There's Talk of Shrinking the City's Contribution to U.K. GDP
Longtime readers of financial blogs will know that there is one chart likely to stir readers into a frenzy.
It is Deutsche Bank Strategist Jim Reid's graph showing the contribution of Wall Street to U.S. nominal GDP. (It was also this particular correspondent's introduction to the strong emotions held by many when it comes to logarithmic charting).
We bring it up because Charlie Bean has released the interim results of his independent review of U.K. economics statistics, in which the former Bank of England deputy governor seeks to improve on Britain's economic data. And while the U.K. is quite clearly not the U.S., it does still have a large financial sector that makes a sizable contribution to GDP figures.
That contribution could soon be smaller, however, as Bean appears close to recommending adjusting the measurement of financial services in British GDP to strip out distortions caused by the "inclusion of risk-taking" in the banking industry.
Here's what Bean says in the report (emphasis ours) about so-called financial intermediation services indirectly measured, or Fisim:
An important limitation of FISIM lies in its inadequate treatment of risk. The margin a bank charges on its loans over what it can earn by investing instead in a risk-free asset is meant to cover not just any costs of administering the loan but also the risk of default. The loan spread will therefore be higher if the perceived risk of default rises. But the existing approach nonsensically treats this as an increase in the value of intermediation services provided. Several studies have shown [that] the consequence of allowing for risk can be substantial. For instance, one study showed that the current methodology overstates imputed bank output in U.S. by almost a half, equivalent to 0.3 percent of U.S. GDP. A similar exercise for the euro area obtained comparable figures. ... Movements in the interest rates used in FISIM calculations can also generate counterintuitive effects on estimates of banking-sector output. For instance, the UK financial sector recorded its fastest growth on record in the final quarter of 2008, the period just after Lehman Brothers went bankrupt! But this was merely an artefact of the spike in short-term market interest rates that occurred as risk premia exploded. As a consequence, FISIM measures as presently calculated are in general likely to be unreliable during episodes of financial stress. Recognising this, in 2013 the US Bureau of Economic Analysis introduced an adjustment for risk into its calculation of FISIM. There are strong grounds for exploring the implications of making a similar adjustment to UK data.
The language used by Bean has mostly flown under the media radar this morning, but should it?
As Marc Ostwald, strategist at London-based ADM Investor Services, puts it: "This is very important as it has implications for the trend rate of U.K. GDP (per se lower as a result); it is also not good when regulation is already shrinking the banking sector."