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January 21, 2005
(mis?) measurement in financial services
One of the tidbits that came out of the Advancing Knowledge conference (see previous posting) was a nice example of how our current thinking inadvertently penalizes investment in intangibles. This is from Bob Hunt, a senior economist at the Federal Reserve Bank of Philadelphia:
The standard efficiency analysis for commercial banks is to examine some variation of the ratio of non-interest expense to average assets.
Bank expenses are divided into two large categories - interest expense and non-interest expense. Interest expense is the cost of borrowed funds (e.g. deposits), but the primary focus is on non-interest expense, which includes such things as the cost of buildings, etc.
One problem with this measure is that banks don't amortize much of their investments in new products and services, or in reducing the cost of providing existing services. In particular, banks have no conception of investing in research and development. This is all expensed, and it appears in the non-interest expenses of the bank. As a result, a bank that is investing heavily in new products and services may appear less efficient than a bank that isn't making these investments.
Yet, efficiency is an important measure of the health of a nation's banking sector and a key economic goal of the financial regulations. It has become clear that financial institutions have been using technology and other innovations to become more efficient. But as Dr. Hunt points out:
Our accounting for this sector is rooted in a very static view of the industry even though there is ample evidence of financial innovation in the U.S. over the last 30 years.
We simply don't have an accurate measure of R&D performed by the financial services sector. Some recent input-output tables performed by the Bureau of Economic Analysis suggests that this sector produced about $20 billion of software for its own use. Based on the conventional accounting, it appears that nearly all this effort was expensed.
NSF is now generating estimates of R&D in financial services in its survey of industrial R&D, but that is a very recent innovation and it is not exactly clear who is being surveyed and what is being measured.
Any new measure of innovation in the financial services sector would be a welcome step, but can not stop at simple estimated of R&D. As I have argued before, we need a survey of innovation, similar to the EU's Community Innovation Survey - not just a measure of R&D. At best, R&D is a proxy measure of inputs to the innovation system. At worse, it is a misleading indicator of how well we are doing. We need to do better.
Posted by Ken Jarboe at January 21, 2005 8:29 AM
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Tracked on June 30, 2005 6:55 PM