The Financial Account shows financial assets and liabilities, such as loans, shares, investment funds and pension funds. The overall change in the account is the total increase in assets minus the total increase in liabilities and this is the Net Lending or Net Borrowing. If we are better off then we are a net lender; if we are worse off then we are a net borrower. Net Lending/Net Borrowing is presented as a single item in the accounts, with a positive sign if it is Net Lending and a negative sign if it is Net Borrowing. In National Accounts, Net Lending and Net Borrowing is shown for the economy as a whole and for Institutional Sectors, such as Households, Corporations or Government.
Becoming a net borrower does not necessarily mean being worse off: it is based solely on financial assets. Fixed assets, such as houses, and Non-Produced Assets, such as land are also stores of wealth that might increase while our wealth in financial assets is decreasing. For Households, changes in Net Lending might be caused by borrowing to buy homes, or by paying off a mortgage, or by putting money on deposit, or by saving in pension funds and so on. In Ireland up to 2008, incomes were growing but households were net borrowers because most saving was invested in houses and apartments, not in bank accounts or other financial assets.
These changes in non-financial assets, and all the other transactions are shown in the Non-Financial Account. This account also adds up to the same Net Lending/Borrowing. This Non-Financial Account is a Sequence of Accounts that starts with Output and goes through Value Added, Primary Income, Secondary Income, and Capital Investment. Once Households, Government and Corporations have been paid for their work, or got their income from investments, have paid their taxes and social contributions and received their social benefits, have consumed and made capital investments, if, after all that, they have anything left over, they have generated Net Lending. On the other hand, if all their out-goings were more than their in-comings, then they have generated Net Borrowing for themselves.
Thus, Net Lending and Net Borrowing is where the financial transactions flow into the non-financial transactions.
In practice, in National Accounts we do not follow the money from the Non-Financial into the Financial Account for each enterprise or household. The Financial Account and the Non-Financial Account are compiled from completely separate sources. The Financial Account tracks the changes in financial assets and liabilities, and comes up with a Net Lending or Net Borrowing figure independently of the Non-Financial Account. Theoretically, once all the transactions have been included, the Net Lending balance on the financial account should be the same as the Net Lending on the Non-Financial Account. In reality, there is inevitably some discrepancy between the two accounts.
If the country as a whole is a Net Lender then it is a Net Lender to the rest of the world. Being a Net Lender means the country is building up its wealth, which is often a good thing. However, if the country is a Net Borrower from the rest of the world because it is borrowing to fund Capital Investment, that can also bode well for the long term growth of the economy. In Ireland, there are some very big Foreign-Owned Corporations with large international transactions. The activities of these corporations can move the Net Lending for the country, but have little real impact on the domestic economy. For the country as a whole, the Net Lending or Net Borrowing is equal to the International Accounts balance on the current account plus the small balance of the capital account. The Modified Current Account in International Accounts removes some of the distorting effects of Globalisation to give a better indicator of Ireland's transactions with the rest of the world.
If the Government is a Net Lender then there is a Government Surplus. The Net Borrowing of Government is the Government Deficit; in general, if Government is continually borrowing large amounts it is building up debt that it might not be able to repay. The European Union has set rules on how big the Government Deficit can be.