Table of Contents
- What Is a Financial Account?
- Key Takeaways
- Understanding Financial Accounts
- Capital Account vs. Current Account
- Transaction Recording
- Risks and Benefits of Increased Access
- What Makes Up the Balance of a Financial Account?
- What Is a Current Account and Financial Account?
- Does the Financial Account Always Balance?
- The Bottom Line
What Is a Financial Account?
Let me explain what a financial account is in macroeconomics. It's a component of a country's balance of payments that covers claims on or liabilities to nonresidents, specifically concerning financial assets. The components include direct investment, portfolio investment, and reserve assets, broken down by sector.
When we record this in a country's balance of payments, nonresidents' claims on residents' financial assets count as liabilities, while claims made against nonresidents by residents are assets.
Key Takeaways
You should remember that a financial account is part of a country’s balance of payments, covering claims on or liabilities to nonresidents about financial assets. Its components are direct investment, portfolio investment, and reserve assets by sector. It involves assets like gold, currency, derivatives, special drawing rights, equities, and bonds.
Understanding Financial Accounts
The financial account tracks shifts in international asset ownership, and it's made up of two subaccounts. The first covers domestic ownership of foreign assets, such as foreign bank deposits and securities in foreign companies. The second includes foreign ownership of domestic assets, like foreign entities buying government bonds or providing loans to domestic banks.
To see how the financial account can go up or down, consider these scenarios for the United States. If there's an increase in U.S.-owned foreign assets abroad, that's a financial outflow and decreases the U.S. financial account, shown as a negative value. On the other hand, a decrease in U.S.-owned foreign assets abroad is a financial inflow and increases the account, shown as positive.
If there's an increase in foreign-owned assets in the U.S., it's a financial inflow that increases the account, with a positive value. Conversely, a decrease in foreign-owned assets in the U.S. is a financial outflow that decreases the account, shown as negative.
Capital Account vs. Current Account
The financial account is different from the capital account, which records transfers of capital assets. Those capital account transactions don't affect a country’s production levels, savings rate, or overall income.
The current account shows the country’s trade balance, plus net income and direct payments, measuring imports and exports of goods and services. Together with the financial and capital accounts, they make up the country’s balance of payments.
Transaction Recording
The financial account deals with assets like gold, currency, derivatives, special drawing rights, equities, and bonds. In a complex transaction with capital assets and financial claims, a country might record part in its capital account and part in its current account.
Because entries in the financial account are net entries offsetting credits with debits, they might not show up in the balance of payments, even for transactions between residents and nonresidents.
Risks and Benefits of Increased Access
Easing access to a country’s capital is part of broader economic liberalization, and a more open financial account connects a country to global capital markets.
However, reducing restrictions on the financial account carries risks. The more integrated a country’s economy is with others worldwide, the more likely foreign economic troubles will impact the domestic situation. You have to weigh this against benefits like lower funding costs, access to global 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 or 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 transfers between residents and foreign residents. A financial account measures changes in a country's ownership of international assets.
Does the Financial Account Always Balance?
The current account is offset by the capital and financial accounts, so the sum of these, which is the balance of payments, balances to zero.
The Bottom Line
Financial accounts are part of a nation's balance of payments, covering nonresident claims and liabilities on assets like gold, equities, bonds, derivatives, and special drawing rights. Their purpose is to track changes in international asset ownership.
Other articles for you
The required rate of return (RRR) is the minimum return investors demand for the risk of holding a stock or pursuing a project.
The information ratio measures a fund manager's ability to generate consistent excess returns over a benchmark relative to the volatility of those returns.
IRS Form 2848 allows you to authorize someone to represent you before the IRS and access your tax information without relieving you of tax liability.
An emerging industry involves companies forming around new products or ideas in early development, often tied to innovative technologies with high risks and potential rewards.
The EBITDA-to-sales ratio measures a company's profitability by comparing EBITDA to net sales, highlighting operational efficiency after operating expenses.
Merger arbitrage is an investment strategy that exploits price differences in merging companies' stocks due to deal uncertainties for potential profits.
Mutually exclusive events or options cannot occur at the same time, often applied in business for decision-making on budgets and projects.
The needs approach calculates life insurance needs based on immediate obligations and future income for dependents.
Required minimum distributions (RMDs) mandate annual withdrawals from certain retirement accounts starting at age 73 to avoid tax penalties.
Hazard insurance is a component of homeowners insurance that protects against damage from natural events like fires and storms.