Learning Objectives

The Financial System & Intermediation

The role of banking in an economy
Commercial Banks: Australian Banking

Structure and Purpose

Changes in banking
Banks vs Non-Banks
Bank Services
Key trends in banking
Regulation
Practice Questions
Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Financial intermediation
The Financial System Capital and Securities Markets

Makes possible transactions for the exchange of goods and services Money spent on
by providing money as a unit of payment consumption

Individuals plan their spending and savings patterns over a period of Provision of goods
time and services
Enables the creation of productive capital Producing Units Consuming Units
Allocates capital amongst competing uses
Labour and other productive
Efficient when the transaction cost is low thus good for an economy capacity supplied
2 components: Money paid in return
domestic market and international market for services
Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2 4
The role of banking in an economy Banks Balance Sheet
Financial intermediation (banking) is the process of channelling funds Assets Liabilities
Balance due to other banks
from the savings sector to the borrowing sector at a low cost Cash
Balance due to Central Bank
This enables increasing wealth for the country and its people Balance due from other banks
Customer deposits
Balance due from Central bank Certificates of Deposit
Interest rates Government Investments Long term debt/ Bonds
Loans and Advances Derivative instruments
Derivative instruments Other borrowings
for money Equity
Investments
Fixed Assets Share capital
Reserves
Other assets
Retained earnings

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Australian Banking Australian Banking

Banks tend to be the largest and oldest financial organisations in an economy Australian banks can be classified into the following four main sub-categories:
Many definitions on what a bank is:
APRA - - Major banks: the four largest Australian banks are the Australia and New Zealand Banking Group
Limited, the Commonwealth Bank of Australia, the National Australia Bank Limited, Westpac Banking
Many banks have expanded vigorously Corporation and their subsidiary banks;
A few have merged with non-bank financial institutions to diversify their product offering
Some ADI financial institutions have taken steps to become banks Other domestic banks: all locally-owned banks excluding those classified as major banks (e.g. Bank
of Queensland Limited, Macquarie Bank Limited);
APRA minimum capital requirements
Foreign subsidiary banks: foreign banks authorised to carry on banking business in Australia through
Banks are the largest depository institutions in terms of size in Australia a locally incorporated subsidiary (e.g. HSBC Bank Australia Limited, ING Bank (Australia) Limited
In 2017 ADIs held $4.6 trillion in assets, around two-and-a-
trillion nominal economy. Foreign bank branches: foreign banks licensed to conduct banking business in Australia through
branches, subject to a condition which specifically restricts the acceptance of retail deposits (e.g.
Main function of a bank is lending money Citibank, N.A., Credit Suisse AG).
In making credit available, banks are rendering a great social service
Key issues about banking is public trust
Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2
Australian Banking Australian Banking
The

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Australian Banking Australian Banks: recent trends

In 2017 Australia had 147 banks (ADI), compared to 13 banks in 1985.
Overall increase in number of banks driven by:
relaxation of entry requirements
changes in the regulatory requirements of non-bank depository institutions.
There are 20 regional banks in Australia with a focus on consumer and
small business lending.
Increase also due to building societies and credit unions becoming
banks

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

The changing nature of banking Changes reshaping banking
Changes over the last decade (GFC impacts) Since the Global Financial Crisis (GFC) many changes have occurred
Managerial, regulatory and consumer preferences Governments concerned with risks banks have taken
Regulators trying to reduce bank risk taking
No longer a clear distinction Reintroducing or changing old rules on capital and liquidity
What is clear banks must- Impact of globalisation
manage their assets (loans) and liabilities (deposits)
need to plan and forecast Banks are the major source of loans to:
adequate controls and procedures Individuals and companies
maintain public confidence Governments

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Banks vs Non-Banks Bank Services

Large number of firms that would like to offer some banking services
Banks feel they are being discriminated against
They have a large number of regulations they must comply with
e.g. capital adequacy, liquidity requirements.
Banks believe they have a special place in the economy
Payment services
efficient depository institutions provide payment services, such as cheque
clearing, transfer of currencies (foreign exchange)
Maturity Intermediation (borrowing and lending)
the risk of mismatching the maturities of their assets and liabilities
Credit Allocation
major source of financing for a particular sector of the economy, such as farming,
mining, small business and residential real estate

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Bank Services
Integrated wealth transfers
superannuation funds, ability to transfer wealth from one generation to the next
Denomination Intermediation
managed funds, allow small investors to overcome constraints to buying assets
imposed by large minimum denomination size
Bank deposits offer highly liquid, low risk returns, while the banks
invest in illiquid, risky loans.
Diversification benefits available as long as the intermediary is
sufficiently large to gain from diversification.
Commercial Bank Management LECTURE 2
Bank Trends
Banks most heavily regulated companies/ organisations
safer and more conservative business models
Banking is a public trust
if left to industry whims might assume too much risk
Highest gross yields comes from the loan portfolio
To compensate for declining margins, increasing loan to asset ratios
High loan growth also raises bank capital requirements
Regulators consider loans to be risky assets
encourage banks to add to their loss reserves and capital base
Commercial Bank Management LECTURE 2
Bank Trends Crisis, Reform and Change
Consumers have more choices now than ever before
Bank collapses and loan losses Lehman Brothers, Northern Rock
Government bailouts and intervention
Changing nature of banking reputation risk
Banks have gained greater flexibility in diversifying their asset base
Advances in technology
faster to respond to changing market and new products and services
Innovation
change the way they offer products and services
Commercial Bank Management LECTURE 2
Bank Trends Balance sheet
Shift from commercial lending to lending for residential housing over
the last 20 years:
changes in the structure of the banking industry
implementation of capital adequacy regulations in 1989 and changing.
Growth of foreign currency assets and liabilities:
relaxation of regulations re holdings of foreign currency deposits
banks enabled to access funding in Eurodollar market
Shift in liabilities raised through Australian dollar deposits due to retail
savings growth in superannuation accounts and offshore funding
markets.
Commercial Bank Management LECTURE 2
Bank Trends Off Balance sheet
Increased importance of off-balance-sheet (OBS) activities:
move onto the balance sheet when a contingent event occurs
OBS products are used to generate additional income
Without having to finance them
4 major types of OBS business:
direct credit substitutes
trade- and performance-related OBS activities
interest rate derivative contracts
foreign exchange derivative contracts
Bank Trends -Securitisation
Bank originate assets, typically loans
Combines these loans into pools with similar features and sells them
through "pass through" certificates
Pool is secured by interest & principal payments on the original loans
Originating bank collects interest and principal payments on the loans,
passes through cash flows to the certificate holders
There maybe a fee for managing the certificates to the bank

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Why Securitisation? Why are banks regulated?

Securitisation
reduces a banks capital requirements
Control the money supply and growth of the economy
reduces assets
increases fee income Promote public confidence in the financial system
reduces loss provisions and Facilitate the orderly payment for goods and services
eliminates interest rate risk
Provide government with tax revenues and other services
bank becomes an investment bank.

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Banking Regulation Australian Prudential Regulation Authority (APRA)
Institutions regulated by APRA are called authorised deposit-taking
institutions (ADIs).
The Wallis Committee recommended the introduction of three ADIs are covered by the Banking Act 1959.
agencies, each with specific functional responsibilities APRA considers its approach to regulatory supervision as:
Australian Prudential Regulation Authority (APRA) forward-looking
Australian Securities and Investments Commission (ASIC) risk-based
Reserve Bank of Australia (RBA) consultative
consistent
in line with international best practice.

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Australian Prudential Regulation Authority (APRA) Australian Securities and Investments Commission (ASIC)
The Australian Prudential Regulation Authority (APRA) supervises institutions
across banking, insurance and superannuation and promotes financial system ASIC is Australia's integrated corporate, markets, financial services
stability in Australia. and consumer credit regulator.
Responsible for the prudential regulation and supervision of the financial services
industry. Responsible for market integrity and consumer protection across the
Prudential regulation is concerned with maintaining the safety and soundness of financial
institutions, such that the community can have confidence that they will meet their financial
financial system.
commitments under all reasonable circumstances.
Sets standards for financial market behaviour with the aim to protect
APRA responsibilities include : investor and consumer confidence.
financial stability
protecting the interests of depositors, policyholders and superannuation fund members Administers the Corporations Law to promote honesty and fairness in
APRA seeks to reduce the likelihood of a financial institution failing
Regulates ADIs under licensing regime companies and markets.
Working closely with the Australian Treasury, the Reserve Bank of Australia (RBA), and the
Australian Securities and Investments Commission (ASIC)

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Reserve Bank of Australia (RBA) Questions
The central bank of Australia. 1. How could a fall in the real estate market affect the viability of a
The Reserve Bank of Australia (RBA) conducts monetary policy, works to bank?
maintain a strong financial system and issues the nation's banknotes.
2. Why would unfavourable publicity about a bank lead to liquidity
The RBA also manages Australia's gold and foreign exchange reserves. problems?
The aim of monetary policy is to achieve low and stable inflation over the 3. What impact is Securitisation likely to have on the quality of assets
medium term.
that the banks keep in their portfolios?
Responsible for overall financial system stability, promoting the efficiency of
the payment system and promoting competition for payment services.
Lender of last resort function.

Commercial Bank Management LECTURE 2 Commercial Bank Management LECTURE 2

Questions
Managing the difference between interest earned on assets and
interest paid on liabilities is:
a)managing the spread
b)liquidity management
c)leverage
d)financial contracting
e)none of the above

Commercial Bank Management LECTURE 2