Depository Institutions Overview In this chapter, we explore two major depository institution (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 Regulation Authority (APRA) authorises financial institutions to carry out financial intermediation.
1-2 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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. 1-3 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Size of Banks in 2005 In 2005, the Commonwealth Bank of Australia was the largest bank in terms of total assets ($258.93 billion). Ranks 2, 3 and 4 were taken by the National Australia 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. 1-4 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Banks
Banks are the largest depository institutions in terms of size. Major difference between banks and credit unions/savings institutions: banks have more varied assets and liabilities. Differences in operating characteristics and profitability across size classes for instance, with regards to the size of the commercial loan portfolio. 1-5 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Banks: Recent Trends In 2005 Australia had 49 banks, 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. In 2005, the Big 4 banks plus St George Bank held 73.9% of the assets of all Australian banks, which points towards a highly concentrated industry (see Table 1.3 in text). 1-6 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 1-7 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 1-8 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 residential housing loans due to their origins as building societies. 1-9 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Profitability of Four Largest Banks Full-service provision by major banks has led to enhanced margins. Enhanced margins led to: Higher performance, as reflected in their return on shareholders funds. Greater cost efficiencies. However, in the late 1980s banks implemented poor credit strategies, leading to poor performance in the early 1990s. 1- 10 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Profitability of Four Largest Banks 1-11 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Balance Sheet and Recent Trends: Banks 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. Growth of foreign currency assets and liabilities: Relaxation of regulations with respect to banks holdings of foreign currency deposits. Banks enabled to access funding in Eurodollar markets. 1-12 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Balance Sheet and Recent Trends: Banks Large drop of liabilities raised through Australian dollar deposits due to retail savings growth in superannuation accounts. Increased importance of off-balance sheet (OBS) activities: OBS activities = items that move onto the balance sheet when 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. 1-13 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Off-Balance-Sheet Activities: Banks 1-14 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Building Societies: Size, Structure and Composition
Building societies are DIs that usually operate on a cooperative basis. Depositors are members of the society. Licensed under Banking Act to undertake the business of banking. Subject to Corporations Law for corporate governance. In 2004 there were 14 building societies, compared to 31 in 1992. 1-15 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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. 1-16 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 supply of funds for housing loans at reasonable prices. Growth in credit unions ensured availability of relatively low-cost unsecured and secured personal loans. Both industries could offer high-rate deposits, while banks were subject to interest rate ceilings. 1-17 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher The 1980s Market share of building societies and credit unions was threatened due to deregulation of banking sector in 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.
1-18 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Building Societies and Credit Unions: Performance 1-19 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Regulation Australias current financial regulatory framework has its origins in the late 1990s Financial System Enquiry (Wallis Committee). Full implementation of recommendations by 1999. The Wallis Committee recommended the introduction of three agencies, each with specific functional responsibilities. 1-20 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Regulation: APRA APRA = Australian Prudential Regulation Authority. Responsible for the prudential regulation and supervision of the financial services industry. Specific responsibilities include development of prudential policies that balance: Financial Safety, Competition, Contestability, and Competitive neutrality. 1-21 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Regulation: APRA (cont) APRA regulates Australian DIs under one licensing regime. Institutions regulated by APRA are called authorised deposit-taking institutions (ADIs). ADIs are covered by the Banking Act 1959. APRA considers its approach to regulatory supervision as: Forward-looking, Risk-based, Consultative, Consistent, and In line with international best practice. 1-22 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Regulation: ASIC ASIC = Australian Securities and Investments Commission. Responsible for market integrity and consumer protection across the financial system. Sets standards for financial market behaviour with the aim to protect investor and consumer confidence. Administers the Corporations Law to promote honesty and fairness in companies and markets. 1-23 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Regulation: RBA RBA = Reserve Bank of Australia. Responsible for the development and implementation of monetary policy and for overall financial system stability. The aim of monetary policy is to achieve low and stable inflation over the medium term. Lender of last resort function. 1-24 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Regulatory Framework 1-25 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 Prudential Reporting. 1-26 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 1-27 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Financial Services Reform Act 2001 (CLERP6) CLERP = Corporate Law Economic Reform Program Issued by government in response to recommendations made by Wallis Committee. Outcome of CLERP6 consultation process: Financial Services Reform (FSR) Act. Aim of reforms: Flexible and simple licensing of group structures, and Flexible and simple delivery of financial services. 1-28 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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. 1-29 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 1-30 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Web Resources For more information on individual regional banks in Australia, visit, for example:
Adelaide Bank: www.adelaidebank.com.au
Bank of Queensland: www.bankofqueensland.com.au
Bendigo Bank: www.bendigobank.com.au 1-31 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 1-32 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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 1-33 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Financial Statement Analysis using a ROE Framework ROE = return on equity ROE = ROA EM, where ROA = return on assets and EM = equity multiplier ROA = PM AU, where PM = profit margin and AU = asset utilisation The decomposition of ROE into its different components allows us to identify a firms strengths and weaknesses. 1-34 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher Financial Statement Analysis using a ROE Framework 1-35 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher ROE: Example A bank has $100m in total assets. Twenty per cent of these assets are funded through debt, while the remaining eighty percent are funded through equity capital. Assume the banks net income is $5m, while total operating income is $30m. a. Calculate the banks ROE. b. Decompose the ROE into its different components. 1-36 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher 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. 1-37 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher ROE: Example (continued) Solutions: b. Decompose the ROE into its different components. We know that ROA EM = ROE and that PM AU = ROA. Thus: ROE = PM AU EM ROE = (net income / total operating income) (total operating income / total assets) (total assets / total equity capital) 1-38 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher ROE: Example (continued) Solutions: ROE = ($5,000,000 / $30,000,000) ($30,000,000 / $100,000,000) ($100,000,000 / $20,000,000) ROE = 16.67% 30% 5.0 ROE = 5.00% 5 = 25%
Note: Ideally performance should be compared over time (time-series analysis) and in comparison to similar institutions (cross-sectional analysis).
1-39 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions Management 2e, by Lange, Saunders, Anderson ,Thomson and Cornett Slides prepared by Maike Sundmacher