Fictitious Capital by Cédric Durand

Author:Cédric Durand
Language: eng
Format: epub
Publisher: Verso Books

Source: Author’s computations based on World Bank (WDI), OECD and national central banks

Figure 21: Market capitalisation and central bank assets

FINANCIAL INSTITUTIONS’ PROFITS

Let us now examine one last type of financial profit, namely the profits of the companies fulfilling the role of financial intermediaries. This includes the income stemming from the operations they conduct on their own account (dividends, interests and capital gains) but also the profits generated by the activities they realise for their clients.

These institutions’ most immediately tangible source of revenue comes from the fees and commissions they charge. The operations concerned are extremely diverse. To take just a few examples, they range from the commissions the big investment banks award themselves when they are conducting mergers and acquisitions to account management fees and the commissions commercial banks take on cash machine withdrawals or currency exchange operations.

This second type of revenue is at the heart of financial intermediaries’ activity. From banks to mortgage loan insurance, from exchange operations to export credit, and from consumer credit companies to pension savings, in financial institutions the same principle is always at work: transforming debts’ qualities and maturities such that the available money-capital can meet the demand for finance. For example, taking premiums from their clients, insurers build up a portfolio of assets. They invest this while deducting the pay outs they have to make. For insurance activity to remain stable and reliable, these assets must exceed the present value of the estimated cost of the pay outs. The same general principle also applies in pension funds and banking activities. The profits these financial institutions generate thus result from their capacity to achieve valorisation rates for their assets superior to the dynamic evolution of their liabilities.

The present-day measurement of future liabilities is fundamental in this regard. It is uncertain in two senses. The first uncertainty corresponds to the evaluation of future liabilities (for insurers, the risk of accidents; for pension funds, the payment of pensions, etc.). Without doubt, it is very difficult to evaluate this uncertainty, though these actors can mark it out in broad terms on the basis of past experience. Conversely, the second uncertainty is a systemic one: it is situated precisely in the discount rates used to evaluate these future liabilities’ present value. The higher these rates, the lower the present value of present liabilities, and vice versa.

As a general rule, under the new financial accounting norms the discount rates given for the long-term liabilities of actors like insurers and pension funds are equivalent to the return on AA-rated bonds (typical of long-term government bonds). The problem is that when interest rates fall – as in recent years with negative official deposit facility rates in Japan and the Eurozone, among others – returns on safe assets plunge, leaving these actors with rising liabilities and no corresponding upswing in their receipts. This difficulty in managing risks is a real conundrum.17 With more than $13bn of assets traded at negative rates, including 55 per cent of public debt securities in the Eurozone, for many institutions the situation is becoming critical.

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