APPENDIX DEPOSIT AND LOAN FACILITIES IN THE CPI
DEPOSIT AND LOAN FACILITIES IN THE CPI
This appendix describes the conceptual and methodological issues relevant to the construction of price indexes for deposit and loan facilities.
In order to construct an overall measure of price change for deposit and loan facilities there are two key factors that need to be addressed concerning the ways in which these services are charged for. Banks and other deposit taking institutions earn income by lending funds at a higher rate of interest than they pay on deposits (the difference being referred to as 'interest rate margins') and by charging explicit fees for account keeping services and/or certain transactions.
To the extent that income from interest margins is obtained from households, it is legitimate to regard that amount as representing a payment by households for the services they obtain. The difficulty is that these interest rate margins are not directly observable. While the explicitly charged fees are observable, the impact of these on individual households can vary significantly depending on factors such as the type of account, the frequency of particular transaction types, the account balance and the total volume of business that the customer conducts with the service provider.
The challenge confronting the ABS was to develop a methodology for measuring changes in the amounts payable as explicit fees and charges, and the amounts payable as interest rate margins. The changes in both these elements then need to be combined to obtain the aggregate or net change in the price of deposit and loan facilities.
Calculation of Direct Fees
The schedules used to determine the amounts payable as explicit fees are generally not linear in nature and tend to incorporate some form of step function. In other words, rather than setting a universally applied price per transaction, it is often the case that fees for certain types of transactions are only incurred after some threshold is breached (e.g. after say four transactions in a month or when account balances fall below some level). Furthermore, financial institutions often bundle products together, with the price paid for particular products depending on the bundling arrangements. In these circumstances it is not possible to simply calculate an average price from observable schedules. What would be required would be to price different bundles of each service, for example three, four, five and six over the counter withdrawals, and derive an average across the different bundles and construct a measure of price change from the changes in this average over time.
However, there are several problems with this approach. Obtaining enough detailed information to construct sufficiently representative bundles of the individual services attracting fees would be an expensive process and still subject to error. It would also not be able to account for cases where the fees vary with the value of the transaction or individual account balances or cases where rebates are applied against the total of all fees that would have been charged. For these reasons, the ABS believes that the only way to reliably measure changes in fees is to work with a sample of customers' accounts.
The approach adopted is similar in principle to that used for other components of the CPI. For each sampled institution (service provider) a sample of products is selected to represent each of the major product categories such as current accounts, savings and investment accounts, retirement accounts, housing and home-equity loans, personal loans, and credit cards. The specific product selected from each group (e.g. the sampled home loan product) is assigned a weight to represent all fees plus margins paid in respect of the product group (e.g. housing loans).
For each sampled product the institutions provide a sample of accounts for customers living in each of the eight capital cities. Each sampled account contains information that is similar to that included on the monthly statements received by customers with the exception that any identifying information (such as the customer and who a payment was made to or received from) has been removed. However, the value of any transaction, the type of transaction (cheque, automatic teller machine (ATM) withdrawal etc.) and running balances have been retained along with any other information that influences the determination of charges (such as a customer relationship value or a fee-waiving flag). Each sampled account covers a full twelve months of activity. All up, the ABS has sampled approximately seven thousand individual accounts for the purpose of compiling these indexes. In aggregate these sampled accounts contain approximately three million transactions.
The ABS has built a computer system capable of emulating the charging regimes employed by financial institutions. This enables the ABS to calculate, each month, the total amounts that would be paid in fees over a full year for each sampled account based on the currently prevailing fee schedules. The use of a full year's activity in this way is consistent with the methodology used to measure price change for all items in the CPI, which is based on an annual quantity basket.
Some products, mainly loan products, incur an establishment fee. These are not accounted for by the sample of accounts and therefore require a separate estimation procedure. The price measure for establishment fees is calculated using changes in the average establishment fee charged on new accounts each month (information provided by the sampled institutions). Changes in these average fees reflect any discounting or waiving of fees by institutions.
Calculation of margins
The first issue is how to calculate the amount paid as an interest margin on any single product (or account provided by a financial institution). The 1993 System of National Accounts (SNA 93) recommends [para 6.125 and Annex III] that the value of services provided by means of interest-rate margins be valued as the product of the balance on the account multiplied by the difference between the interest rate payable or receivable and a reference rate of interest. This approach has the effect of valuing the service provided to a borrower as the difference between the amount of interest paid by the borrower and the (lesser) amount that would have been paid had the reference rate been used. The converse applies for depositors. Therefore, the price of the service per dollar borrowed is given by the difference between the interest rate paid by the borrower and the reference rate. For a depositor, it is the difference between the reference rate and the interest rate received by the depositor.
In practice, statisticians experience great difficulty in identifying an exogenous reference rate that does not also result in volatile and sometimes negative measures of interest margins (as would occur if the reference rate lies above the lending rate or below the deposit rate). When valuing these services in the national accounts the ABS has adopted the practical expediency of setting the reference rate at the mid-point of the borrowing and lending rates. A reference rate determined in this way could be regarded as representing a market-clearing rate (i.e. the rate that would have been struck in the absence of financial intermediaries by depositors dealing directly with borrowers).
To minimise problems with potential non-response and changes to the structure of the financial sector, it was decided that a slight variation of the approach used in the national accounts would be adopted in the construction of the price indexes for financial services in the CPI. A separate reference rate is calculated for each sampled service provider for these indexes.
It is important to recognise that this reference rate is not intended to approximate a financial institution's cost of funds. In the simplest case, where an institution's only source of funds is amounts on deposit, its cost of funds would equal the interest rate paid on deposits. Using this as the reference rate would result in the measurement of zero services being provided to depositors.
The sampled institutions provide monthly data on balances and interest flows (yields) by product and in aggregate. These data are used to calculate a current period interest rate margin for each of the sampled products. However, to minimise the effect of any short-term accounting anomalies, such as posting effects and adjustments of various types, the ABS constructs three-month moving averages of the average balances and interest flows and derives the required interest rates, reference rates and margin rates from the smoothed data.
Estimating Base Period Expenditure Weights
Estimating the base period value of expenditure on deposit and loan facilities, as required for weighting purposes, is a complex exercise. What follows is a simplified description of the general procedure.
The starting point was to select a sample of deposit taking institutions each of which was then approached to obtain information on balances, interest flows and fees by product and in aggregate for a full financial year. Interest flows (payments on deposit products and receivables on loan products) and balances were used to compute interest rates (or yields) at the individual product level and for deposits and loans in total. The reference rate was calculated as the mid-point of the rate paid on deposits and the rate earned on loans. The percentage margin on each product was calculated as described above and the dollar value of the margin computed. For all those products identified as being consumer products (as distinct from those used by businesses), the total receipts from households were computed by summing the margins and fees. The aggregate ratio of these receipts to total balances for the sampled institutions was applied to aggregate balances for all deposit taking institutions to derive a national estimate. The capital city level estimates were imputed by reference to aggregate data from the Household Expenditure Survey.
Measuring total price change
Because percentages (such as margin rates) are not prices, the latest period margin rates have to be applied to some monetary amount in order to compute the current period amounts that would be paid as margins. To preserve the quantities underpinning the values of the individual transactions and account balances in the base period, the values in the sampled accounts are updated each period using a four-quarter moving average of the all-groups CPI.
The process for measuring price change for any individual sampled account from one period to the next can be described in the following way. Each quarter the transaction values and the starting balances in the sampled accounts are updated using a four-quarter moving average of the CPI lagged by one quarter. The fee schedules for each sampled product are updated, where necessary, each month as are the current period margin rates.
The ABS calculates the dollar value of the interest margins by applying the current period margin rate to the updated average balances of the sampled accounts. These amounts are added to the amounts calculated for fees and charges (as described above) giving a total price paid for each sampled account.
The price index is constructed by comparing the change over time in these total amounts. In practice this means that if percentage margins remain unchanged over time, margin prices will move in line with the lagged four-term moving average of the CPI.
The aggregate index for deposit and loan facilities is produced by weighting together the indexes for each of the sampled products using the base period expenditure weights described above.