• Sat. Apr 20th, 2024

Financial Account Definition, With Components and Assets

What Is a Financial Account?

In macroeconomics, a financial account is a component of a country’s balance of payments that covers claims on or liabilities to nonresidents, specifically concerning financial assets. Financial account components include direct investment, portfolio investment, and reserve assets broken down by sector.

When recorded in a country’s balance of payments, nonresidents’ claims made on residents’ financial assets are liabilities, while claims made against nonresidents by residents are assets.

Key Takeaways

  • A financial account is a component of a country’s balance of payments that covers claims on or liabilities to nonresidents concerning financial assets.
  • Financial account components include direct investment, portfolio investment, and reserve assets broken down by sector.
  • The financial account involves financial assets such as gold, currency, derivatives, special drawing rights, equities, and bonds.

Understanding Financial Accounts

The financial account is a tracking mechanism for shifts in international asset ownership, and it is composed of two subaccounts.

  • The first subaccount includes domestic ownership of foreign assets, such as foreign bank deposits and securities in foreign companies.
  • The second subaccount includes foreign ownership of domestic assets, such as the purchase of government bonds by foreign entities or loans provided to domestic banks by foreign institutions.

To compare how the financial account can increase or decrease, let’s analyze the following scenarios for the financial account of the United States:

  • If there’s an increase in U.S.-owned foreign assets abroad, it’s a financial outflow and decreases the financial account of the U.S., as shown by a negative value.
  • Conversely, if there’s a decrease in U.S.-owned foreign assets abroad, it’s considered a financial inflow and increases the financial account; shown as a positive value.
  • If there’s an increase in foreign-owned assets in the U.S., it’s a financial inflow and increases the financial account of the U.S., showing a positive value.
  • Conversely, if there’s a decrease in foreign-owned assets in the U.S., it’s a financial outflow and decreases the financial account of the U.S., showing a negative value.

Capital Account vs. Current Account

The financial account differs from the capital account in that the capital account records transfers of capital assets. Transactions in the capital account have no impact on a country’s production levels, rate of savings, or overall income.

The current account reflects the country’s current trade balance, combined with net income and direct payments, and measures the import and export of goods and services. When combined with the financial and capital accounts, the three accounts form a country’s balance of payments.

Transaction Recording

The financial account involves financial assets such as gold, currency, derivatives, special drawing rights, equities, and bonds. During a complex transaction containing capital assets and financial claims, a country may record part of a transaction in its capital account and the other part in its current account.

In addition, because entries in the financial account are net entries that offset credits with debits, they may not appear in a country’s balance of payments, even if transactions occur between residents and nonresidents.

Risks and Benefits of Increased Access

Easing access to a country’s capital is considered part of a broader movement toward economic liberalization, and a more liberalized financial account opens a country up to capital markets.

However, reducing restrictions on the financial account has risks. The more a country’s economy is integrated with other economies worldwide, the greater the likelihood that economic troubles abroad will affect the domestic situation. This potential outcome is weighed against the potential benefits: lower funding costs, access to global capital markets, and increased efficiency.

What Makes Up the Balance of a Financial Account?

The balance of a financial account is the sum of net direct investments, net portfolio investments, asset funding, and errors/omissions.

What Is a Current Account and Financial Account?

The current account records imports and exports; the movement of goods in and out of a country, measuring the transfers between U.S. residents and foreign residents. A financial account measures the change in a country’s ownership of international assets.

Does the Financial Account Always Balance?

The current account is offset by the capital account and the financial account, meaning the sum of these accounts, which is the balance of payments, will balance to zero.

The Bottom Line

Financial accounts are a part of a nation’s balance of payments that covers nonresident claims and liabilities, which comprises assets such as gold, equities, bonds, derivatives, and special drawing rights. The purpose of a financial account is to track the changes in international asset ownership.

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