alternatively, they can be calculated by applying progressively higher percentages for lower quality assets, reflecting the increasing probability of losses. Specific provisions are charges against the value of specific loans (including a collectively assessed group of loans) and reflect identifiable losses.⁷⁰

4.33 The Guide relies on national practices in identifying loan loss provisions and distinguishing between specific and general provisions, but recommends that such practices be clearly documented. Provisions for the accrual of interest on nonperforming assets should not be included under loan loss provisions, as they are identified within (and excluded from net interest income.⁷¹ While provisions for losses or future expenses reduce net income, subject to national practice, overprediction of expected losses or expenses in any one period could be reversed in subsequent periods, increasing income in those periods. An explanation of how provisioning affects assets and capital and reserves is provided in Box 4.3. Also, Appendix VI includes a discussion of approaches to the classification of assets and provisioning.

4.34 Other financial asset provisions include provisions against any other financial assets that can be valued reliably. If it is not feasible at this time to include unrealized gains and losses on securities—such as those in the investment account—within gains and losses on financial instruments (see paragraph 4.22), the same approach as with loan provisioning should be adopted for these securities, so that losses on these assets are captured within net income.⁷² This item also includes any new provisions made for supervisory purposes to take account of changes in the volatility of bid-ask spreads or other factors relating to closing out a position in a less-liquid tradable instrument. ⁷³ Gross income less operating expenses and provisions⁷⁴ equates to net income (before extraordinary items and tax).

4.35 Extraordinary items cover events that are extraordinary in relation to the business ordinarily carried out by the enterprise. Such events would be rare and include catastrophic losses arising from a natural or other disaster. Extraordinary items can include income but will usually be expense items. Income taxes are those taxes that accrue in the period under review and are related to the income, profits, and/or capital gains of deposit-takers. Once extraordinary items and taxes are deducted from net income, the total is equal to net income after tax.

4.36 Dividends are amounts declared payable in the period under review to the owners of deposit-takers after all other expenses have been met, leaving retained earnings to be posted to the retained earnings account of capital and reserves.

Balance sheet

Nonfinancial assets

4.37 Nonfinancial assets are all economic assets other than financial assets. A definition of these assets is provided in the discussion below on the sectoral balance sheet for nonfinancial corporations (paragraph 4.106).

Financial assets and liabilities

4.38 Financial assets⁷⁵ are those financial claims over which ownership rights are enforced, from which economic benefits may be derived by their owners, and which are a store of value. Financial claims arise out of contractual relationships between pairs of institutional units, and in many instances, such claims entitle the owner (i.e., the creditor) to receive one or more payments, for example, interest payments, from the institutional unit on whom they have the claim (the debtor). In addition, some financial assets generate holdings gains (and losses) for their owners. When a financial claim is created, a liability of equal value is simultaneously incurred by the debtor as the counterpart to the financial asset.

4.39 The identification and presentation of the different types of financial assets and liabilities can vary depending on analytical needs and national accounting practice. In the list of FSI ratios, the primary focus is on instruments by functional type, such as loans, equities, securities, and derivatives. Thus, in the Guide, the primary classification of financial assets and liabilities is: currency and deposits, loans, debt securities,⁷⁶ shares and other equity (assets), capital and reserves, financial derivatives, and other assets (liabilities).

4.40 Currency consists of notes and coins in circulation that are commonly used to make payments. They are usually (but not always) issued either by central banks or government units and are liabilities of the units that issue them. Currency has a fixed nominal value. Gold and commemorative coins that are not in circulation as legal tender are classified as nonfinancial assets rather than as currency.

4.41 Deposits include all non-negotiable financial claims represented by evidence of deposit. Deposits comprise transferable deposits and other deposits. Transferable deposits comprise all deposits in domestic or foreign currency that are (1) exchangeable, without penalty or restriction, on demand at par and (2) directly usable for making third-party payments by check, draft, giro order, direct debit/credit, or other direct payment facility.⁷⁷ Other deposits comprise deposits that have restrictions on the number of third-party payments that can be made per period and/or the minimum size of individual third-party payments and so are considered nontransferable. These include:

• Sight deposits that permit immediate cash withdrawals, but not direct third-party payments.

• Savings and fixed-term deposits, including non-negotiable certificates of deposit.

• Nontransferable deposits denominated in foreign currency.

• Shares or similar evidence of deposit issued by savings and loan associations, building societies, credit unions and the like, which are, legally or in practice, redeemable immediately or at relatively short notice.

• Possibly repurchase agreements (see paragraph 4.48).

4.42 Customer deposits are those considered to be more “stable,” less volatile, types of deposits that can be employed to fund long-term lending. It is a series required to calculate an encouraged FSI.

4.43 Volatility of deposits refers to how sensitive depositors are to events that could affect confidence in deposit-takers. More specifically, it refers to the likelihood that depositors will, at short notice, withdraw funds in response to a perceived weakness in an individual deposit-taker or in the banking system. Determining such a likelihood ex-ante is difficult, but typically the key factors taken into account are the type of depositor, insurance coverage, and maturity (remaining maturity). Experience suggests that some types of depositors are less likely to move their funds than others. However, deposits covered by credible insurance schemes are more likely to be a stable form of funding than those not covered. In addition, deposits with a long remaining maturity are likely to be more stable, although the lower the penalties for withdrawal, the less relevant this factor is in determining the likelihood of withdrawal.

4.44 The Guide recommends that the type of depositor be the primary factor in defining customer deposits both because of its relevance and general applicability. Thus, customer deposits include all deposits (resident or nonresident) except those placed by other deposit-takers and other financial corporations (resident and nonresident). The depositors in the excluded sectors are more likely to monitor deposit-takers’ financial information, less likely to be covered by deposit insurance, and perhaps have a fiduciary responsibility to safeguard their assets. They are, therefore, more prone to shifting deposits as risks increase than other depositors. Perhaps because of deposit insurance, household depositors tend to be less aware of the risks, while commercial depositors may have other relationships with banks that make them more reluctant than institutional investors to move funds.⁷⁸ Provided it can be determined that the penalties for withdrawal are high, customer deposits could also include those from the excluded sectors that have a remaining maturity of over one year.⁷⁹

4.45 Loans include those financial assets created through the direct lending of funds by a creditor to a debtor through an arrangement in which the lender either receives no security evidencing the transactions or receives a non-negotiable document or instrument. Collateral, in the form of either a financial asset (such as a security) or nonfinancial asset (such as land or building) may be provided under a loan transaction, though it is not an essential feature. Included are commercial loans, installment loans, hire-purchase credit, loans to finance trade credit and advances, financial leases, repurchase agreements not classified as a deposit (see also paragraph 4.48), and overdrafts. Trade credit and similar accounts receivable/payable are not loans. To meet the requirements of the agreed FSI list, in Table 4.1 loans to other deposit-takers (resident and nonresident) are distinguished from other loans, which are attributed by sector as defined in Chapter 2 on a residence basis.

4.46 If a loan becomes tradable and is, or has been, traded in the secondary market, the loan is reclassified as a debt security instrument. Given the significance of the reclassification, firm evidence of secondary market trading is needed before a debt instrument is reclassified from a loan to a security. Evidence of trading on secondary markets would include the existence of market makers and bid-offer spreads for the debt instrument. A transfer or one-time sale of a loan would not normally constitute a basis for reclassifying the loan as a security.

4.47 Two forms of loans require further discussion. A financial lease is a contract under which a lessee contracts to pay rentals for the use of a good for most or all of its expected economic life. In this case, de facto, the risks and rewards of ownership are transferred from the legal owner of the good, the lessor, to the user of the good, the lessee. The lessee is frequently responsible for the maintenance and repair of the good. Under statistical and accounting convention, the good is imputed to have changed ownership, and a loan liability of the lessee is created. The value of the loan at inception is equal to the value of the good. The loan is repaid through the payment of rentals (which comprise both interest and principal elements) and any residual payment at the end of the contract (or, alternatively, by the return of the good to the lessor).⁸⁰ The assets that have been leased should be removed from the balance sheet of the lessor.

4.48 A securities repurchase agreement (repo) is an arrangement involving the sale for cash of securities at a specified price with a commitment to repurchase the same or similar securities at a fixed price either on a specified future date (often a few days hence) or with an open maturity.⁸¹ Because the risks and rewards of ownership of the security remain with the original owner, the economic nature of the transaction is that of a collateralized loan (or possibly a deposit).⁸² In other words, the funds advanced by the security taker to the security provider are classified as a loan (or deposit) asset of the security taker (and a liability of the security provider) and the underlying securities remain on the balance sheet of the security provider, despite the legal change in ownership. A gold swap, under which gold is exchanged for other assets, usually foreign exchange, is similar in nature to a repo and is to be recorded similarly. Securities lending is a similar arrangement to a repo except that noncash collateral in the form of securities is provided, and so no loan is recorded. If the security taker provides cash as collateral, then the arrangement is treated in the same way as a repo. The securities involved remain on the balance sheet of the security provider.

4.49 If securities acquired under a repo or securities lending arrangement are sold to third parties, the security taker should record on balance sheet a negative security asset equal to the current market value of the security that was sold.

4.50 Specific loan provisions are the outstanding amount of provisions made against the value of individual loans, collectively assessed groups of loans, and loans to other deposit-takers⁸³ (see also paragraph 4.32).^{84 85}

4.51 Debt securities are negotiable⁸⁶ financial instruments serving as evidence that units have obligations to settle by means of providing cash, a financial instrument, or some other item of economic value. The debt security provides evidence that the claim exists, is tradable in financial markets, and gives the holder an unconditional right to receive interest and/or principal payments. Examples of debt securities are

• Bills, such as treasury bills.

• Bonds and debentures, including bonds that are convertible into shares.

• Commercial paper.

• Negotiable certificates of deposit.

• Tradable depository receipts.

• Notes issued through revolving underwriting facilities and note-issuance facilities.

• Negotiable securities backed by loans or other assets.

• Loans that have become de facto tradable.

• Preferred stocks or shares that pay a fixed income but do not provide for participation in the distribution of the residual value of the corporation on dissolution.

• Bankers’ acceptances.

• Mandatorily redeemable shares.

4.52 Some corporate bonds are convertible into shares of the same corporation at the option of the bondholder. If the conversion option is traded separately, then it is recorded as a separate asset, and classified as a financial derivative.

4.53 Table 4.1 includes all the above instruments under the heading of debt securities. However, it is recognized that national practice might separately identify certain types of instruments, such as mortgage-backed securities, government securities, and securities considered to be of a liquid nature.

4.54 Shares and other equity comprise all instruments and records acknowledging, after the claims of all creditors have been met, claims on the residual value of a corporation. Ownership of equity is usually evidenced by shares, stocks, participation, or similar documents. Preferred stocks or shares, which also provide for participation in the distribution of the residual value on dissolution of an incorporated enterprise, are included.⁸⁷ Buy-backs by a deposit-taker of its own equity securities reduce the number of equity securities outstanding.

4.55 Shares and other equity assets include equity investments in associates, unconsolidated subsidiaries and reverse equity investments, as well as other equity investments in deposit-takers.⁸⁸ In the context of domestic data, shares and other equity assets include any share capital provided to foreign branches.

4.56 Financial derivatives are financial instruments that are linked to a specific financial instrument, indicator, or commodity, and through which specific financial risks can be traded in financial markets in their own right. Their value depends on the price of the underlying item. Unlike debt instruments, no principal is advanced to be repaid and no investment income accrues. Typical derivative contracts are futures (exchange traded forward contract), interest and cross-currency swaps, forward rate agreements, forward foreign exchange contracts, credit derivatives, and various types of options.⁸⁹ Gross market values for financial derivative assets and liabilities should be recorded in the balance sheet and any valuation gains and losses in the income and expense statement.

4.57 Under a forward-type contract, the counterparties agree to exchange an underlying item—real or financial—in a specified quantity, on a specified date, at an agreed contract (strike) price. In the case of a swaps contract, the counterparties agree to exchange cash flows, determined with reference to price(s) of, say, currencies or interest rates, according to prearranged rules. At the inception of the contract, risk exposures of equal market value are exchanged and the contract normally has zero value. But as market prices change, asset and liability positions are created, which may change both in magnitude and direction over time.

4.58 Under an option contract, the purchaser of the option, in return for an option premium, acquires from the writer of the option, the right but not the obligation to buy (call option) or sell (put option) a specified underlying item—real or financial—at an agreed contract (strike) price on or before a specified date. Throughout the life of the contract the writer of the option has a liability and the buyer an asset, although the option can expire worthless; the option will be exercised only if settling the contract is advantageous for the purchaser.

4.59 The Guide prefers that if an instrument such as security or a loan contains an embedded derivative that is inseparable from the underlying instrument, the instrument is valued and classified according to its primary characteristics, and the embedded derivative is not classified and valued separately. ⁹⁰ Examples of instruments with embedded derivatives are bonds that are convertible into equity securities, and securities with options for the repayment of principal in currencies that differ from those in which the securities were issued.⁹¹

4.60 Other assets (or other liabilities from the debtor perspective) cover trade credits and advances, prepayments of insurance premiums, and miscellaneous other items due to be received or paid. Miscellaneous other items receivable or payable include accrued but unpaid taxes, dividends (including dividends declared but not yet payable), purchases and sales of securities, rent, wages and salaries, social contributions, social benefits, and similar payments. Definitions of trade credit and advances are provided in the discussion below of the sectoral balance sheets for nonfinancial corporations (paragraph 4.112). If significant provisions are made against these assets, particularly trade credit, compilers are encouraged to separately identify these provisions in the same manner as for loans (see above).

4.61 Debt is defined as the outstanding amount of those actual current, noncontingent, liabilities that require payments of principal and/or interest by the debtor at some point(s) in the future. Thus, debt comprises those financial liabilities that are currency and deposits, loans, debt securities, and other liabilities.

4.62 Capital and reserves is defined as the equity interest of the owners in an enterprise, and is the difference between total assets and liabilities.⁹² It represents the amount available to absorb unidentified losses.

4.63 In the Guide, total capital and reserves include:

• Funds contributed by owners. This item comprises the total amount from the initial and any subsequent issuance of shares, stocks, or other forms of ownership of deposit-takers. This item is valued as the nominal amount of proceeds from the initial and subsequent issuances. It is not revalued.

• Retained earnings: Changes in this item reflects all after-tax profits that are not distributed to shareholders nor transferred to or from the reserve and valuation accounts. Deducted (included) is any goodwill arising from the purchase (sale) of a stake in an associate or subsidiary (or reverse equity investment stake).⁹³ This item is also valued at the nominal amount of earnings that have been retained, and is not revalued.

• General and special reserves, are reserves that reflect appropriations from retained earnings. These reserves are also to be valued at nominal value and are not revalued.

• Provisions included in the income and expense statement (see paragraph 4.32) other than specific provisions. Specific provisions reduce the value of the relevant asset in the balance sheet. ⁹⁴

• Valuation adjustment is the counterpart to net changes in the market or fair values of assets and liabilities on the balance sheet (excluding any such changes that affect other items within capital and reserves, such as retained earnings). Unrealized gains or losses on assets or liabilities that have been reflected in the valuation adjustment and are now realized should be transferred to retained earnings.⁹⁵ The Guide recommends that this item should only include valuation changes arising from nonfinancial assets, as well as equity investments in associates and unconsolidated subsidiaries, and reverse investments that have not been reflected in retained earnings.

4.64 Tier 1 capital is the core measure of capital (see paragraph 4.70). In the absence of Tier 1 data (such as in the case of units not subject to Basel Capital Adequacy guidelines), the data for funds contributed by owners together with retained earnings (including those earnings appropriated to reserves) could be identified.⁹⁶

4.65 Under consolidated reporting, when the parent has less than full ownership of a subsidiary, the capital and reserves attributable to minority shareholders in the subsidiary(ies) is included in capital and reserves, because the focus of FSIs is on the total capital and reserves of the deposit-takers in the reporting population.

Memorandum series

Other series required to calculate the FSIs

4.66 Some of the series required to calculate the FSIs are not directly available from the financial statements described above. They are included as memorandum items to the financial statement. These series fall into three categories: (1) supervisory-based series; (2) series that provide a further analysis of the balance sheet; and, (3) balance-sheet-related series. Series that go beyond those required to calculate these FSIs, but which in the discussions on the Guide were considered particularly relevant for macroprudential analysis, are set out in Appendix III.

Supervisory-based series

4.67 These are series to be directly sourced from supervisory information because the definitions conform with supervisory guidance. The Guide relies on national practice in calculating regulatory capital and risk-weighted assets data series.

4.68 The Basel Committee on Banking Supervision has developed a specific regulatory definition of capital that is used as the numerator in its official regulatory capital adequacy ratio. The definition extends beyond purely capital and reserve account items identified above to include several specified types of subordinated debt instruments that need not be repaid if the funds are needed to maintain minimum capital levels. ⁹⁷ All internationally active banks are expected to have regulatory capital of at least 8 percent of a measure of risk-weighted assets. National supervisors may require a higher ratio, and have some leeway in establishing the specific standards for their country.⁹⁸

4.69 There are three tiers of regulatory capital. ⁹⁹

4.70 Tier 1 capital comprises paid up shares and common stock—issued and fully-paid ordinary shares/common stock and perpetual noncumulative preference shares—and disclosed reserves created or increased by appropriations of retained earnings or other surplus.¹⁰⁰ The latter include, inter alia, share premiums, retained profit, general reserves, and legal reserves, ¹⁰¹ and are considered to be freely and immediately available to meet claims against the bank.¹⁰²

4.71 Tier 2 capital consists of (1) undisclosed reserves—that part of accumulated retained earnings that banks in some countries may be permitted to maintain as an undisclosed reserve, (2) asset revaluation reserves—with regard to fixed assets, and long-term holdings of equities valued in the balance sheet at historic cost but for which there are “latent” revaluation gains, (3) general provisions/general loan-loss reserves (up to 1.25 percent of risk assets),^{103 104} (4) hybrid instruments that combine the characteristics of debt and equity and are available to meet losses, and (5) unsecured subordinated debt with a minimum original fixed term of maturity of over five years and limited-life redeemable preference shares. Tier 2 capital and subordinated debt cannot exceed 100 percent and 50 percent, respectively, of Tier 1 capital.

4.72 Tier 3 capital comprises medium-term debt of two-year or longer maturity with “lock-in provisions” that stipulate that neither principal nor interest need be paid if the payment reduces the bank’s overall capital to less than the minimum capital requirement. Tier 3 capital is intended to cover only market risk and is limited to 250 percent of Tier 1 capital.

4.73 Supervisory deductions cover goodwill (see paragraph 4.110), as a deduction from Tier 1 capital. With regard to total capital, supervisory deductions cover investments in unconsolidated banking and financial subsidiaries, and, at the discretion of national authorities, investment in capital of other banks and financial institutions.¹⁰⁵

4.74 Risk-weighted assets include currency and deposits, loans, securities, and other on-balance-sheet assets. Assets are weighted by factors representing their credit riskiness and potential for default. Through the use of credit conversion factors, the credit risk of off-balance-sheet items, such as credit line commitments and letters of credit that serve as financial guarantees, are also taken into account in determining regulatory capital requirements.¹⁰⁶ Also, market risk is taken into account when measuring risk-weighted assets.¹⁰⁷

4.75 How does the total regulatory capital measure of capital compare with the measure of capital and reserves in the sectoral balance sheet provided in Table 4.1 (after the sector-level adjustments described in the next chapter)? Because of the absence of the application of common accounting standards, measures of regulatory capital and measures of sectoral balance sheet capital can differ among countries because of different national practices. In this context, only some general statements can be made.

• Both regulatory capital and the sectoral balance sheet measure cover equity capital, reserves (both disclosed and undisclosed), and general provisions and so in this sense are the same. Goodwill is deducted from both. However, in the regulatory measure there is a limit on the amount of general provisions (1.25 percent of risk weighted assets) that can be included. Moreover, the amounts posted to reserves can differ due to different accounting approaches, such as the treatment of gains and losses on financial instruments.

• The regulatory measure covers certain debt instruments, such as subordinated debt, which are excluded from the sectoral balance sheet measure.

• At the sector level, intra-sector equity investments in both related and unrelated deposit-takers are excluded from the sectoral balance sheet measure. As noted above, at national discretion investments in unrelated deposit-takers can be included in regulatory capital calculations.¹⁰⁸

• Non deposit-takers can be consolidated for the calculation of regulatory capital (or investments in such entities deducted from regulatory capital) but this is not preferred for the calculation of the sectoral balance sheet measure.

4.76 Large exposures refers to one or more credit exposures to the same individual or group that exceed a certain percentage of regulatory capital, for example 10 percent.¹⁰⁹ The number of large exposures of deposit-takers is identified under the national supervisory regime.

Series that provide a further analysis of the balance sheet

4.77 To calculate the agreed FSIs there is a need for a number of series that are subtotals of balance sheet totals, and which provide a further analysis of the balance sheet beyond that presented in the main table.

4.78 Liquid assets are those assets that are readily available to an entity to meet a demand for cash. While it may be possible to raise funds through borrowing, conditions in the market may not always be conducive, and experience has shown the necessity for deposit-takers to maintain a prudent level of liquid assets. For a financial asset to be classified as a liquid asset, the holder must have the reasonable certainty that it can be converted into cash with speed and without significant loss under normal business conditions.¹¹⁰

4.79 To some extent, whether an instrument is considered liquid or not depends on judgment and is influenced by market conditions. For example, cash, transferable deposits, and deposits that permit immediate cash withdrawals are typically liquid and are included in liquid assets, while nontraded instruments with a long time until maturity are not. Other deposits provide certainty of value, but may not be readily convertible into cash because of restrictions on withdrawals prior to maturity. Conversely, tradable securities, particularly those issued by the government or the central bank might be readily converted into cash through sale on the secondary market, but their realizable value is dependent upon the market price at the time of sale.

4.80 In the Guide, liquid assets comprise (1) currency, (2) deposits and other financial assets that are available either on demand or within three-months or less (although deposit-takers deposits and other nontraded claims with other deposit-takers included in the reporting population are excluded¹¹¹), and (3) securities that are traded in liquid markets¹¹² (including repo markets) that can be readily converted into cash, with insignificant risk of change in value under normal business conditions. Typically, securities issued by the government and/or the central bank in their own currency meet the criteria to be classified as liquid assets, and in a number of markets high credit-quality private securities—both debt and equity securities—also meet the criteria. For instance, if a financial instrument is eligible under normal business conditions for repurchase operations or for rediscount at the central bank, then it can be classified as a liquid asset in that economy. It is recommended that securities issued by private entities with less than an investment grade rating be excluded from the concept of liquid assets, subject to national supervisory guidance.

4.81 Because of the difficulty in defining and measuring liquidity, there is merit in compiling more than one measure. For instance, the instruments in (1) and (2) in the paragraph above can be classified as core liquid assets, while the instruments in (3) can be added to provide a broad measure of liquid assets, as the latter instruments may lose their liquidity characteristics during times of financial stress. Moreover, distinguishing between foreign-and domestic-currency-denominated liquid assets can be important, particularly in periods of financial stress.

4.82 The availability of foreign exchange in the local market may also be an important consideration in assessing the liquidity of an institutional unit or sector in some countries. For example, a currency mismatch between liquid assets and liabilities, particularly in an environment of restricted access to foreign exchange, can impede the ability to meet foreign-currency-denominated obligations with sales of liquid assets that are denominated in local currency.

4.83 Short-term liabilities are the short-term element of deposit-takers’ debt liabilities (line 28) and the net (short-term, if possible) market value financial derivatives position (liabilities (line 29) less assets (line 21));¹¹³ the definition excludes such liabilities to other deposit-takers in the reporting population. Preferably “short-term” should be defined on a remaining maturity basis, although original maturity is a (more limited) alternative.

4.84 To improve the cross-country comparability of data, the Guide recommends that loans (and other assets)¹¹⁴ should be classified as NPL when payments of principal and interest are past due by three months (90 days) or more, or interest payments equal to three months (90 days) interest or more have been capitalized (reinvested into the principal amount), refinanced, or rolled over (that is, payment has been delayed by agreement).¹¹⁵ The 90-day criterion is the time period that is most widely used by countries to determine whether a loan is nonperforming.¹¹⁶ In addition, NPLs should also include those loans with payments less than 90-days past due that are recognized as nonperforming under national supervisory guidance—that is, evidence exists to classify a loan as nonperforming even in the absence of a 90 day past due payment, such as when the debtor files for bankruptcy. Indeed, the Guide regards the guideline of 90-days past due as an outer bound and does not intend to discourage “stricter” approaches. The loan (and other assets) amount recorded as nonperforming should be the gross value of the loan as recorded on the balance sheet, not just the amount that is overdue.

4.85 After a loan is classified as nonperforming, it (and/or any replacement loan(s)) should remain classified as such until written off or payments of interest and/or principal are received on this or subsequent loans that replace the original loan. It is recognized that some national supervisory practices might be “stricter” in that loans are classified as nonperforming until payments are received for specified periods of time. As noted above, the Guide does not intend to discourage “stricter” approaches.

4.86 Replacement loans include loans arising from rescheduling or refinancing the original loan(s) and/or loans provided to make payments on the original loan.¹¹⁷ While these loans may be granted on “easier” than normal commercial terms, provided the terms and conditions of the replacement loan are complied with by the debtor, and subject to national supervisory guidance, the loan is no longer classified as an NPL. However, in discussions on the Guide, for assessing the credit quality of the loan portfolio, there was strong support among experts for identifying the share of replacement loans within total loans. For this reason, Appendix III provides a memorandum item to Table 4.1 on restructured loans.

4.87 Given the various practices, when disseminating data on NPLs it is essential that metadata describing the practice adopted be disseminated.

4.88 Residential real estate loans are those loans that are collateralized by residential real estate. Residential real estate includes houses, apartments and other dwellings (such as houseboats and mobile homes), and any associated land, intended for occupancy by individual households. Commercial real estate loans are those loans that are collateralized by commercial real estate, loans to construction companies, and loans to companies active in the development of real estate (including those companies involved in the development of multi-household dwellings). Commercial real estate includes buildings, structures, and associated land used by enterprises for retail, wholesale, manufacturing, or other such purposes.

4.89 The geographic distribution of loans refers to an attribution of loans on the basis of the residence of the immediate counterpart—that is, the country of residence of the debtor. While country circumstances will differ, a regional classification of lending is encouraged, with perhaps additional detail on lending to residents of other countries that are of particular relevance, such as perhaps neighboring countries. The regional groupings provided in the dissemination framework in Chapter 12 are based on the IMF’s World Economic Outlook classification.

4.90 For deposit-takers, foreign currency loans and foreign currency liabilities are those assets and liabilities that are payable in a currency other than the domestic currency and those that are payable in domestic currency but with the amounts to be paid linked to a foreign currency (foreign currency linked).¹¹⁸ For financial derivative liabilities it is recommended that the net market value position (liabilities less assets) be included in the foreign currency liability measure rather than the gross liability position because of the market practice of creating offsetting contracts, and the possibility of a forward-type instrument switching from an asset to a liability position and vice versa from one period to the next. Domestic currency is defined in paragraph 3.45.

4.91 A deposit-taker’s net open position in equities is described in more detail in Chapter 6 (paragraphs 6.40 to 6.43).

4.92 The net open position in foreign currency for on-balance-sheet items, and the total net open position in foreign currency is calculated by summing the net position for each foreign currency and gold into a single unit of account (the reporting currency). The calculation is described in more detail in Chapter 6 (paragraphs 6.31 to 6.37).

Balance-sheet-related series

4.93 To compile the agreed FSIs there is also a need for a number of series that are derived from the balance sheet but require additional information or calculation.

4.94 Exposures of the largest deposit-takers to the largest entities in the economy is the total exposure of the five largest deposit-takers (the number may vary somewhat depending upon national circumstances) to the five largest resident nondeposit-taker entities measured by asset size (including all branches and subsidiaries) in both the other financial corporations sector and nonfinancial corporations sector; this is in addition to the exposure to the general government. Total exposures include all forms of debt assets of the deposit-taker, equity securities owned, and the net asset position in financial derivatives.¹¹⁹ Preferably, the value of contingent liabilities of the type described in Chapter 3 (paragraph 3.12 to 3.17) should also be included, consistent with the supervisory approach. The focus is on gross exposures and the concept of maximum loss, consistent with the supervisory approach. However, deposit-takers might take steps to reduce the credit risk (so-called credit risk mitigation), for example through requiring the provision of collateral. Any disseminated data should meet national confidentiality commitments.

4.95 Exposure to affiliated entities and other connected counterparties is otherwise known as connected lending. It is to be calculated by summing the total exposures of each deposit-taker to their affiliated entities (including parent entities, such as an insurance corporations) in other sectors, including nonresident entities, and exposures to directors and other employees, as well as exposures to shareholders or owners of the deposit-taker. The definition of exposures is the same as in the previous paragraph.

Other financial corporations

4.96 The sectoral balance sheet statement for other financial corporations is set out in Table 4.2. The definition of balance sheet series presented in this table is the same as for the corresponding series in Table 4.1.

Table 4.2.

Other Financial Corporations

¹To understand the interconnections among other financial corporations, separate identification of claims on other other financial corporations in the reporting population is encouraged.

Table 4.2.

Other Financial Corporations

Balance sheet120
1.	Total assets (=2+3)
2.	Nonfinancial assets
3.	Financial assets (= 4 to 10)
4.	Currency and deposits1
5.	Loans1
6.	Debt securities1
7.	Shares and other equity
8.	Insurance technical reserves1
9.	Financial derivatives1
10.	Other assets1
11.	Liabilities(= 17+18)
12.	Currency and deposits
13	Loans
14.	Debt securities
15.	Insurance technical reserves
16.	Other liabilities
17.	Debt (=12 to 16)
18.	Financial derivatives
19.	Capital and reserves
20.	Balance sheet total (=11+19 = 1)

¹To understand the interconnections among other financial corporations, separate identification of claims on other other financial corporations in the reporting population is encouraged.

View Table

Table 4.2.

Other Financial Corporations

Balance sheet120
1.	Total assets (=2+3)
2.	Nonfinancial assets
3.	Financial assets (= 4 to 10)
4.	Currency and deposits1
5.	Loans1
6.	Debt securities1
7.	Shares and other equity
8.	Insurance technical reserves1
9.	Financial derivatives1
10.	Other assets1
11.	Liabilities(= 17+18)
12.	Currency and deposits
13	Loans
14.	Debt securities
15.	Insurance technical reserves
16.	Other liabilities
17.	Debt (=12 to 16)
18.	Financial derivatives
19.	Capital and reserves
20.	Balance sheet total (=11+19 = 1)

¹To understand the interconnections among other financial corporations, separate identification of claims on other other financial corporations in the reporting population is encouraged.

4.97 The sectoral balance sheet for other financial corporations includes the separate identification of insurance technical reserves. Such reserves include (1) net claims of households on life insurance and pension fund reserves—although held and managed by these entities, these reserves are considered to be owned by households, (2) prepayments of premiums by policy holders, and (3) reserves for outstanding, valid, claims—such amounts are considered to be claims of the policy holder.

4.98 Regarding coverage, shares and other equity assets include such claims on associates, unconsolidated subsidiaries and reverse equity investments.¹²¹ In the case of domestic data, shares and other equity assets also include any share capital provided to foreign branches.

Nonfinancial corporations

4.99 Table 4.3 sets out the sectoral financial statement for nonfinancial corporations.

Table 4.3.

Nonfinancial Corporations

¹To understand the interconnections among nonfinancial corporations, separate identification of claims on other nonfinancial corporations in the reporting population is encouraged.

²Funds contributed by owners plus retained earnings (including appropriations from retained earnings to reserves). Purchased goodwill is excluded.

Table 4.3.

Nonfinancial Corporations

Income and Expense Statement		Balance Sheet
1.	Revenue from sales of goods and services (excluding indirect sales taxes)	13.	Total assets (=14+17)
		14.	Nonfinancial assets
2.	Cost of sales	15.	Produced o/w fixed assets inventories
3.	Net operating income (= 1 minus 2)
4.	Interest income	16.	Nonproduced
		17.	Financial assets
5.	Interest expense
		18.	Currency and deposits
6.	Other income (net)
		19.	Debt securities1
7.	Net income (before extraordinary items and taxes) (= 3 + 4 - 5 + 6)	20.	Shares and other equity
		21.	Trade credit1
		22.	Financial derivatives1
8.	Extraordinary items	23.	Other assets1
9.	Corporate income taxes	24.	Liabilities(=29+30)
		25.	Loans
10.	Net income after taxes (= 7 minus (8+9))	26.	Debt securities
		27.	Trade credit
11.	Dividends payable	28.	Other liabilities
		29.	Debt (= 25 to 28)
12.	Retained earnings (= 10 minus 11)	30.	Financial derivatives
		31.	Capital and reserves (i) o/w narrow capital 2
		32.	Balance sheet total (= 24+31=13)
Memorandum series
Other series required to calculate the agreed FSIs
33.	Interest income receivable from other nonfinancial corporations
34.	Earnings before interest and tax (item 3 plus 4 plus 6 less 33)
35.	Debt service payments
36.	Corporate net foreign exchange exposure for on-balance-sheet items
37.	Total corporate net foreign exchange exposure
Additional series
38			Debt service interest payments
39.	Debt service receipts (interest and principal) from other nonfinancial corporations
			interest principal
40.	Shares and other equity investments in nonfinancial corporations in the reporting population
				Associates Other nonfinancial corporations
41		Liquid assets (core measure)
42.	Liquid assets (broad measure)
43.	Variable rate debt

¹To understand the interconnections among nonfinancial corporations, separate identification of claims on other nonfinancial corporations in the reporting population is encouraged.

²Funds contributed by owners plus retained earnings (including appropriations from retained earnings to reserves). Purchased goodwill is excluded.

View Table

Table 4.3.

Nonfinancial Corporations

Income and Expense Statement		Balance Sheet
1.	Revenue from sales of goods and services (excluding indirect sales taxes)	13.	Total assets (=14+17)
		14.	Nonfinancial assets
2.	Cost of sales	15.	Produced o/w fixed assets inventories
3.	Net operating income (= 1 minus 2)
4.	Interest income	16.	Nonproduced
		17.	Financial assets
5.	Interest expense
		18.	Currency and deposits
6.	Other income (net)
		19.	Debt securities1
7.	Net income (before extraordinary items and taxes) (= 3 + 4 - 5 + 6)	20.	Shares and other equity
		21.	Trade credit1
		22.	Financial derivatives1
8.	Extraordinary items	23.	Other assets1
9.	Corporate income taxes	24.	Liabilities(=29+30)
		25.	Loans
10.	Net income after taxes (= 7 minus (8+9))	26.	Debt securities
		27.	Trade credit
11.	Dividends payable	28.	Other liabilities
		29.	Debt (= 25 to 28)
12.	Retained earnings (= 10 minus 11)	30.	Financial derivatives
		31.	Capital and reserves (i) o/w narrow capital 2
		32.	Balance sheet total (= 24+31=13)
Memorandum series
Other series required to calculate the agreed FSIs
33.	Interest income receivable from other nonfinancial corporations
34.	Earnings before interest and tax (item 3 plus 4 plus 6 less 33)
35.	Debt service payments
36.	Corporate net foreign exchange exposure for on-balance-sheet items
37.	Total corporate net foreign exchange exposure
Additional series
38			Debt service interest payments
39.	Debt service receipts (interest and principal) from other nonfinancial corporations
			interest principal
40.	Shares and other equity investments in nonfinancial corporations in the reporting population
				Associates Other nonfinancial corporations
41		Liquid assets (core measure)
42.	Liquid assets (broad measure)
43.	Variable rate debt

¹To understand the interconnections among nonfinancial corporations, separate identification of claims on other nonfinancial corporations in the reporting population is encouraged.

²Funds contributed by owners plus retained earnings (including appropriations from retained earnings to reserves). Purchased goodwill is excluded.

Income and expense

4.100 Operating income of a nonfinancial corporation is the revenue from the sales of goods and services (excluding taxes on goods and services) less the cost of those sales. The cost of sales include personnel (staff) costs (defined in paragraph 4.31); costs of materials purchased for the production process; fixed and variable production overheads (including depreciation expense or an allocation thereof); rentals paid on building, other structures, and equipment; rents paid on land and subsoil assets; royalties paid for the use of other produced or nonproduced assets; distribution costs including all costs to deliver products to customers, including transportation expense, advertising expense, and depreciation and maintenance of any retail shops; any other costs attributed to sales, such as professional fees, insurance, and research and development costs; taxes other than income taxes—such as taxes on the ownership or use of land and buildings or on labor employed; and any fines and penalties imposed, such as by courts of law, and any amounts payable as compensation to other institutional units for injury and damage.

4.101 In order to provide a better measure of current health and soundness, the Guide prefers that provisions for estimated costs related to product warranties, when they can be measured reliably (see paragraph 3.18), be included as a cost of sales and as a general reserve in capital and reserves.¹²²

4.102 When inventories are sold, their value is recognized as an expense in the cost of sales line in the period in which the related revenue is recognized (see also paragraph 4.108). All losses on goods held in inventory—whether through normal wastage or exceptional losses—are also recorded as an expense.

4.103 In addition to operating income, other sources of income include net interest income (interest income less interest expense) and other income (net). Other income (net) encompasses rents, rentals, and royalties receivable (payable); income from holdings of shares and other equity; gains or losses arising during the period on financial instruments, and on the sales of fixed assets; and any amounts receivable (payable) by nonfinancial corporations arising from compensation for damage or injury.

4.104 Rents, rentals, and royalty income receivable (payable) is income arising from rents received for the use of land, and the right to extract (or explore for) subsoil assets; rentals from buildings, other structures, and equipment; and royalties for the use of other produced and nonproduced assets (e.g., films and music). Income from holdings of shares and other equity includes dividends declared payable in the period by other corporations or cooperatives in which nonfinancial corporations have shares and other equity stakes, ¹²³ and the prorated share—on the basis of the share of equity owned—of net income after tax from associates, unconsolidated subsidiaries, and reverse equity investments, and, for the compilation of domestic data, from foreign branches. ^{124 125} Gains and losses on financial instruments is defined as for deposit-takers (see paragraph 4.22); however for unlisted companies, gains and losses on financial instruments that relate only peripherally to a firm’s primary operating activities can be measured as the difference between the sale value and the balance sheet value at the previous end-period. Gains (or losses) from sales of fixed assets are measured as the difference between the sale value and the balance sheet value at the previous end-period.

4.105 As with deposit-takers, extraordinary items cover events that are extraordinary and rare by the nature of the event or transaction in relation to the business ordinarily carried out by the enterprise. Corporate income taxes are those taxes payable by the nonfinancial corporations that are related to its income.¹²⁶ The amount of income subject to tax is usually less than total income because various deductions are permitted. After taxes are deducted, the total is net income after tax, and after dividends payable, retained earnings are left to be posted to capital and reserves.

Balance sheet

Nonfinancial assets

4.106 By definition, nonfinancial assets provide benefits to their owners, but do not represent claims on other units. Most nonfinancial assets provide benefits either through their use in the production of goods and services or in the form of property income. Nonfinancial assets can come into existence as outputs from a production process (e.g., machinery), be naturally occurring (e.g., land), or be constructs of society (e.g., patented entities). Fixed assets, inventories, and valuables are all forms of produced assets, while examples of nonproduced assets include land and patented entities.

4.107 Fixed assets are produced assets that are used repeatedly or continuously in processes of production for more than one year. Included are tangible fixed assets (dwellings and other buildings and structures, machinery and equipment, and cultivated assets such as livestock and orchards) and intangible fixed assets (such as the “capitalization” of mineral exploration expenses and computer software), whose use in production is restricted to the units that have established ownership rights over them or to other units licensed by the latter.

4.108 Inventories are goods held by the institutional unit for sale, use in production, or use at a later date. They can be materials and supplies, work-in-progress, finished goods and goods for resale. The Guide prefers that inventories be valued at market value (i.e., the current purchaser’s price) with any valuation gains included in the valuation adjustment and then in retained earnings when the inventories are sold. However, it recognizes the difficulties in implementing such an approach and that in this complex field compilers may need to follow commercial accounting practices when recording inventories as assets or in sales.

4.109 Valuables are produced assets that are not used primarily for the purpose of production or consumption, but are held as stores of value over time. They can be precious metals and stones, antiques and other art objects, and other valuables such as collections of jewelry.

4.110 Nonproduced assets are assets needed for production that have not been produced, such as land, subsoil assets, water resources, and certain intangible assets such as patented entities, leases and other transferable contracts relating to nonfinancial assets. Nonpatented know-how is not recognized as an asset in the Guide because there is no legal evidence of ownership rights. This treatment may differ from commercial accounting, where know-how that is not patented can be included on the balance sheet if its value can be reliably measured, on the grounds that by keeping that know-how secret, an enterprise controls the benefits that are expected to flow from it. The value of patent protection is amortized over time following commercial accounting standards.¹²⁷ Goodwill acquired on purchasing an associate or unconsolidated subsidiary stake (or adding to it)—that is, the excess of the cost of an acquired entity over the market or fair value of the net assets acquired—is deducted from (the narrow measure of) capital and reserves and is not an asset of the acquirer.¹²⁸ Therefore, there is no goodwill to be amortized in income in future periods.

Financial assets and liabilities

4.111 The definitions of balance sheet series presented in this table are the same as for the corresponding series in Table 4.1.

4.112 The sectoral balance sheet for nonfinancial corporations separately identifies trade credit. Trade credits and advances include (1) trade credit extended directly to purchasers of goods and services and (2) advances for work that is in progress or is to be undertaken, such as progress payments made during construction, or for prepayments of goods and services. Trade credit does not include loans, debt securities, or other liabilities that are issued to finance trade credit. So, trade-related loans provided by a third party, such as a deposit-taker, to an exporter or importer are not included in this category but under loans.

4.113 Regarding coverage, shares and other equity assets include such claims on associates, unconsolidated subsidiaries, any reverse equity investments. For data compiled on a domestic basis, shares and other equity assets also include any share capital provided to foreign branches.¹²⁹

4.114 Capital and reserves is otherwise known as equity. As in the case of deposit-takers, funds contributed by owners plus retained earnings (including those earnings appropriated to reserves) could be identified as a narrow measure of capital and reserves. However, in many countries there is a paucity of sectoral information on nonfinancial corporations, and in calculating FSI data for this sector, preference is given to total capital and reserves.

Memorandum series

Other series required to calculate the agreed FSIs.

4.115 Interest receivable from other nonfinancial corporations is that amount of interest income (line 4) that is receivable from other nonfinancial corporations that are also in the reporting population.

4.116 Earnings before interest and tax (EBIT) is defined as operating income (item 3) plus interest income (item 4) plus other income (net) (item 6) less interest receivable from other nonfinancial corporations (item 33). Interest expenses are excluded by definition. Interest receivable from other nonfinancial corporations is deducted from earnings before interest and tax data to ensure that sector earnings are not exaggerated by such intra-sector income.

4.117 Debt service payments are interest and principal payments made on outstanding debt liabilities within the specified time period of the statement. Such payments always reduce the amount of debt outstanding: interest payments are those periodic payments¹³⁰ that meet interest costs arising from the use of another entity’s funds, and principal payments are all other payments that reduce the amount of principal outstanding.

4.118 The corporate net foreign exchange exposure for on-balance-sheet items and the total corporate net foreign exchange exposure are calculated by summing the net positions for each foreign currency and gold into a single unit of account (the reporting currency). The calculation is described in more detail in Chapter 6 (paragraphs 6.31 to 6.37).

Households

4.119 The financial statement for households is set out in Table 4.4.

Table 4.4.

Households

Table 4.4.

Households

Income and Expense Statement		Balance Sheet
Sources of income		7.	Total assets (= 8+11)
of which		8.	Nonfinancial assets(= 9+10)
1.	Wages and salaries from employment
		9.	Residential and commercial real estate
2.	Property income receivable
		10.	Other
3.	Current transfers (e.g., from government)
4.	Other	11.	Financial assets(= 12 to 16)
5.	Less taxes including social security contributions, and other current transfers made	12.	Currency and deposits
		13.	Debt securities
		14.	Shares and other equity
		15.	Financial derivatives
6.	Gross disposable income	16.	Other assets
		17.	Liabilities (= 20+21)
		18.	Loans
		19.	Other liabilities
		20.	Debt
		21.	Financial derivatives
		22.	Net worth
		23.	Balance sheet total (= 17 +22 = 7)
Memorandum series
Other series required to calculate the agreed FSIs
24.	Debt service payments (interest and principal)
25.	Debt collateralized by real estate

View Table

Table 4.4.

Households

Income and Expense Statement		Balance Sheet
Sources of income		7.	Total assets (= 8+11)
of which		8.	Nonfinancial assets(= 9+10)
1.	Wages and salaries from employment
		9.	Residential and commercial real estate
2.	Property income receivable
		10.	Other
3.	Current transfers (e.g., from government)
4.	Other	11.	Financial assets(= 12 to 16)
5.	Less taxes including social security contributions, and other current transfers made	12.	Currency and deposits
		13.	Debt securities
		14.	Shares and other equity
		15.	Financial derivatives
6.	Gross disposable income	16.	Other assets
		17.	Liabilities (= 20+21)
		18.	Loans
		19.	Other liabilities
		20.	Debt
		21.	Financial derivatives
		22.	Net worth
		23.	Balance sheet total (= 17 +22 = 7)
Memorandum series
Other series required to calculate the agreed FSIs
24.	Debt service payments (interest and principal)
25.	Debt collateralized by real estate

Income and expense

4.120 The main source of income for households is wages and salaries (gross of any income tax) from employment. These are payable in cash or kind, and are a component of compensation for employment (see also paragraph 4.31).¹³¹ Other major sources of income include property income receivable (interest, dividends, and rent), and current transfers, including from general government. Other income sources include operating income from production activity (gross of consumption of fixed capital).¹³² Gross disposable income includes these sources of income less current taxes on income and wealth, contributions for social insurance (e.g., for old-age insurance, paid by households to general government), and other current transfers (such as payments of fines, penalties, and subscriptions to NPISHs).

Balance sheet

4.121 The financial assets and liabilities series in Table 4.4 are defined the same as in Table 4.1.

Memorandum series

4.122 As noted above in paragraph 4.117, debt service payments are interest and principal payments made on outstanding debt liabilities within the specified time period of the statement. Debt collateralized by real estate coves all debt for which real estate is used as a form of collateral. This includes borrowing for the purchase, refinancing, or construction of buildings and structures (including alterations and additions to such), and for equivalent operations regarding land (see paragraph 4.88).

Chapter Five Aggregation and Consolidation of Data

Introduction

5.1 The analysis of FSI ratios is affected by the extent to which the data used for their calculation are consolidated. Thus, when constructing FSI ratios, attention needs to be paid to whether the data reported by entities are on a consolidated basis, and the method by which the data for the whole of the reporting population¹³³ are aggregated. This chapter explains what is meant by consolidation and aggregation, and sets out the various approaches. It also sets out the adjustments required to produce sector-level data.

5.2 Data that cover domestically controlled deposit-takers with international operations on a cross-border consolidated basis are required to compile FSIs as this approach is best suited for financial soundness analysis. Data on domestically located operations might be separately distinguished if the authorities believe it would contribute materially to their financial stability analysis (e.g., in order to illustrate the linkage with other macroeconomic information). For every other sector, a preferred approach is also outlined. The data implications of the Guide's preferred approaches are explained in Chapter 11.

Defining terms

What is meant by the terms “aggregation” and “consolidation”?

5.3 Aggregation refers to the summation of data on gross positions or flows. Under an aggregation approach, the total positions and flows data for any group of reporting units are equal to the sum of the gross information for all individual units in the group.¹³⁴ So, the group and subgroup totals equal the sum of their component elements and the data on claims and liabilities between the members of the group are preserved.

5.4 In contrast, consolidation refers to the elimination of positions and flows between units that are grouped together for statistical purposes. Consolidation can arise at various levels of grouping. For an individual institutional unit, all intra-unit positions and flows are eliminated. If related institutional units are grouped together to form one individual reporting entity—say, foreign branches of domestic banks are grouped with their parent bank—then all positions and flows within that reporting entity are eliminated from the reported information—that is, all flows and positions among the branches and with their parent are eliminated. If data for a group of reporting entities are consolidated, such as those in the same institutional sector (or subsector), then intra-sector flows and positions are eliminated, leaving data on positions and flows with entities in other sectors (or subsectors).

5.5 Consolidation and aggregation can be combined for the purpose of compiling data series for use in calculating FSIs. For instance, reporting entities might provide consolidated data to the compiling agency, which then aggregates these data to create sector totals. On the other hand, the data provided might be consolidated rather than aggregated at the sector level. In this case, information on positions and flows among the entities covered in the reporting population need to be available to the compiling agency in order to be eliminated. The approach to consolidation and aggregation in compiling series for use in calculating FSIs is discussed ahead.

What is meant by the terms “subsidiaries” and “associates”?

5.6 Before discussing consolidated data in more detail, definitions of subsidiaries and associates are required as these terms are used throughout the rest of this chapter.

5.7 Subsidiaries are corporations over which a parent has established control. While recognizing that national practice on determining control can differ, control is defined in the Guide as the ability to determine general corporate policy by choosing (or removing) appropriate directors so as to obtain benefits from the activities of the corporation. Control is unambiguously established through ownership of more than half of the voting shares or otherwise controlling more than half of the shareholder voting power (including through ownership of a second corporation that in turn has a majority of the voting shares). Control could also be established with ownership of less than half the voting shares,¹³⁵ such as, but not confined to, through special legislation, decree, or regulation.¹³⁶

5.8 An associate is a corporation over which the investor has a significant degree of influence and which is not a subsidiary. Significant influence is usually assumed to arise when the investor owns between 10 percent to 20 percent (depending on national practice) and 50 percent of the equity/voting power of the entity. Typically, if the ownership stake reaches the threshold for classification as an associate but is expected to be of a temporary nature, the investment continues to be classified as a non-associate equity investment. However, for FSI purposes, if the equity investment has reached the level to be classified as an associate for two successive reporting periods, the implication is that the investment is not temporary.

5.9 Joint ventures are separate entities owned and operated by two or more parties for their mutual benefit. In the Guide, such entities are classified either as subsidiaries, as associates, or neither, depending upon the criteria set out in the previous two paragraphs. So if there are two or more investing parties each of which has a significant degree of influence over the joint venture, they should each classify the entity as an associate, consistent with the definition in the previous paragraph.

What is meant by the terms “domestic control” and “foreign control”?

5.10 When discussing reporting populations in more detail, definitions of domestic and foreign control are required.

5.11 Deposit-taking entities are defined in the Guide as foreign controlled if they are subsidiaries or branches of a foreign parent deposit-taker. Foreign controlled deposit-takers, in addition to supervision by the host supervisory authority, are typically subject to supervision by their parent supervisory authority, as recommended in the Basel Concordat of May 1983 (“Principles for the Supervision of Banks’ Foreign Establishments”). (See BCBS, 1983.) This criterion should be taken into account if there is uncertainty as to the classification of a deposit-taker as foreign controlled. All other deposit-taking entities should be classified as domestically controlled. If a domestic deposit-taker is controlled by a bank holding company in a foreign country, which is subject to banking supervision in that foreign economy, then it should be also classified as foreign controlled.¹³⁷

5.12 For corporations in other sectors, they are foreign controlled if they are subsidiaries or branches of a foreign parent. All other resident corporations are to be classified as domestically controlled.

The aggregate resident-based approach

5.13 In the Guide, under an aggregate resident-based approach, data are reported at the level of institutional units resident in the economy and aggregated by the compiling agency to provide totals of the sectors. This is the approach adopted in the 1993 SNA, the sectoral balance sheets in the MFSM, and related national accounts methodologies. The Guide recommends this approach for the compilation of FSI data for the household sector.

5.14 For corporations in an aggregate resident-based system, the institutional unit within which all transactions and positions are consolidated consists of a headquarters office and any branch offices resident in the economy.¹³⁸

The consolidated-based approach

5.15 In the Guide, the consolidated-based approach refers to the consolidation of data at both the group and sector levels. It is the required approach for compiling data on deposit- takers and other corporate sectors for use in the calculation of FSIs. The text ahead discusses both consolidated group reporting and compiling consolidated sector-level data. The deposit-taking sector is used as an illustration, but the principles espoused are also relevant and can be applied to other corporate sectors. Table 5.1 supports the text.

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Schematic Presentation of Levels of Consolidation

Citation: Policy Papers 2003, 008; 10.5089/9781498329712.007.A001

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Consolidated group reporting

5.16 Consolidated group reporting by a resident deposit-taker includes coverage not only of its own activities but also those of its (1) branches and (2) subsidiaries, with any transactions and positions among these entities eliminated on consolidation. In essence, consolidation is based on the concept of control by a parent of other operating units. Such an approach is an essential element of banking supervision¹³⁹ and is adopted to preserve the integrity of capital in deposit-takers by eliminating double counting (gearing) of capital.¹⁴⁰ It is for this reason, and also in order to avoid the double counting of income and assets arising from the intra-group activity of deposit-takers—that is, activity that rests on the same pool of capital—the Guide recommends that deposit-takers data be compiled on a consolidated group basis.

Cross-border consolidated data

5.17 Cross-border consolidated data is represented by Blocks 1a, 1b, 1c, 2a, 2b, and 2c in Table 5.1. This approach consolidates flows and positions of the domestically incorporated deposit-taker with their branches (foreign and domestic) and deposit-taking subsidiaries (foreign and domestic); the approach is described as solo (bank-only) supervision by bank supervisors. The cross-border consolidated approach focuses on domestically incorporated deposit-takers, and provides an indication of their financial soundness regardless of where the deposit-taking business is undertaken.¹⁴¹

Domestically controlled, cross-border consolidated data

5.18 Domestically controlled, cross-border consolidated data is represented by Blocks 1a, 1b, and 1c in Table 5.1. This approach consolidates the data of domestically controlled and incorporated deposit-takers with their branches (domestic and foreign) and all deposit-taking subsidiaries (domestic and foreign).

5.19 The focus on the health and soundness of domestically controlled deposit-takers arises because domestic authorities might ultimately be required to provide financial support. If domestically controlled deposit-takers have foreign branches and subsidiaries, they may well be among the larger deposit-takers in the domestic economy, so the potential direct financial risk of the failure of these deposit-takers could pose a systemic risk.

Domestically controlled, cross-sector consolidated data

5.20 Another option is to consolidate information from all branches and subsidiaries involved in financial intermediation—that is, beyond just deposit-taking business—with that of the domestically controlled and incorporated parent entity. In other words, consolidating information beyond that in 1a, 1b, and 1c. This approach is termed the domestically controlled cross-sector consolidated approach in the Guide. Most supervisory data rely on this form of consolidation, as it is the approach used in the Basel Capital Accord (although insurance activity is typically excluded).

5.21 The cross-sector consolidated approach can highlight financial strengths and weaknesses of a group in the context of the full range of activities and so can provide a broader view of soundness than the approach that focuses only on deposit-takers. For instance, weak nonbank subsidiaries might trouble the deposit-taking sector. However, there are some drawbacks. At the sector level, the clarity of the institutional sector information is diminished because flows and positions of entities owned by—but are outside—the institutional sector of the parent entity are included. This could make difficult the early detection of emerging weaknesses in the performance of deposit-takers. The coverage of activities is not clear-cut; for instance, should insurance companies in the group be included? Moreover, interpretation of these data might prove problematic, particularly in periods of merger and acquisition activity among units in different institutional sectors. In addition, relationships with other nondeposit-taking members of the group would not be detected, such as connected lending between the deposit-takers and their nondeposit-taking affiliates.

Foreign-controlled, cross-border consolidated data

5.22 Foreign-controlled cross-border consolidated data is represented by Blocks 2a, 2b, and 2c in Table 5.1. This approach consolidates the data of branches (domestic and foreign) and all deposit-taking subsidiaries (domestic and foreign) with their domestically incorporated foreign-controlled parent. Depending on country circumstances, authorities may consider it necessary to monitor (on a nationality basis) the performance of foreign controlled deposit-takers and their deposit-taking parents.

5.23 As foreign subsidiaries are part of a larger deposit-taking group, their activities in the economy are affected by the policy decisions of their parent, while ultimately foreign banking supervisors are most concerned about the health and soundness of these institutions. To this extent, from the viewpoint of the host authorities, there is a significant prudential difference between foreign-controlled and domestically controlled institutions. However, the host authorities should not be indifferent to the health and soundness of these institutions as their activities do affect the domestic economy, and financial risks arising from their subsidiaries and branches abroad could ultimately have an impact on the domestic economy.

5.24 The relevance of data on foreign subsidiaries in the economy will vary depending upon country circumstances, as will the interest in collecting information on the foreign branches and subsidiaries of such institutions.

Domestic consolidated data

5.25 The Guide defines domestic consolidated data as that which consolidate flows and positions of the resident deposit-taker with their branches and deposit-taking subsidiaries (if any) resident in the domestic economy. Domestic consolidated data are represented by Blocks 1a, 2a, and 3 in Table 5.1. The reported data include flows and positions with all nonresidents and residents.

5.26 Data compiled using this approach are of analytical interest because deposit-takers resident in a domestic economy provide payment services, saving opportunities for the public, and allocate funds for viable investment projects. These institutions are also the agents through which central banks undertake monetary policy actions. In turn, resident deposit-takers are affected by domestic conditions.¹⁴² Therefore, their actions both affect and are affected by the domestic economy, and if resident banks fail to undertake, or sharply curtail, their financial intermediation activity there would be detrimental consequences for the domestic economy.

5.27 Moreover, domestic consolidated data provide a link to other macroeconomic datasets, such as the national accounts and monetary aggregates. Indeed, monitoring the interconnections between domestic consolidated data and macroeconomic data series, such as on the real economy, credit growth, fiscal positions, and international capital flows, as well as asset price bubbles, could support macroprudential analysis.¹⁴³

5.28 While the net income/loss arising from foreign operations is captured, this approach does not identify the risks to domestic deposit-takers incurred through their foreign branches and subsidiaries.

Applying consolidated group reporting to the needs of FSI data

5.29 As noted above, for compiling data for use in the calculation of FSIs, consolidated group reporting is preferred for deposit-takers and other corporate sectors. However, as already discussed, there are several possibilities for the scope of the reporting population. Should only units located in the domestic economy be covered or also their foreign offices? Should coverage be distinguished by domestic and foreign control? For deposit-takers, should coverage encompass institutional units that do not meet the definition of deposit- takers but are subsidiaries of deposit-takers?

5.30 On these questions the Guide provides the following advice.

Deposit-takers

5.31 First, the Guide requires the compilation of data covering domestically controlled deposit-takers on a cross-border consolidated basis for soundness analysis (see paragraphs 5.18 and 5.19). The data need to cover domestically controlled deposit-takers with international operations (foreign deposit-taking subsidiaries and branches). For economies that compile BIS consolidated banking data, the Guide supports identification of a FSI dataset as consistent as possible in coverage with that of the BIS data, as analytical benefits could accrue from comparing the datasets. When foreign deposit-takers play a significant role in a financial system, the authorities could compile FSIs on a cross-border consolidated basis for all domestically incorporated deposit-takers—that is domestically controlled deposit-takers and the local subsidiaries of foreign deposit-takers, consolidated with their own branches and deposit-taking subsidiaries (if any).¹⁴⁴ Such data could then be disaggregated into separate FSIs for domestically controlled deposit-takers and for the local subsidiaries of foreign deposit-takers. ¹⁴⁵

5.32 In some instances, supervisory data on a deposit-takers-only basis may not be available because of the structural features of the banking system. In such circumstances, the inclusion of subsidiaries whose activities are closely related to deposit-takers¹⁴⁶ could be justified on soundness grounds.¹⁴⁷

5.33 The compilation of data covering all deposit-takers resident in the economy (domestically controlled and foreign-controlled) on a domestic consolidated basis might be separately considered if the authorities believe it would contribute materially to their financial stability analysis by promoting understanding of the relationship with the macroeconomy (see paragraphs 5.25 to 5.28).^{148 149} Domestic consolidated data can (1) facilitate comparability with other macroeconomic data, (2) promote cross-country data comparability, and (3) are consistent with the BIS’s locational international banking statistics. Providing these data series through the development of sectoral accounts based on national accounts concepts would be an attractive approach and the Guide provides guidance on how this can be achieved. Such an approach might be a medium-term objective in those economies where sectoral accounts are still relatively underdeveloped.¹⁵⁰

5.34 The purpose of compiling cross-border consolidated data is financial soundness analysis while that of compiling domestic consolidated data is to illustrate links to the macroeconomy. It is clear from discussions during the preparation of the Guide that neither consolidation approaches will always satisfy both these purposes.

5.35 To undertake meaningful analysis it is important that the accounting rules and concepts are applied as consistently as possible across all datasets, regardless of the approach to consolidation. When disseminating any data, the institutional coverage and basis of consolidation should be made explicit.

Other corporate sectors

5.36 For FSIs covering the other financial and nonfinancial sectors, a consolidated approach is preferred so as to avoid double counting of assets and capital, and in the case of nonfinancial corporations, to avoid double counting of earnings.

5.37 For other financial corporations, the two FSIs currently listed—assets to total financial sector assets and assets to GDP—are intended to provide an indication of the importance of these institutions in the domestic financial system. The first of these two indicators could be compiled on either a cross-border consolidated basis or a domestic consolidated basis, while the second should be compiled on a domestic consolidated basis (for better consistency with GDP). It is important to note that the two currently listed FSIs above could be supplemented by additional FSIs for the sector. Specific proposals for FSIs for the insurance sector, in particular, are likely to be forthcoming in the near future to be compiled on a cross-border consolidated basis.

5.38 For nonfinancial corporations, as with deposit-takers, data might be compiled on both domestically controlled cross-border consolidated basis and domestic consolidated basis. Data on the former basis would capture corporates’ financial strength, and might for example be drawn from published corporate financial statements for the larger firms. Where such data are available and cover a substantial part of the sector, its reporting is encouraged. As with any partial coverage of the sector, the potential “survivor bias” would need to be kept in mind.¹⁵¹

5.39 However, the Guide acknowledges that in many countries, there is a relative lack of official, sector-level cross-border data and thus accepts, in the first instance, the compilation of domestic consolidated data based on national accounts methodology. Such an approach, through the link to other macroeconomic datasets, would also support the analysis of sectoral behavior in the context of macroeconomic developments, complementing macroprudential analysis. Providing these data series through the development of sectoral accounts would be an attractive approach. In disseminating any data, the institutional coverage and basis of consolidation should be made explicit, along with information on the accounting rules and concepts employed.

Specific issues arising from the consolidated approach

5.40 While aggregation of data is a simple concept, consolidation is more complex, particularly when deciding when and how to consolidate the activities of a subsidiary with the parent and other affiliated entities when the subsidiary is less than 100 percent owned.

5.41 The reason for consolidating activities of a subsidiary with a parent entity and other subsidiaries is that the parent entity has control over its activities and, therefore, directly affects and is affected by the activities of that subsidiary. However, consolidating the activities of minority-owned subsidiaries with a parent entity could potentially result in double counting among reporting entities and compilers should remain alert to this possibility.

5.42 Furthermore, when consolidating the activities of less than 100 percent owned subsidiaries, the issue arises as to how to account for the minority interest—the other owners. The approach taken in the Guide is that full consolidation should be undertaken. Minority interests should not be separately identified in earnings or in the balance sheet as a liability item, but rather included as part of the capital and reserves of the consolidated entity. For deposit-takers, such full consolidation is consistent with that of the Basel Capital Accord for the measurement of Tier 1 capital, and reflects the focus on the total capital and reserves of the deposit-taker in the consolidated group.

5.43 For any unconsolidated subsidiaries¹⁵² and associates, earnings and the value of the equity investment are to be recorded in the income statement and the capital and reserves, respectively, of the owner of the stake on a proportionate basis. That is, if the owner of the investment has a 50 percent stake in an entity, half of the net earnings after tax should appear as income from the equity investment, and half of the value of the capital and reserves of the entity should be recorded as the value of the equity investment in the balance sheet of the owner. There should be similar treatment for any equity investment by an associate and unconsolidated subsidiary in a parent (reverse equity investment).

5.44 Commercial accounting and bank supervisory data tend to prefer the full consolidation approach for subsidiaries, and a pro-rated approach for profits and capital of associates. A version of the proportionate approach is that adopted in the 1993 SNA for both foreign subsidiaries and associates whereby proportionate shares of their earnings and capital are attributed to the parent; however, this is not the treatment adopted in the 1993 SNA for domestic subsidiaries or associates.

Compiling consolidated sector-level data

5.45 The compilation of consolidated sector-level data for use in FSIs is a two-step process. Given consolidated group reporting for each sector, (1) data reported by the corporations in the reporting population are aggregated, and (2) further sector-level adjustments (consolidations) are made to produce sector-level data.¹⁵³ If data are not reported on a consolidated group basis, additional adjustments are required to eliminate intra-group positions and transactions.¹⁵⁴

5.46 In compiling sector level, data it is important to appreciate that the range of deposit- takers whose activities are to be captured in the sector-level data (known in the Guide as the reporting population) will vary depending upon the consolidated group reporting approach adopted. In other words, each consolidated group reporting approach has its own sector-level reporting population, which will differ from that for other consolidated group reporting approaches. For instance, if foreign branches and deposit-taking subsidiaries are included in the consolidated group data, then the reporting population at the sector level under this approach will be larger than if they were not. The idea that for FSI purposes more than one reporting population can be defined contrasts with other macroeconomic datasets, such as the monetary and financial statistics, for which the reporting population is singly defined based on residence and the nature of the activity undertaken.

5.47 Furthermore, for FSI purposes (and, again, different in approach from other macroeconomic statistics) sector-level adjustments are needed to eliminate double counting of capital and income among the reporting population. These adjustments can be summarized as follows:

• Intra-sector equity investments are deducted from the overall capital in the sector so that capital and reserves held within the sector are not double-counted.

• Neither gains and losses from the intra-sector claims nor intra-sector transactions should affect the sector’s net income, or capital and reserves. That is, for deposit- takers, value is added or lost through their transactions with and claims on entities that are outside the deposit-taking sector.

5.48 A more detailed specification of the sector-level adjustments required is provided in the text annex below.

5.49 It is noteworthy that sector-level data compiled for FSI purposes should include any intra-sector positions in debt and financial derivatives on a gross basis, that is, such positions among groups should not be eliminated. This approach allows the interrelationships among groups in the sector, and hence potential contagion risks, to be identified. This is viewed as particularly relevant for the deposit-taking sector. This is because asset-based FSIs are intended primarily to identify the gross risks faced by the deposit-taking sector, and these risks encompass claims on each other.¹⁵⁵ For instance, in order to discover whether certain types of deposit-takers concentrate on lending in, say, foreign currency; potentially excluding a portion of such lending could be misleading. The same reasoning applies to the other asset- based FSIs. In contrast, in theMFSM, in its other depository corporations survey, flows and positions among the reporting population are eliminated.¹⁵⁶

5.50 More generally, the Guide encourages separate identification and monitoring of gross information on interbank positions.

Text Annex. Detailed Specification of the Sector-Level Adjustments Required¹⁵⁷

Deposit-takers

5.51 Table 5.2 presents data for three deposit-takers (1, 2, and 3) resident in the domestic economy. The income and expense and balance sheet statement data of each deposit-taker are presented in the first three columns, and the sector-level data in column 4. Deposit-taker 3 is an associate of deposit-taker 2. The table illustrates the sector-level adjustments required to aggregate individual deposit-taker data to avoid double counting of capital and income. They are explained in the rest of this annex. Because of the focus on adjustments, not all lines in the full statement of accounts (as set out in Table 4.1) are separately identified. The text notes the adjustments that are also required for the other corporate sectors.

Table 5.2.

Sector-Wide Data: Consolidating Income and Expense as well as Balance Sheet Items

Table 5.2.

Sector-Wide Data: Consolidating Income and Expense as well as Balance Sheet Items

				Deposit Taker 1	Deposit Taker 2	Deposit Taker 3	Sector-Wide Data
Income and expense
Gross interest income				600	1,300	400	2,300
less provisions for accrued interest on nonperforming assets				0	150	0	130
		Of which: On loans to other deposit-takers 1/		0	20	0	Eliminated
Interest income				600	1,150	400	2,170
Interest expense				300	500	200	1,000
Net interest income				300	650	200	1,170
Noninterest Income				250	700	400	1,213.8
	Fees and commissions receivables			110	300	200	580
		Of which: From other deposit-takers		0	30	0	Eliminated
	Gains/losses on financial instruments			50	100	100	245
		Of which: On deposit-takers’ equities		5	0	0	Eliminated
	Pro-rated earnings			0	100	0	20.8
		Of which: From other deposit-takers		0	79.2	0	Eliminated
	Other income			90	200	100	368
		Of which: Dividends from deposit-takers		7	0	0	Eliminated
			Other income receivable from other deposit-takers	0	0	15	Eliminated
Gross income				550	1,350	600	2,383.8
Operating expenses				500	600	150	1,215
		Of which: Fees and commissions payable to other deposit-takers		15	0	15	Eliminated
			Other expenses payable to other deposit-takers	0	5	0	Eliminated
Provisions (net)				50	80	10	132
		Of which: Provisions on loans to deposit-takers		0	8	0	Eliminated
Net income (before extraordinary items and taxes)				0	670	440	1,036.8
Income tax				0	272	176	448
Net income after tax				0	398	264	588.8
Dividends payable				0	300	140	391
		Of which: To other deposit-takers		0	0	49	Eliminated
Retained earnings				0	98	124	197.8
Balance sheet
Nonfinancial assets				500	500	300	1,300
Financial assets				11,250	17,800	7,300	36,158
	Loans (excluding specific provisions)			8,850	14,100	5,500	28,458
	(i) Gross loans			9,250	14,400	5,600	29,250
	(ii) Specific provisions			400	300	100	792
		Of which: Provisions on loans to deposit-takers		0	8	0	Eliminated
	Shares and Other Equity			100	300	200	400
		Of which: Investment in deposit-taking associates		0	180	0	Eliminated
			Investment in other deposit-takers	20	0	0	Eliminated
	Other financial assets			2,300	3,400	1,600	7,300
Total assets				11,750	18,300	7,600	37,458
Liabilities				11,000	16,700	7,000	34,700
Capital and reserves				750	1,600	600	2,758
Total liabilities and capital				11,750	18,300	7,600	37,458

View Table

Table 5.2.

Sector-Wide Data: Consolidating Income and Expense as well as Balance Sheet Items

				Deposit Taker 1	Deposit Taker 2	Deposit Taker 3	Sector-Wide Data
Income and expense
Gross interest income				600	1,300	400	2,300
less provisions for accrued interest on nonperforming assets				0	150	0	130
		Of which: On loans to other deposit-takers 1/		0	20	0	Eliminated
Interest income				600	1,150	400	2,170
Interest expense				300	500	200	1,000
Net interest income				300	650	200	1,170
Noninterest Income				250	700	400	1,213.8
	Fees and commissions receivables			110	300	200	580
		Of which: From other deposit-takers		0	30	0	Eliminated
	Gains/losses on financial instruments			50	100	100	245
		Of which: On deposit-takers’ equities		5	0	0	Eliminated
	Pro-rated earnings			0	100	0	20.8
		Of which: From other deposit-takers		0	79.2	0	Eliminated
	Other income			90	200	100	368
		Of which: Dividends from deposit-takers		7	0	0	Eliminated
			Other income receivable from other deposit-takers	0	0	15	Eliminated
Gross income				550	1,350	600	2,383.8
Operating expenses				500	600	150	1,215
		Of which: Fees and commissions payable to other deposit-takers		15	0	15	Eliminated
			Other expenses payable to other deposit-takers	0	5	0	Eliminated
Provisions (net)				50	80	10	132
		Of which: Provisions on loans to deposit-takers		0	8	0	Eliminated
Net income (before extraordinary items and taxes)				0	670	440	1,036.8
Income tax				0	272	176	448
Net income after tax				0	398	264	588.8
Dividends payable				0	300	140	391
		Of which: To other deposit-takers		0	0	49	Eliminated
Retained earnings				0	98	124	197.8
Balance sheet
Nonfinancial assets				500	500	300	1,300
Financial assets				11,250	17,800	7,300	36,158
	Loans (excluding specific provisions)			8,850	14,100	5,500	28,458
	(i) Gross loans			9,250	14,400	5,600	29,250
	(ii) Specific provisions			400	300	100	792
		Of which: Provisions on loans to deposit-takers		0	8	0	Eliminated
	Shares and Other Equity			100	300	200	400
		Of which: Investment in deposit-taking associates		0	180	0	Eliminated
			Investment in other deposit-takers	20	0	0	Eliminated
	Other financial assets			2,300	3,400	1,600	7,300
Total assets				11,750	18,300	7,600	37,458
Liabilities				11,000	16,700	7,000	34,700
Capital and reserves				750	1,600	600	2,758
Total liabilities and capital				11,750	18,300	7,600	37,458

5.52 The relevance of each adjustment will depend upon national circumstances. Some adjustments, such as for fees and commissions, might be generally applicable whereas others, such as for provisions on loans to other deposit-takers may not. Compilers should make a judgment on the costs and benefits of the collection of new data. If available evidence suggests that an adjustment is not relevant or would be insignificant, the benefits of collecting such information may not outweigh the potential costs to reporters and the compiling agency.

Adjustments in the income statement

5.53 For the purposes of compiling data for use in calculating FSIs, up to seven adjustments are required to the income statement in order to eliminate intra-sector transactions and gains and losses from the intra-sector claims. Each of the adjustments is described ahead:

• Provisions for accrued interest on nonperforming loans (and other claims) to other deposit-takers.

• Fees and commissions receivable and payable from other deposit-takers in the reporting population.

• Dividends receivable and payable from other deposit-takers in the reporting population.

• The investing deposit-taker’s pro-rated share of the earnings of associate deposit- takers also in the reporting population.

• Other income receivable and payable from other deposit-takers in the reporting population.

• Gains and losses on deposit-takers’ ownership of equities of other deposit-takers in the reporting population.

• Provisions on loans to other deposit-takers in the reporting population.

5.54 A notable exclusion from the list above is data on intra-deposit-takers’ interest income and expense. These data are presented gross because they sum to zero in the net interest income line.

Eliminating provisions for accrued interest on intra-sector loans ¹⁵⁸

5.55 The Guide recommends that, once a loan is classified as nonperforming, interest ceases to accrue. If such a loan is to another deposit-taker in the reporting population, an asymmetry of approach will arise in that the debtor deposit-taker continues to accrue interest, but the creditor deposit-taker is not supposed to. Therefore, an adjustment is required to eliminate this asymmetry.

5.56 In Table 5.2, of the 1,300 of gross interest income of deposit-taker 2, there are provisions of 150 for accrued interest on nonperforming loans, of which 20 relates to an intra-sectoral loan. In calculating the sector-wide total (column 4), 20 of the provision is eliminated so that the sector-wide net interest income is greater than the aggregated amount for deposit-takers 1, 2, and 3.

5.57 A similar adjustment is still required even if interest income is reported as a single figure excluding accrued interest on nonperforming loans. Moreover, if the debtor deposit- taker subsequently paid interest, which the Guide recommends be recorded in the provisions line, this payment would need to be eliminated in calculating sector-wide data.

Eliminating intra-deposit-takers’ fees and commissions

5.58 While intra-sector fees and commissions receivable and payable do not affect sector-level net income—since they net out to zero—four FSIs use either the data series “gross income” or “noninterest expense.” Therefore, for these gross data series, the Guide recommends the exclusion of intra-sector fees and commissions.¹⁵⁹

5.59 In Table 5.2, of the 300 fees and commissions receivable by deposit-taker 2, 30 is receivable from (payable by) the other two deposit-takers in the reporting population. These amounts are intra-sector transactions, representing neither income from or payments to other sectors. Therefore, in calculating the sector-wide total (column 4), 30 is eliminated from fees and commissions receivable and payable.

Eliminating intra-deposit-takers’ dividends receivable and payable

5.60 For dividends receivable and payable, these amounts net out to zero in the sector-wide retained earnings. However, as with the adjustments required for fees and commissions, including these amounts on a gross basis affects specific series that are used to calculate FSIs. Most notably, the inclusion of dividends receivable from other deposit-takers in the reporting population in other income would double count sector-level gross and net income, because the income is already reflected as part of gross and net income of the deposit-taker paying the dividend. Therefore, the Guide recommends that intra-sector dividends receivable and payable are excluded from the gross amounts in which they are included, that is, from other income (dividends receivable) and from dividends payable.

5.61 In Table 5.2, of the 90 of other income of deposit-taker 1, 7 corresponds to dividends receivable from deposit-taker 3. This intra-sector transaction is eliminated by subtracting 7 from sector-level noninterest income and dividends payable.

5.62 The same sector-level adjustments are required for intra-sector dividends payable and receivable in the nonfinancial corporations sector.

Eliminating an investing deposit-taker’s pro-rated share of an associate’s earnings

5.63 For associate (and reverse) investments, the investor recognizes as revenue (expense) each period its proportionate share of the net income (loss) of the associate. For the same reason as given for dividends payable and receivable—to eliminate double counting of income—the value of the earnings of a deposit-taker that are attributable to an investing deposit-taker also in the reporting population are eliminated.

5.64 In Table 5.2, of the 100 under pro-rated earnings of deposit-taker 2, 79.2 corresponds to the proportionate share of the net income of deposit-taker 3 (the associate). Of this amount, 42 corresponds to the proportionate share of dividends payable and 37.2 to the proportionate share of retained earnings. These intra-sector transactions are eliminated by subtracting 79.2 from sector-level noninterest income (deposit-taker 2’s proportionate share), 42 for dividends payable (deposit-taker 3’s amount payable), thus reducing retained earnings by 37.2.

5.65 The same sector-level adjustments are required for intra-sector associate (and reverse investment) earnings in the nonfinancial corporations sector.

Eliminating deposit-takers’ intra-sector other income

5.66 Other income includes all noninterest income other than trading gains and losses, less those items otherwise identified and for which separate adjustments are made—fees and commissions, dividends receivable, and the pro-rated share of retained earnings. As four FSIs use either the data series “gross income” or “noninterest expense,” for these gross data series the Guide recommends the exclusion of intra-sector other income.

5.67 As other income receivable and payable among deposit-takers does not affect sector- level net income—since these amounts net out to zero—in excluding intra-sector other income flows two adjustments are made, one in income and the other in expenses. An exception to this symmetric treatment occurs if the income received is a gain/loss on the sale of a fixed asset. In such instances, the gain or loss is deducted from “other income” but there is no adjustment in expenses because such income does not represent an expense of the purchaser. The same sector-level adjustments are required for the nonfinancial corporations sector.

5.68 In Table 5.2, of the 100 of other income receivable by deposit-taker 3, 15 is receivable from (payable by) deposit-taker 2. This amount is an intra-sector transaction, representing neither income from or expenses paid to other sectors. Of this amount, 10 is a gain on the sale of a fixed asset to another deposit-taker. Therefore, in calculating the sector- wide total (column 4), 15 is eliminated from other income receivable and 5 is deducted from operating expenses payable, thus reducing sector-wide retained earnings by 10.

Eliminating gains and losses on ownership of other deposit-takers’ shares and other equity

5.69 Gains and losses on deposit-takers’ ownership of other deposit-takers’ shares and other equity (other than equity investments related to associates and subsidiaries, and reverse investments) should be eliminated from the sector-level gains and losses on financial instruments data so that gains and losses from the intra-sector claims do not affect sector- level income. Unlike debt securities, in the Guide equity assets and liabilities of deposit- takers are measured differently on the two sides of the balance sheet. While the deposit- taking owner records gains and losses on the shares and other equity assets based on market prices, there is no corresponding change in the issuer’s books. Thus, in the absence of exclusion of gains and losses on holdings of the shares and other equity of other deposit- takers in the reporting population, sector-level income would be affected.

5.70 Further, at the sector level, the Guide considers that transactions in deposit-takers’ shares and other equity (both intra-sector and inter-sector) are equity financing transactions—that is, transactions that can increase or decrease capital without having to go through the income account. Therefore, at the sector level it is immaterial which deposit- taker sells or purchases shares and other equity vis-à-vis an outside sector; all sales and purchases reflect exchanges of equity for capital resources regardless of whether the transactions involve issuance of own equity or secondary purchases in securities markets. The adjustments required at the sector level are further developed below in the discussion on the balance sheet adjustment for intra-sector holdings of shares and other equity.

5.71 In Table 5.2, of the 50 of gains on financial instruments of deposit-taker 1, 5 corresponds to a gain arising from the ownership of shares and other equity of deposit-taker 3. At the sector level, this gain of 5 is eliminated from noninterest income, thus reducing retained earnings by 5.

5.72 When recorded in other income at the entity level, the same sector-level adjustments are required for the gains and losses on intra-sector shares and other equity holdings in the nonfinancial corporations sector.

Elimination of specific provisions on loans to other deposit-takers

5.73 Specific provisions on loans to other deposit-takers in the reporting population need to be eliminated to avoid double recording of losses. A deposit-taker will likely make a provision on its loans to another deposit-taker if the net income and capital of the borrower deteriorates sharply. The provision decreases the lending deposit-taker’s net income as the borrower deposit-taker’s net income and capital resources decrease on account of the same adverse event. At the sector level, the impact of the adverse event would be counted twice unless the specific provisions on intra-deposit-takers loans were eliminated.

5.74 Moreover, an asymmetry arises if specific provisions reduce the net amount of loans on the lender’s books but a similar reduction in the amount of loan liabilities is not made in the borrower’s books.

5.75 In Table 5.2, out of 80 in provisions recorded by deposit-taker 2, 8 corresponds to provisions on loans to deposit-taker 1. At the sector level, the provision of 8 is eliminated from provisions, thus increasing retained earnings by 8.

Calculating sector-wide retained earnings

5.76 In Table 5.2, sector-wide retained earnings (197.8) are not equal to the sum of the retained earnings data of deposit-takers 1, 2, and 3 (222). How is the difference reconciled?

5.77 One difference is the pro-rated share of deposit-taker 2 of the retained earnings of deposit-taker 3 (37.2), which is eliminated to avoid double counting of retained earnings at the sector level. A second difference arises from adjustments made to gross income data, which are not mirrored elsewhere in the accounts. These adjustments are on account of the provisions for accrued interest on loans to other deposit-takers in the reporting population, the gains and losses on other deposit-takers’ equity, the gains and losses on the sale of fixed assets to other deposit-takers, and the provisions on loans to other deposit-takers.

5.78 Therefore, sector-wide retained earnings (197.8) are equal to the aggregate retained earnings of deposit-takers 1, 2, and 3 (222) less the pro-rated share of deposit-taker 2 of the retained earnings of deposit-taker 3 (37.2), less the gain on equity of deposit-taker 1 (5), less the gain of deposit-taker 3 on the sale of fixed assets (10), plus the provision of deposit-taker 2 for accrued interest (20) and for loan losses (8).

Adjustments in the balance sheet

5.79 For the purposes of compiling data for use in calculating FSIs, three adjustments are required to the sector-level balance sheet data, primarily to avoid the double counting (double leveraging) of capital at the sector level. The adjustments concern

• Investments in associates resident in the economy.

• The market value of shares and other equity investments in other deposit-takers in the reporting population.

• Specific provisions on loans to (and other claims on) other deposit-takers.

Eliminating the investor’s pro-rated share of an associate’s capital and reserves

5.80 In all measurement systems, a distinction is made when an equity investment reaches a level at which the investor achieves significant influence over management decisions, and hence over the use of the capital resources of the entity. As noted earlier (paragraph 5.8), depending on national practice, this level may be 10 percent or 20 percent. Consistent with such a distinction, associate investments (and reverse equity investments) by deposit-takers in other deposit-takers in the reporting population are valued on the basis of the investor’s proportion share of the associates’ capital and reserves (for participation in equity below that level, the investment is recorded at market value). If the associate’s capital and reserves and the investor’s proportionate share of that capital are both included in sector-wide capital and reserves, there will be double counting of capital at the sector level. To avoid this doublecounting, the value of the intra-sector associate (and reverse) investment is eliminated from assets and capital and reserves.

5.81 In Table 5.2, out of 300 of shares and other equity assets of deposit-taker 2, 180 corresponds to an investment in deposit-taker 3, which is its associate. This investment is valued according to its pro-rated share in the capital and reserves of the associate.¹⁶⁰ At the sector level, 180 is eliminated from assets and from capital and reserves.

5.82 The same sector-level adjustments are required for intra-sector associate (and reverse) investments in the sector-level consolidation for other financial corporations and nonfinancial corporations sectors, respectively.

Eliminating the market value of the shares and other equity investments in other deposit- takers in the reporting population

5.83 The market value of the shares and other equity investments of one deposit-taker in another deposit-taker in the reporting population (except for investments in associates and subsidiaries) should be eliminated from the sector-level data to avoid double counting (double leveraging) of capital; the counter-adjustment is a reduction in sector-level assets.

5.84 If a deposit-taker holds the shares and other equity throughout the period and their value increases (decreases) during the period, this increase (decrease) should be deducted from sector-level earnings (as described in paragraphs 5.69-5.71). The end-period market value of the shares and other equity should be deducted from sector-level assets and capital and reserves. The reason is that the increase in value does not represent additional capital resources from outside the sector. If a deposit-taker sells to a second deposit-taker the shares and other equity of a third deposit-taker in the reporting population, any gains and losses made by the first deposit-taker since the end of the previous period should be deducted from sector-wide income. Such a sale has no impact on capital and reserves as the equity “merely” switches ownership within the sector, with any subsequent gains and losses deducted from sector-wide income, and the market value of the equity deducted from sector-level assets and capital and reserves. Appendix V provides numerical examples of how to record these transactions and positions.

5.85 In Table 5.2, deposit-taker 1 has shares and other equity investment in deposit-taker 3 with a market value of 20. This amount is eliminated from sector-level data by deducting it from assets and from capital and reserves.