In analysing the sustainability of government finances, the focus tends to be on gross government debt as a percentage of GDP. However, as gross debt does not take into account the asset side of government balance sheets, this measure only tells part of the story. Assets may generate income or be sold in order to redeem part of gross debt, and are therefore very relevant in assessing the financial health of government as well. A government with a high level of liabilities but also with significant amounts of assets on its balance sheet may be better off than a government with a lower level of liabilities and hardly any assets. Therefore, net government debt, which incorporates information on assets, constitutes a useful additional measure to gross government debt. It provides insight into the capabilities of governments to service debt in the longer run and thus presents a more comprehensive and nuanced picture of government financial health.
How do OECD countries compare in terms of gross and net government debt?
Figure 1 shows gross and net financial debt as a percentage of GDP in 2013 for selected OECD countries
The impact of the inclusion of financial assets in the debt measure differs considerably across countries. The impact is particularly large for Norway, Japan (which may be partly due to the fact that debt data are not consolidated across different government units, i.e. gross debt figures include liabilities between these units which cancel out in net debt data), Finland, Luxembourg, Sweden, Slovenia and Greece. These countries have a relatively large amount of financial assets on their balance sheets, and so they rank lower on the basis of net government debt than on the basis of gross debt. For some of them, the debt measure even changes sign, implying that the amount of financial assets is higher than that of financial liabilities. On the other hand, the difference is relatively modest for the United States, Hungary, Italy, Poland, Belgium and the Slovak Republic. These countries only have a small amount of financial assets on their balance sheets and their net and gross debt ratios are therefore similar.
What happened during the crisis?
During the recent financial crisis most countries experienced an increase in their debt levels. This was a direct consequence of the economic downturn, which resulted in lower tax revenues and increasing expenditures. Furthermore, some governments increased their spending to actively support the economy and acquired assets in financial institutions to prevent a collapse of the financial sector. As these policies affected liabilities and assets in different ways, the impact on gross and net government debt levels also differed among countries. And of course, changes in GDP levels also affected debt ratios in different ways.
Figure 2 presents the changes in gross and net debt ratios between 2007 and 2013 for selected OECD countries
Most countries experienced increases in both gross and net debt ratios during the crisis, but the extent of such increases differs substantially between countries. Ireland reported the largest increase in gross debt ratio, from 26.9% in 2007 to 125.4% in 2013. This increase was the result of a sharp rise in liabilities combined with a decrease in GDP. As assets only increased to a small degree, the net debt ratio showed a sharp increase as well (from -1.4% to 72.8%).
Greece, Portugal, and Spain also registered large increases in their gross debt ratios in the period 2007 to 2013. As was the case with Ireland, this was due to a combination of increased liabilities and a decrease in GDP levels. In that respect, it can be noted that the United States reported a larger relative increase in liabilities than Portugal and Greece (86.0% versus 77.5% and 28.5%), but due to an increase in its GDP level over the same time period, the gross debt ratio increased to a lesser extent (by 46.4 percentage-point versus 64.4 percentage point and 75.1 percentage point in Portugal and Greece, respectively). It is interesting to note that while Spain recorded a lower increase in its gross debt ratio than Portugal and Greece, in terms of net debt ratios, the increase was higher in Spain. And the increase in the net debt ratio in the United States was almost as high as in these three countries, although the increase in the US gross debt ratio was much lower. Both effects are due to the fact that Spain and the United States experienced smaller increases in the value of their assets than Portugal and Greece. Therefore, the change in the net debt ratio for the former countries is relatively close to the change in their gross debt ratio, contrary to the latter countries.
The Czech Republic and Poland are the only two countries in which the net debt ratio increased more than the gross debt ratio. Both countries recorded increases in liabilities of more than 80%, whereas the value of assets only increased by 0.8% for the Czech Republic and by 8.7% for Poland. Combined with increases in their GDP levels of respectively 1.0% and 5.7% per year, this led to increases in their net debt ratios that exceeded those in their gross debt ratios.
The measure explained
In this Statistical Insight, we compare gross debt to net financial debt, calculated as gross debt minus the value of all financial assets. Whereas in gross debt only liabilities defined as debt instruments are taken into account, i.e. liabilities that constitute a financial claim on the debtor and that involve payments of interest and/or principal (therefore excluding liabilities in the form of shares, equity, financial derivatives and monetary gold), all financial assets, including e.g. equity, are taken into account in calculating net debt. The rationale is that all financial assets are deemed to be available for debt redemption. In some cases, non-financial assets are taken into account in calculating net debt, but as some of these assets may be highly illiquid (like land or infrastructure) and relevant data are only available for a few countries, they are not included here. With regard to valuation, the nominal value is used for liabilities, as that is the amount that the government owes the creditors, and market value is used for assets, as that best reflects the amount that can be obtained to service the debt.
Where to find the underlying data
The underlying data are published in the OECD data warehouse: OECD.Stat.
- GDP, output approach, in current prices: OECD (2015), “Aggregate National Accounts, SNA 2008: Gross domestic product“, OECD National Accounts Statistics (database).
- Financial assets, general government: OECD (2015) “Financial Balance Sheets, SNA 2008: Consolidated stocks, annual” except for Japan, for which the data have been derived from OECD (2015) “Financial Balance Sheets, SNA 1993: Non-consolidated stocks, annual“, OECD National Accounts Statistics (database).
- Liabilities: ‘currency and deposits’, ‘loans’, ‘Insurance pension and standardised guarantees’, and ‘Other accounts payable’: OECD (2015) “Financial Balance Sheets, SNA 2008: Consolidated stocks, annual” except for Japan, for which the data have been derived from OECD (2015) “Financial Balance Sheets, SNA 1993: Non-consolidated stocks, annual“, OECD National Accounts Statistics (database).
- Debt securities: OECD (2015), “Public Sector Debt“, OECD National Accounts Statistics (database), taking the 4thquarter data of each year, except for debt securities 2007, nominal value, for Greece, Poland and Slovenia for which the data have been extracted from Eurostat, Government consolidated debt at face value – Debt securities.
- Bloch, D. and F. Fall (2015), “Government debt indicators: Understanding the data“, OECD Economics Department Working Papers, No. 1228, OECD Publishing, Paris.
- European Commission; IMF; OECD; UN; and World Bank (2009), “System of National Accounts 2008“
- IMF and the OECD (2015), “Availability of Net Debt”, Paper prepared for the Meeting of the Task Force on Finance Statistics of 12-13 March 2015.
- IMF (2014), “External Debt Statistics: Guide for Compilers and Users“
- IMF (2013), “Staff Guidance Note for Public Debt Sustainability Analysis in Market-Access Countries“
- Ynesta, I. Van de Ven, P., Kim, E.J., and Girodet, C. (2013), Government finance indicators: truth and myth, Paper prepared for the Working Party on Financial Statistics of 30 September-1 October 2013
For further information please contact the OECD Statistics Directorate at [email protected]
Today’s post is from Adrian Blundell-Wignall, Special Advisor to the OECD Secretary-General on Financial Markets. The view expressed here is his own and does not necessarily reflect that of any OECD government.
This week, the German Parliament’s Finance Committee invited Paul Atkinson and me to comment on a draft bank-separation law. The draft is strongly influenced by the 2012 Final Report of the High-level Expert Group on reforming the structure of the EU banking sector chaired by Erkki Liikanen.
Liikanen proposes assigning trading and available for sale securities above a threshold of 15-25% and all activities related to market making to a separate, well-capitalized, subsidiary. This would maintain the advantages of the universal bank model in a holding company structure, but insured deposits could not be used to subsidize the trading activities. The OECD has long proposed a non-operating holding company structure for separation, by ring fencing and separately capitalizing the different activities without restricting a bank from offering a complete range of services to customers. In general terms Liikanen is similar to this. It has the advantage of also of promoting a level playing field for bank competition with stand-alone securities trading firms.
However, the proposal involving a €100 bn “separation trigger” for total assets held for trading and available for sale is not sensible. No bank under €400bn total assets with any amount of derivatives would ever be considered as long as it kept no more than 24.9% of trading assets? If a bank with around €100bn trading assets was subject to a plus or minus 10% volatility cycle in asset values, it could separated and reunited as prices rose and fell.
The Liikanen report urges the Basel Committee and the EU to deal with the shortcomings of model-based risk weighting approach in the capital rules, so that the trading subsidiary (in particular) is well capitalized and not subject to error. The Expert Group also stresses that the directives on resolution and bail-in are an essential complement to its separation proposal. Clarification and pre-notification of instruments that are not guaranteed and will be subject to bail-in should be transparent to promote trust. As far as possible, such instruments should be marketed to non-banks.
Strengthening boards, promoting risk management and disclosure, tackling incentive schemes and sanctions to ensure compliance were also recommended by the Liikanen group.
While the OECD has supported much of this over the years, we disagree with Liikanen on two important points, concerning separation and minimum capital standards.
The first major problem is that, while idea of a threshold for separation is good, the Liikanen group has not chosen the right variable on which to base the threshold. Recent OECD work has sought empirically to explore the factors that make a bank more or less risky: i.e. that take it towards or away from the default point. This research was necessary, because policy after the crisis had to be made ‘on the run’ without enough detailed empirical evidence on which to base reform. Most of the research referred to in the Liikanen report pre-dates the crisis, or is related to recent policy developments, but none of it contains research relating business model features to banks’ distance to default. Yet it is crucial to know which mechanisms are and are not supported by the data.
With respect to the business model features of bank risk, the OECD study shows that liquid trading assets, properly separated from the gross market value of (mainly over the counter illiquid) derivatives, helps to increase the bank’s distance from default and make it less (not more) risky. On the other hand derivatives are overwhelmingly the business model feature that gives rise to interconnectedness risk and default paths arising from illiquidity in crisis conditions (for example the massive margin calls in 2008-2009).
This makes intuitive sense too. Most derivatives are not standardized and trade over-the-counter, i.e. directly between the two parties without being supervised by an exchange. An institution can find itself in a position where it cannot operate because it doesn’t have the liquidity to meet immediate calls for payments on derivatives markets. Dexia is a recent example of such a failure, and if AIG’s derivative commitments had not been met from official sources, bank collapses through interdependence channels would have been difficult to contain. Liquid trading securities, on the other hand, can be sold precisely to meet margin and collateral calls —a very good thing.
This is a fairly major problem for the Liikanen report—they are not looking at the right threshold variable. The idea of a threshold makes sense, but it must be based on the key variable if banks are to be safer. In the OECD view this is derivatives: any bank with a gross market value of derivatives above 10%-15% should be considered for separation.
Putting to one side the empirical evidence for a moment, consider intuitively the case of Wells Fargo (appropriately converted to International Financial Reporting Standards – IFRS – derivatives concepts) and Deutsche Bank. Wells Fargo offers most essential services to its customers, has very low leverage, had no issues in the crisis and is one of the most profitable banks in the world. Wells Fargo received no payments from the US government in settlement of the AIG counterparty positions. Yet Wells Fargo would be considered for separation under Liikanen ‘percent-of-assets’ threshold test. Its trading and available for sale assets were around 21% in mid 2012, but its derivatives were only 6.5% of its adjusted balance sheet—a safe business model for interconnectedness risk according to the OECD research.
Deutsche Bank, on the other hand, with 40% of its balance sheet in derivatives and only 14% of liquid trading and available for sale securities would not be considered for separation on this rule. Deutsche Bank received a payment from the US government in settlement of its AIG positions equal to 37% of equity less goodwill. Enough said.
The second main issue after separation, minimum capital requirements, is dealt with extensively in the Liikanen Report, with calls for “…more robust risk weights…more consistent treatment of risk in internal models [and that] the treatment of real estate lending…should be reconsidered,…”
The Expert Group should have had the courage of its convictions. The core problem is the risk weighting system as proposed in the so-called Basel III international regulatory framework for banks. This introduces an illusory “risk sensitivity” that relates minimum capital requirements to “risk-weighted assets (RWA)”, instead of to actual balance sheets. This has evolved into a system of extreme complexity that invites institutions to look for regulatory ways to reduce RWA relative to total assets (including negotiating with supervisory authorities) rather than ensuring they really have enough capital, defeating the entire purpose of capital adequacy rules.
So long as capital requirements are based on RWA, whose relationship to the actual balance sheet is effectively a management tool, many banks (and the system as a whole) are likely to be under-capitalized. The best solution would be to scrap the risk-weight system at both global and European levels in favor of something vastly simpler and more effective. Failing that, the equivalent can be achieved by strengthening the role of the (non-risk-weighted) leverage ratio to the point where it overrides the risk-weight system.