Week 1 Extra Reading

8/11/2019 Week 1 Extra Reading

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Chapter 1

The Financial Services Industry:

Depository Institutions


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Overview

In this chapter, we explore two major depositoryinstitution (DI) groups: Banks, and Non-bank depository institutions.

We focus on the major characteristics of each group: Size, structure and composition of industry group, Balance sheets and recent trends, Regulation.

In Australia, the Australian Prudential RegulationAuthority (APRA) authorises financial institutions tocarry out financial intermediation.

1-2Copyright 2007 McGraw-Hill Australia Pty LtdPPTs t/a Financia l Inst i tu t ions Management 2e, by Lange, Saunders, Anderson ,Thomson and CornettSlides prepared by Maike Sundmacher


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Products Sold by the

Financial Services Industry

Comparing the products of DIs in 1950 and 2006: Much greater distinction between types of DIs in terms

of products in 1950 than in 2006.

Blurring of product lines and services over time.

Wider array of services offered by all DI types. Refer to Tables 1.1A and 1.1B in the text.



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Size of Banks in 2005 In 2005, the Commonwealth Bank of Australia was

the largest bank in terms of total assets ($258.93billion).

Ranks 2, 3 and 4 were taken by the NationalAustralia Bank, Westpac and ANZ Banking Group

respectively. The largest four banks in Australia are also referred

to as the Big 4.

All the banks listed in Table 1.2 in the text were larger

in terms of assets than non-bank Dis.



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Banks

Banks are the largest depository institutionsin terms of size.

Major difference between banks and creditunions/savings institutions: banks have

more varied assets and liabilities. Differences in operating characteristics and

profitability across size classesforinstance, with regards to the size of the

commercial loan portfolio.



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Banks: Recent Trends

In 2005 Australia had 49 banks, comparedto 13 banks in 1985.

Overall increase in number of banks drivenby:

relaxation of entry requirements changes in the regulatory requirements of non-bank

depository institutions.

In 2005, the Big 4 banks plus St GeorgeBank held 73.9% of the assets of all

Australian banks, which points towards ahighly concentrated industry (see Table 1.3in text).



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Major Banks

There are 5 major banks in Australia. Asset composition in November 2005:

Cash and securities: $165,106 million

Loans: $709,569 million Other assets: $121,571 million

Inference:

Focus on lending



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Regional Banks

There are 6 regional banks in Australia. Asset composition in November 2005:

Cash and securities: $13,495 million

Loans: $90,861 million

Other assets: $9,648 million

Inference:

Focus on lending

Minor overall share compared to major banks



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Operational Foci of Banks

Four largest banks: National focus. Offer complete corporate and retail banking

services in Australia, NZ and Papua New Guinea.

They also operate in Asia, the US and the UK. Smaller (regional) banks: Regional focus with operations across state

borders.

Large proportion of assets invested in residentialhousing loans due to their origins as buildingsocieties.

1-9Copyright 2007 McGraw-Hill Australia Pty Ltd

PPTs t/a Financia l Inst i tu t ions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett

Slides prepared by Maike Sundmacher


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Profitability of Four

Largest Banks

Full-service provision by major banks has led toenhanced margins.

Enhanced margins led to:

Higher performance, as reflected in their return onshareholders funds.

Greater cost efficiencies.

However, in the late 1980s banks implementedpoor credit strategies, leading to poorperformance in the early 1990s.

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Copyright 2007 McGraw-Hill Australia Pty Ltd




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Balance Sheet and

Recent Trends: Banks

Shift from commercial lending to lending forresidential housing over the last 20 years:

Changes in the structure of the banking industry.

Implementation of capital adequacy regulations in1989.

Growth of foreign currency assets and liabilities:

Relaxation of regulations with respect to banksholdings of foreign currency deposits.

Banks enabled to access funding in Eurodollarmarkets.





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Balance Sheet and

Recent Trends: Banks Large drop of liabilities raised through Australian dollar

deposits due to retail savings growth in superannuationaccounts.

Increased importance of off-balance sheet (OBS)activities:

OBS activities = items that move onto the balance sheetwhen a contingent event occurs.

Used to generate additional income.

Four major types of OBS business:

Direct credit substitutes. Trade- and performance-related OBS activities.

Interest rate derivative contracts.

Foreign exchange derivative contracts.





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Off-Balance-Sheet Activities:

Banks





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Building Societies:

Size, Structure and Composition

Building societies are DIs that usually operateon a cooperative basis.

Depositors are members of the society.

Licensed under Banking Act to undertake thebusiness of banking.

Subject to Corporations Law for corporategovernance.

In 2004 there were 14 building societies,compared to 31 in 1992.





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Credit Unions:

Size, Structure and Composition

Mutually cooperative organisations. Members are usually linked by a common

bond, such as a trade union or locality.

In December 2004 there were 180 credit

unions in Australia. In 2004, the five largest credit unions held

approximately 25% of total sector assets.





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Building Societies and

Credit Unions:

Balance Sheet and Trends Significant growth period in 1960s and 1970s at

expense of banks.

Growth in building societies ensured sufficient supplyof funds for housing loans at reasonable prices.

Growth in credit unions ensured availability ofrelatively low-cost unsecured and secured personalloans.

Both industries could offer high-rate deposits, whilebanks were subject to interest rate ceilings.





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The 1980s

Market share of building societies and credit unionswas threatened due to deregulation of banking sectorin 1980s.

Responses to loss in market share by non-bank DIs: Mergers for efficiency and scale reasons.

Adoption of improved technology. Diversification of products and activities.





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Building Societies and Credit Unions:

Performance





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Regulation

Australias current financial regulatoryframework has its origins in the late 1990sFinancial System Enquiry(Wallis Committee).

Full implementation of recommendations by

1999. The Wallis Committee recommended the

introduction of three agencies, each withspecific functional responsibilities.





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Regulation: APRA

APRA = Australian Prudential RegulationAuthority.

Responsible for the prudential regulation andsupervision of the financial services industry.

Specific responsibilities include developmentof prudential policies that balance:

Financial Safety,

Competition, Contestability, and

Competitive neutrality.





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Regulation: APRA (cont)

APRA regulates Australian DIs under one licensingregime.

Institutions regulated by APRA are called authoriseddeposit-taking institutions (ADIs).

ADIs are covered by the Banking Act 1959.

APRA considers its approach to regulatorysupervision as: Forward-looking,

Risk-based,

Consultative, Consistent, and

In line with international best practice.





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Regulation: ASIC ASIC = Australian Securities and Investments

Commission.

Responsible for market integrity and consumerprotection across the financial system.

Sets standards for financial market behaviourwith the aim to protect investor and consumerconfidence.

Administers the Corporations Law to promote

honesty and fairness in companies and markets.





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Regulation: RBA

RBA = Reserve Bank of Australia. Responsible for the development and

implementation of monetary policy and for overallfinancial system stability.

The aim of monetary policy is to achieve low andstable inflation over the medium term.

Lender of last resort function.





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Regulatory Framework





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Prudential Standards for ADIs

1. Capital Adequacy.

2. Capital Adequacy: Measurement of Capital.

3. Capital Adequacy: Credit Risk.

4. Capital Adequacy: Market Risk.

5. Funds Management and Securitisation.

6. Liquidity.

7. Credit Quality.

8. Large Exposures.

9. Equity Associations.

10.Audit and Related Arrangements for PrudentialReporting.





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Web Resources

For more detailed information on the regulators, visit: http://www.apra.gov.au

http://www.asic.gov.au

http://rba.gov.au

Web Surf


PPTs t/a Financia l Inst i tu t ions Management 2e, by Lange, Saunders, Anderson ,Thomson and CornettSlides prepared by Maike Sundmacher
http://www.apra.gov.au/http://www.asic.gov.au/http://rba.gov.au/http://rba.gov.au/http://www.occ.treas.gov/http://www.asic.gov.au/http://www.fdic.gov/http://www.apra.gov.au/


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Financial Services Reform Act 2001

(CLERP6)

CLERP = Corporate Law Economic Reform Program

Issued by government in response to recommendationsmade by Wallis Committee.

Outcome of CLERP6 consultation process: FinancialServices Reform (FSR) Act.

Aim of reforms:

Flexible and simple licensing of group structures, and

Flexible and simple delivery of financial services.



M j C t


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Major Components

of the FSR Act

Uniform Regulation of Financial Products. Licensing of Financial Services Providers.

Financial Service Provider Conduct and Disclosure.

Licensing of Financial Product Markets.

Other Reforms.




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Web Resources

For more information on Australias large banks, visit:

ANZ Bank:www.anz.com.au

Commonwealth Bank of Australia:www.cba.com.au

National Bank of Australia:www.nab.com.au

St.George Bank:www.stgeorge.com.au

Westpac:www.westpac.com.au


http://www.anz.com.au/http://www.cba.com.au/http://www.nab.com.au/http://www.stgeorge.com.au/http://www.westpac.com.au/http://www.westpac.com.au/http://www.stgeorge.com.au/http://www.nab.com.au/http://www.cba.com.au/http://www.anz.com.au/


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Web Resources

For more information on individual regional banks inAustralia, visit, for example:

Adelaide Bank:

www.adelaidebank.com.au

Bank of Queensland:

www.bankofqueensland.com.au

Bendigo Bank:

www.bendigobank.com.au


http://www.adelaidebank.com.au/http://www.bankofqueensland.com.au/http://www.bendigobank.com.au/http://www.bendigobank.com.au/http://www.bankofqueensland.com.au/http://www.adelaidebank.com.au/


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Web Resources

For more information on individual credit unions, visit,for example:

Australian National Credit Union:www.australiancu.com

Credit Union Australia:www.cua.com.au

Police & Nurses Credit Society:www.pncs.com.au

Police Credit Union:www.policecu.com.au


http://www.australiancu.com/http://www.cua.com.au/http://www.pncs.com.au/http://www.policecu.com.au/http://www.policecu.com.au/http://www.pncs.com.au/http://www.cua.com.au/http://www.australiancu.com/


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Web Resources

For more information on individual building societies,visit, for example:

Heritage Building Society:www.heritageonline.com.au

IMB Building Society:www.imb.com.au

Newcastle Permanent Building Society:www.newcastlepermanent.com.au

Wide Bay Capricorn Building Society:www.widebaycap.com.au



Financial Statement Analysis
http://www.heritageonline.com.au/http://www.imb.com.au/http://www.newcastlepermanent.com.au/http://www.wideestpac.com.au/http://www.wideestpac.com.au/http://www.newcastlepermanent.com.au/http://www.imb.com.au/http://www.heritageonline.com.au/


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using a ROE Framework

ROE = return on equityROE = ROA EM,

where ROA = return on assetsand EM = equity multiplier

ROA = PM AU,where PM = profit marginand AU = asset utilisation

The decomposition of ROE into its different

components allows us to identify a firmsstrengths and weaknesses.



Fi i l St t t A l i


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using a ROE Framework




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ROE: Example (continued)

Solutions:a. Calculate the banks ROE.

ROE = net income / total equity capital

ROE = $5,000,000 / $20,000,000

ROE = 0.25 = 25%.This means that shareholders earn a 25% return on

their invested funds.

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ROE: Example (continued)

Solutions:

b. Decompose the ROE into its differentcomponents.

We know that ROA EM = ROEand that PM AU = ROA.

Thus: ROE = PM AU EMROE = (net income / total operating income) (total operating income / total assets) (total assets / total equity capital)

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Week 1 Extra Reading