FIN111 Lecture Notes - Lecture 3: Commercial Paper, Futures Contract, Asset Management
1. Structure in the banks in Australia
2. Banks sources and uses of funds
3. Off balance sheet activities
4. Discuss the performance of Australian banks in terms of sources of income and expenses
5. Liquidity risk management
6. Capital requirements
7. Credit risk management
8. Interest rate risk management
*No calculations in this chapter
The Australian Banking Industry:
• There are 15 locally owned banks in Australia. However, the big 4 banks account for 80% of
the total assets of this group. The Australian banking industry is characterised by a few large
players and a group of smaller competitors.
Banking regulation:
• The banking system plays a key role in the growth and prosperity of the national economy.
Australia's strict regulatory regime has provided much needed resilience and stability to
Australia's financial system during the GFC.
Consolidation in the banking sector:
• Consolidation has occurred in two way: through mergers and takeovers which has characterised
the Australian banking sector over the last twenty years.
• Banks have used mergers and takeovers to grow quickly, diversify their operations and improve
their geographical spread.
• While banks have undertaken takeovers of foreign entities, the government has required no
further consolidation of the local market (not allowed any further concentration within the
banking sector, with the 4 major banks prohibited from merging or taking one another over).
This is the 'four pillars policy' that aims to maintain competition in the banking sector.
The source of bank funds:
• The principal source of funds for banks is deposit accounts: demand, savings, and term
deposits.
• Funds sources from deposits are similar to funds sources elsewhere except that deposits take
precedence in the event of a bank failure.
• For large banks, borrowed funds are a more important source of funds than deposits. Increased
demand for loans has outpaced the growth of deposits and banks rely on borrowed funds to
finance their operations.
• Deposit accounts:
Serve as the bank medium of exchange in the economy.
May take 3 main forms:
• Transaction accounts: in which the owner is entitled to receive their funds on demand, which
transfers ownership of the funds to others by cheque or EFTPOS.
• Savings accounts: interest bearing accounts of individuals and partnerships.
• Term deposits: are legally due on a maturity date and the funds cannot be transferred to others.
• Borrowed funds:
• Borrowed funds are short term borrowings by commercial banks from the wholesale money
markets.
• These borrowings may include; bankers acceptances, debt issues, loan capital*** know what
these are.
• Bankers acceptances: draft drawn on a bank by aa corporation to raise funds that are guaranteed
by a bank.
• Debt issues: ST and LT instruments that raise funds from public debt issues. E.g. commercial
paper, debentures, unsecured notes including euro notes.
• Loan capital: LT, subordinated notes and debentures, some of which may be convertible into
common stock.
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• They have grown in importance because high levels of loan demand have increasingly provided
banks with the incentive to develop other sources of funds. Thus, borrowed funds fill the
funding gap.
• Capital accounts:
• Bank capital is the ownership funds of the bank.
• Loan and security losses are charged against this account.
• Three principal types of capital accounts for commercial banks: share capital (direct investment
into bank it form of stock), retained profits (banks profit that remains after payments to
shareholders), reserve accounts (accounts set up to cover expected losses on loans and
investments and to account for revaluation of assets).
Bank uses of funds:
• Once raised, the funds are used for issuing loans or purchasing investments.
• Loans are contracts between a borrower and the bank and represent an ongoing relationship
between the bank and the customer.
• Investments are contracts issued by large borrowers and purchase by banks. These are more
impersonal and are usually resold by the bank on the secondary markets.
• In regards to loans, large banks concentrate on commercial and industrial loans while
small banks focus on real estate loans.
• In terms of investments, larger banks have access to many more sources of liquid funds
in comparison to smaller banks and as a result do not need to rely as heavily on
investment securities for liquidity. Thus, securities are much more important for small
banks.
Off-Balance-Sheet banking: common exam question
• Off balance sheet banking refers to the activities that represent either contingent assets or
contingent liabilities.
• There has been a large increase in off-balance-sheet banking over the last twenty years.
• Off balance sheet items earn a fee income for the bank. However, these items are contingent
assets or liabilities.
A contingent asset is a potential economic benefit dependent solely on future events that can't be
controlled by the company. E.g. loan commitments, unrealised gains on derivative securities contract.
Contingent liabilities are those off balance sheet activities that may ultimately become obligations of
the bank. E.g. letters of credit, unrealised losses on derivative securities contracts.
Loan commitments:
• Bank loans usually begin as formal promises by a bank to lend money according to certain
terms. These loan commitments may be of three types: E.g. available credit on a credit card.
Lines of credit, term loans, revolving credit facilities.
Letter of credit:
LOC - bank guarantees payment for goods in a commercial transaction. The buyer of the goods
arranges for the bank to pay the seller of the goods.
• Standby LOC - the bank promised to pay a third party in the event the banks customer fails to
perform according to a contact the customer has with the third party.
• Used as backup lines of credit.
Loan brokerage:
• Banks sold commercial loan participations to other banks when a loan was too large for any
single bank.
Diversify loans
Securitisation:
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Document Summary
The australian banking industry: there are 15 locally owned banks in australia. However, the big 4 banks account for 80% of the total assets of this group. The australian banking industry is characterised by a few large players and a group of smaller competitors. Banking regulation: the banking system plays a key role in the growth and prosperity of the national economy. Australia"s strict regulatory regime has provided much needed resilience and stability to. This is the "four pillars policy" that aims to maintain competition in the banking sector. Increased demand for loans has outpaced the growth of deposits and banks rely on borrowed funds to finance their operations: deposit accounts: Serve as the bank medium of exchange in the economy. Bank uses of funds: once raised, the funds are used for issuing loans or purchasing investments, loans are contracts between a borrower and the bank and represent an ongoing relationship between the bank and the customer.
