Banks are intermediaries between those who have money to lend and those who need to borrow it. If a person or a company needs a loan, they don’t have to go around to everyone who can lend: the banks have gathered the money for them. On the other hand, if we have cash that we don’t need to use for a while, we don’t have to go around trying to find someone who needs to borrow, we just deposit it in the bank and they find someone who wants a loan. We say that banks provide financial intermediation services.
The banks make most of their money by paying a lower interest rate to depositors than to borrowers. So you might get 1% interest on a deposit but pay 4% interest on a loan. The difference is the banks’ service charge for going between the borrower and lender and administering the accounts. In National Accounts we want to measure how much the banks have made for their service, and separate this from the ‘pure interest’ charge for the money. However, since all the money deposited goes into one pot and the loans all come out of the same pot, it is not possible to measure directly how much the bank paid the depositor for the money they lent the borrower. For this reason, the service charge is indirectly measured, and so on loans and deposits from banks, National Accounts calculate Financial Intermediation Services Indirectly Measured (FISIM).
The FISIM charge is calculated based around the rate at which banks lend money to each other, this is the reference rate or the ‘pure interest’ rate. The reference rate is calculated as the interest paid by banks in Ireland to other banks in Ireland, divided by the stock of loans between the banks. The CSO and Central Bank of Ireland survey the banks regularly to get the value of interest and the stock of loans.
Generally, the banks will pay households or non-bank corporations who are depositors a rate that is lower than the reference rate. We might imagine the bank taking the money from depositors and lending it to other banks at a higher rate. So, for example, the reference rate might be 1.5%, but the bank pays depositors a return of 1% on the amount deposited. The FISIM is therefore 0.5% multiplied by the amount deposited. The bank will probably pay different depositors different rates, depending on how long the depositors have to wait to withdraw the money and other factors. So the FISIM will vary by the type of depositor.
The Investment Income interest in National Accounts is reported after it has been adjusted for FISIM, so may look different to values reported elsewhere. In the example above, we show the investment income (interest) paid to the depositor as 1.5% of their deposit, even though they only see 1% coming in. National Accounts then show the 0.5% being paid back by the depositor to the bank (as Intermediate Consumption or Final Consumption of the depositor and Output of the bank). So in the National Accounts we show the depositors as having higher investment income and higher expenditure, but the adjustments leave the depositor in the same position in the end as they see in their own accounts.
For borrowers, the banks will charge a rate of interest that is higher than the reference rate. So, for example, the reference rate might be 1.5%, but the interest on a mortgage might be 4%. That is, the bank can borrow from other banks at 1.5% and charge the borrower 4%. The FISIM is therefore 2.5% (that is, 4% minus 1.5%) times the amount borrowed. The bank will charge different borrowers different rates: a car loan, for instance will probably have higher interest than a mortgage. The FISIM on each loan is the amount borrowed multiplied by the difference between the rate paid by the borrower and the reference rate.
In the case of loans in National Accounts, as with deposits, the treatment differs from what is observed. Using the example above, National Accounts show an interest payment by the borrower of 1.5% of the loan as investment income, and 2.5% as Intermediate Consumption or Final Consumption Expenditure. The end result is the same, but the amount paid has been split up into interest and FISIM.
FISIM is part of the total Output or turnover of banks. Banks also make money from other sources, such as fees and commissions. It is not pure profit, since they have to pay their staff (Compensation of Employees) and operating costs (Intermediate Consumption) out of this service charge.
Customers in Ireland may have accounts abroad, and Irish banks may have foreign customers. Hence there are imports and exports of FISIM just like any other service. If a bank here lends to a company abroad, the FISIM on the loan is a service export by the bank; if a company here borrows from a foreign bank the FISIM they pay is a service import (and similarly for cross border deposits, in and out).
The FISIM is a service charge like any other. It is paid by government, by households, and by all types of enterprise.
Corporations other than banks which are still financial intermediaries (known as Other Financial Intermediaries) can also earn FISIM. While the Central Bank of Ireland has loans and deposits, no FISIM is estimated for these in National Accounts.