Loans: Banking on It

INTRODUCTION:

As with all Industries in IMPLAN, there are certain considerations to make when examining the complicated world of banking and lending. Generally speaking, to model the operations of a bank, IMPLAN Industry 441 - Monetary authorities and depository credit intermediation would be the correct choice. This Industry includes commercial banks, savings and loans, and credit unions. Total Employment, Employee Compensation, Proprietor Income, and/or Output can be run through this Industry.  But what if you want to examine the economic impact of the loans that were made? Well, that depends on how the money will be spent.

CONSIDERATIONS ON LOANS:

Analyzing the economic impact of loans is tricky. The first consideration is that of time. A loan may be spread across multiple years and how it is spent may also cross years. In IMPLAN, each year of spending should be modeled separately. 

Also, if this bank didn’t give the loan, there is a possibility that another bank would give the loan. Be careful in attributing the entirety of the investment solely to the existence of this one bank and loans it provides.

The biggest matter, however, is how the loan will be spent by the borrower. There are no lack of possibilities as to how the money could be used, each having drastically different economic impacts. In order to measure the economic impact of the loans, you have to first know how the loan will be spent. Keep in mind that the loan may be spent across a few categories.

OPERATIONS

If the loan will be spent on operations for the business, this can be analyzed using a standard Industry Output Event. Choose the appropriate IMPLAN Industry and enter the loan amount Value. Note that the operations spending may not just be across the board, it may specifically be for new hires or employee raises. 

If the entirety of the loan is modeled through operations, you are assuming that none of the money will be spent on construction or capital. This means that increasing Output doesn’t require any capital purchases. 

CAPITAL

For an in-depth explanation of analyzing capital purchases read more in the Analyzing Capital Investment article.

Construction

The loan may be used to fund new construction. If this is the case, the loan amount should be entered in one of the IMPLAN construction Industries via an Industry Output Event.  Note that new construction is different than repair and maintenance of facilities and needs to be analyzed appropriately. 

Machinery, Equipment, & FF&E

Perhaps the loan will be used for a large capital purchase. This could include an investment in real estate, technology, or machinery, for example. The first consideration with this is whether or not the capital purchase can be made in your Region. Often times, these large items are not produced locally and therefore should be excluded from your analysis.

OTHER USES

Perhaps the loan will actually be used to pay off property taxes. They might also use it to pay off another loan or creditor. If the borrowing is to avert a short term crisis, you may be able to argue that the entire operations of the company was dependent on that loan in order to avoid closing completely.

HOUSEHOLDS:

Banks lend money to households for various purposes, as well. It may be for the purchase of a home, student loan, car, or debt consolidation. Just like with corporate lending, in order to analyze these loans in IMPLAN,  you must decide how the money will be spent and enter the values in the appropriate Industry. 

INTEREST:

A full debt repayment amount should not be run through the banking Industry in IMPLAN. The payment of principle is considered an asset transfer which has no economic impact. However, if the bank that is receiving the payment is within your Region, the interest portion of the debt can be run through the banking Industry. If the bank that is being repaid is out of Region, the entirety of the debt repayment is considered leakage and should not be included.

Interest payments can be thought of as being separated into two parts: interest payments for lending of assets (like cash) and interest payments that are for the value of services provided by financial institutions. Interest for the value of services are not directly measurable and must be estimated as these are included in the Intermediate Expenditure of the bank. The value of the imputed interest would be the difference between the interest income the business could earn were it to lend that money and the interest paid by the bank on the balance of the account. That difference functionally represents a service charge for maintaining the account, providing credit cards, processing information, etc.  

As another example, a business might borrow money from a bank and pay an interest rate of 5%. The bank would give the business various services like loan processing. In this case, the imputed interest would be the difference between 5% and the amount of money the bank could earn were it to lend the same amount of money without providing any services.  The remaining type of interest income, much like interest income that is solely based on returns to lending, is measured on a net basis and is included as a part of Other Property Income (OPI). 

FINAL CONSIDERATIONS:

In IMPLAN, an Industry’s Leontief Production Function represents operational spending only. It does not include investment in capital goods and therefore it does not account for depreciation. Consumption of fixed capital is part of Other Property Income (OPI). Therefore, depreciation is captured as part of Output, but it does not generate Indirect or Induced impacts.

So, we have looked at what the bank did with all that loan money. It’s important, however, to consider the alternatives. If the bank didn’t invest in that million dollar loan to a software company, they might have invested in a multi-family housing structure or personal loans for used car purchases. Perhaps the bank could keep the money in reserves. These examples would obviously have very different effects on the local economy. By investing in the software company, the bank no longer has the capital to fund apartment construction or personal loans. The bank foregoes the potential gain from the alternatives and this is the opportunity cost.

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Written February 14, 2020