Finance Assignment 1 Ricky Chen

Subject Code: FNCE10001 Subject Name: Finance 1

Student ID Number: 693360 Student Name: Ricky Chen

Assignment Name or Number: Case Assignment 1

Tutorial: Thursday 12-1pm Kathryn St. John

 Finance Assignment 1 Ricky Chen

Report on the risks of NAB

To: National Australia Bank (NAB) Board of Directors

From: Chief Risk Officer (CRO) Ricky Chen

Introduction:

It has come to my attention as CRO that NAB is currently faced with an issue of very low
level of cash and liquid securities. The purpose of this report is to explore the overall risk
NAB is currently facing, possible consequences that may follow and recommendations of
minimising the risks. Included is a numerical example demonstrating precisely what NAB
can do to solve this problem.

Risks involved:

In our current situation, NAB is currently facing both funding and liquidity risk. Without
getting sufficient funds immediately, these risks will continue to grow, leaving NAB in a
vulnerable position.

Funding Risk:

Funding risk occurs when ADI’s are unable to maintain adequate funds to cover their
loans. This is when they are unable to reinvest their debts to continue to fund its assets (Hunt
& Terry, 2011). Our bank (NAB) is currently facing funding risk due to our insufficient level
of cash and liquid securities, causing us to have the inability to continue funding our assets.

Liquidity Risk:

Liquidity risk refers to when ADI’s are unable to meet their financial obligations as
they fall due. The basic source of liquidity risk is due to a mismatch in the maturity of ADI’s
securities, their use of funds and their inability to sell securities to gain cash (Hunt & Terry,
2011). With low level of cash, when depositors’ demand for their deposits back, there is the
risk of not being able to complete the request. This may increase the losses of our company.
 Finance Assignment 1 Ricky Chen

Recommendations:

With the different risks involved, it is important for NAB to resolve this problem
immediately. Through calculations, I believe that around $100 million AUD would help solve
our problem and minimise the risks. There are a few options to achieve the level of cash
required:

Certificate of deposit (CD):

One solution is for NAB to issue CD’s. CD is a form of wholesale deposits of a fixed
term (Hunt & Terry, 2011). Investors will deposit money in our bank for a set time period on
an agreed interest rate and in return, we will calculate the future value of the deposit (through
simple interest) and repay our investors on maturity. To make the CD’s more attractive, we
should make it ‘negotiable’, so that investors will be able to trade them in the money market.

Repurchase Agreement (Repo):

Another solution is to enter repurchase agreements (often made with the Reserve
Bank of Australia (RBA)). Repos often involve the sale of securities and the agreement that
the seller will buy back to security at a later date on an agreed price. The general transaction
size for repos is at $50million for periods greater than 7 days (Reciprocal Purchase
Agreements Conventions, 2014).

Securitisation:

Securitisation refers to the process of securitising illiquid assets and selling them to
investors (Hunt & Terry, 2011). In this process, we are paid cash from the buyer of the
security. As we currently have $1,993 million in property, plant and equipment (2013 Full
Year Results (NAB), 2013), we will be able to easily obtain $100 million AUD.

Syndicated Loan:

Another option is getting a loan from the 3 major banks (ANZ, Commonwealth and
Westpac) with one arranging the loan (also referred to as pooling funds). This is a viable
option, if we continue having low levels of cash and liquid securities, we would not be able to
pay out any of our loans, or pay for any retail or wholesale transactions. If the situation was
to worsen, it may create a domino’s effect, affecting the other banks as well. To reduce the
risk, we can put up some of our assets as collateral to increase their willingness to loan to us.
 Finance Assignment 1 Ricky Chen

Numerical Example:

Provided below is a numerical example of issuing CD’s to show exactly how to achieve the
target of $100 million AUD:

With the desperate need for the $100 million AUD due to the risks involved, I’m
going to set the interest rate at 4% p.a, mature in 90 days, for $5 million negotiable CD’s.
The interest is generally placed at 3.15% p.a (Indicator Rates, 2014) but to make it seem
more desirable due to the large value of $5million and to ensure we receive the $100 million
AUD, 4% p.a was decided.

As a result, the future value (F) needed to pay to each investors would be
$ after 90 days have passed with interest of $ . With this, we will
require 50 CD’s valued at $5 million to achieve our goal of $100 million.

Conclusion:

Currently, with low cash levels and liquid securities, we are facing both funding and liquidity
risk. To minimise these risk, we need to collect at least $100 million through Securitisation,
syndicated loans, repos and CD’s. With such recommendations, the company should function
normally.
 Finance Assignment 1 Ricky Chen

Bibliography:

2013 Full Year Results, NAB. Available from

<http://www.nab.com.au/content/dam/nab/about-us/shareholder-centre/financial-
results/documents/full-year-results-2013.pdf> [31st October 2013]

Ben, H & Chris, T, 2011. Financial institutions and markets, 6th edition, Australia.

Indicator Rates-selected term deposit products. Available from

<http://www.nab.com.au/personal/interest-rates-fees-and-charges/indicator-rates-selected-
term-deposit-products> [31st March 2014]

Reciprocal Purchase Agreement Conventions, AFMA. Available from

<http://guides.is.uwa.edu.au/content.php?pid=43218&sid=328596> [March 2013]