Exam Flashcards
what is the channels that help with the role of the financial system?
- banks and other intermediaries which is a financial firm that borrows funds from savers and lends them to borrowers.
- financial markets fascilitate indirect finance and direct finance. Indirect finance is when funds flow from lenders to borrowers through banks. Direct is when funds flow directly from savers to borrowers.
what is the role of financial intermediary
- Asset transformation
– borrowers and savers are offered range of products - maturity transformation
- borrowers and savers are offered products with a range of terms to maturity. - credit risk diversification and transformation
- savers credit risk limited to the intermediary, which has expertise and information - liquidity transformation
- ability to convert financial assets into cash - economies of scale
- financial and operational benefits of organisational size and business volume.
what are the types of markets?
- Primary Vs Secondary Markets
- Wholesale Vs Retail Markets
- Organised Vs Over-the-counter (OTC) Markets
- Other Markets
– The futures market
– The options market
– Foreign exchange markets
– International markets (for example, Eurocurrency and Eurobond markets).
what are money markets?
- Wholesale markets in which short-term securities are issued (primary market transaction) and traded (secondary market transaction)
– Securities highly liquid - Term to maturity of one year or less
- Highly standardised form
- Deep secondary market
– No specific infrastructure or trading place – Enable participants to manage liquidity
what are capital markets?
- Markets in which longer term securities are issued and traded with original term-to-maturity in excess of one year
– Equity market
– Corporate debt market
– Government debt market - Also incorporate use of foreign exchange markets and derivatives markets
- Participants include individuals, business, government and overseas sectors
what is royal commission?
- Major ad-hoc formal public inquiry into a defined issue that is of great importance and controversy.
- Considerable powers, generally greater even than a judge but restricted to the terms of reference of the Commission
- Once started, even the government cannot stop it so the latter will include a date in the TOR by which it must finish
- Usually chaired by retired or serving judges, the Commission is granted immense investigatory powers
what is napier royal commission 1937?
- Set up in 1935 by a conservative government
- To inquire into the monetary and banking systems in operation In Australia
- The key recommendations - the licensing of banks
- direct control of interest rates and the volume of credit;
- The vesting of central banking powers in the Commonwealth
Bank of Australia - Jan 1960 : Commonwealth Bank divided into the new Commonwealth Banking Corporation and the RBA
what is the campbell committee 1981
- Aimed to establish the adequacy of the Australian financial system –Terms of reference
– Tender system for selling treasury bonds;
– Removal of controls on the interest rates banks could pay and charge, on the terms for which they could lend and the direction of their lending;
– Increased flexibility for authorized money-market dealers;
– Freer foreign-exchange market, float of the $A and removal of exchange
controls;
– Deregulation of the stock market and incorporation of broking firms; and
– The entry of foreign banks
what was the wallis inquiry 1997?
- The Wallis Inquiry (1997) was charged with providing a stock take of the results arising from the financial deregulation of the Australian financial system since the early 1980s
- The core theme was prudential supervision
- Technological development and globalization was key driving
force for further change - Recommendations to be made on suitable regulatory arrangements to best ensure an efficient, responsive, competitive and flexible financial system to underpin stronger economic performance, consistent with financial stability, prudence, integrity and fairness.
what are the principes of the re-organisation of the regulatory structure
- There should be a one-to-one relationship between regulatory bodies and causes of financial market failure; &
- Regulation should be imposed in situations where the risk and consequences of market failure are sufficiently large.
- Systemic Instability => Reserve Bank of Australia (RBA)
- Prudential Supervision => Australian Prudential Regulatory Authority (APRA)
- Market Integrity => Australian Securities and Investment Commission (ASIC)
- Anti-Competitive Behavior => Australian Competition and Consumer Commission (ACCC)
why do banks need to be regulated?
- safeguard the stability of financial system
- Banks are key providers of liquidity and ensure a sufficient supply of the means of payment for the economy to operate smoothly and efficiently – payments system.
- The social costs of bank failures and the resulting economic problems are high. Recession following the GFC in 2009.
- The failure of one bank undermines confidence in all other banks. Think back to GFC and collapse of the financial system. Hence, regulation has focussed on reducing this risk which we refer to as systemic risk.
what are the key legislations for bank regulation
– Reserve Bank Act 1959
established the RBA as Australia’s central bank. Sets out powers, objectives and policies of RBA
– Banking Act 1959
* describes authorised depository institutions and outlines their authorisation, prudential regulation and supervision by APRA
what is the role of the RBA
- Implement monetary policy (main responsibility)
- Maintain financial system stability
*Over see the payments system - Production and issue, reissue and cancellation of Australia’s notes
what is monetary policy?
- maintain stable currency
- maintain full employment
- maintain economic prosperity and welfare of the people.
- RBA’s monetary policy’s principal medium-term objective is to control inflation.
- Inflation targeting via setting the interest rates. The reference rate is RBA cash rate.
- By setting the RBA overnight cash rate, the RBA signals its monetary policy stance to the markets.
what are the market operations of the banks?
- the Bank’s Domestic Markets Department (open market operations) has the task of maintaining conditions in the money market so as to keep the cash rate at or near an operating target decided by the Board.
- – On the days when monetary policy is being changed, market operations are aimed at moving the cash rate to the new target level.
– Between changes in policy, the focus of market operations is on keeping the cash rate close to the target by managing the supply of funds available to banks in the money market.
what is the cash rate?
- Cash rate: the interest rate on unsecured overnight loans between banks and represents the primary cost of short-term loan-able funds
- Cash rate is a market-determined, negotiated between borrowers and lenders in the overnight bank market in which banks lend overnight funds to one another.
- deviations in the cash rate around the target are determined by the supply and demand for exchange settlement account (ESA) funds. These funds are held in accounts at the Reserve Bank by banks as well as a number of other institutions, for the purpose of meeting their settlement obligations to each other and to the Bank.
how does the RBA increase/decrease target cash rate?
- To increase target cash rate : decrease the supply of ESA funds by selling Govt securities to banks etc
- To decrease target cash rate : stimulate demand by increasing supply of ESA funds (ie, repurchase Govt securities from banks)
when does RBA have their cash rate meeting?
*The RBA Board determines the target cash rate at its monthly monetary policy meeting, which is the first Tuesday of the month except in January (no meeting).
*Explanations of its monetary policy decisions are announced at 2.30pm on the day of each Board meeting. Any change to the cash rate target will take effect from the following day.
how does the RBA maintain financial system ability?
- Monitor the health of the financial system on an ongoing basis via a range of aggregate financial and economic data to gauge the soundness of the financial system and potential vulnerabilities. (eg high loan growth rate to mortgages)
- Can lend to Financial Institutions in trouble if failure would have serious implications for the rest of the financial system but it is NOT an automatic lender of last resort. This is to minimize the risk of moral hazard.
what is the payments system?
- The “payments system” refers to arrangements which allow consumers, businesses and other organisations to transfer funds to one another.
- The Payments System Board (PSB) of the Reserve Bank oversees the payments system in Australia.
Payments Clearing
*Australian Payments Clearing Association-cheques, direct debit and credit payments, EFTPOS and ATM, high-value payments, & bulk cash.
* Credit cards (MasterCard and VISA)
*BPAY system for payment of bills
* Austraclear System - clearing of private sector, C’wealth Govt Securities etc.
* Clearing House Electronic Sub-register System (CHESS) - ASX - for settlement of equity trades
what is the Australian Securities & Investments Commission (ASIC)
- Responsible for:
Regulating Australian companies, financial
markets, financial services organisations and professionals who deal and advise in investments, superannuation, insurance, deposit taking and credit.
– Consumer credit Regulator – Markets regulator
– Financial services regulator - Examples of ASIC activities:
register companies
and managed investment schemes - register auditors and liquidators
– Investigates
market misconducts Such as insider trading..
When was APRA formed and its objectives?
- APRA was formed in 1998 as the single prudential regulator of the Australian financial services industry
– Oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry. - Objective is to ensure that financial institutions are managed prudently and remain in sound condition, with the result that they can meet their obligations or promises.
- Independent body and funded predominately by levies paid by the institutions that it supervises
what are examples of APRA’s roles and activities
- Licenses institutions that take deposits from the public or write insurance policies;
- Establishes min. capital requirement and operating standards
- Collects information from and investigates FIs
- Take control of institutions in serious financial difficulty.
- Administers the Financial Claims Scheme (FCS) which was established in October 2008 during the GFC
- FCS is Australian govt’s permanent guarantee on deposits of $250,000 per account-holder, per ADI
- Previously, the scheme was only meant to be a temporary measure (due to the GFC) and the cap was $1 million per depositor in any one ADI.
What is the role of AUSTRAC
- Regulatory role:
- Oversees the compliance of Australian businesses, defined as ‘reporting entities’, with their requirements under the (AML/CTF Act) and the Financial Transaction Reports Act 1988 (FTR Act).
- Intelligence role:
- Provides financial information to State, Territory and Australian law enforcement, security, social justice and revenue agencies, as well as certain international counterparts
what are the steps for money laundering?
- placement
– Breaking up large amounts of cash into less conspicuous smaller sums that are then deposited directly into a bank account (“smurfing”)
- somewhere where high traffic will not be noticed or where money can easily be transported to without detection (a convenient unregulated jurisdiction); if possible into anonymous bank accounts - layering
- refers to the creation of complex networks of transactions which attempt to obscure the link between the initial entry point, and the end of the laundering cycle. - integration - refers to the return of funds to the legitimate economy for later extraction
what are the types of financial intermediaries?
- Authorised Deposit-taking Institutions (ADIs)
- Non-ADI Financial Institutions
- Insurers and Funds Managers
what are the characteristics of ADIs?
- banks
- supervised by APRA
- Provide a wide range of financial services to all sectors of the economy, including (through subsidiaries) funds management and insurance services. Foreign banks authorised to operate as branches in Australia are required to confine their deposit-taking activities to wholesale markets. - credit unions and building societies
- supervised by APRA
- Credit Unions and building societies provide deposit, personal/housing loan and payment services to members
what are building societies?
- traditionally mutually owned institutions but increasingly relying on issuing share capital.
- flourished before the 1980s, having a marked competitive advantage against the highly regulated banks
- but now, growth has largely disappeared. Some merged and others converted into banks (ie Bendigo bank), while some collapsed (ie, Pyramid Building Society).
what are credit unions?
- Traditionally cooperatives in which membership is based on a common bond such as membership of a particular profession or a trade union
- Increasingly, these are converting themselves into mutual banks
what are the types of non-ADI financial institutions
- money market corporations (merchant banks)
- asic = supervisor
- Operate primarily in wholesale markets, borrowing from, and lending to, large corporations and government
agencies. Other services, including advisory, relate to
corporate finance, capital markets, foreign exchange and investment management - finance companies
- asic = supervisor
- Provide loans to households and small- to medium-sized businesses. Finance companies raise funds from
wholesale markets and, using debentures and unsecured
notes, from retail investors - securitisers
- Special-purpose vehicles that issue securities backed by pools of assets (e.g. mortgage based housing loans). The securities are usually credit enhanced (e.g. through use of guarantees from third parties).
what are money market corporations?
- MMCs are financial intermediaries that operate primarily in the wholesale credit markets, borrowing and lending to FIs, large corporations and government agencies.
- MMCs raise their funds via the issue or sale of securities, financial products and /or derivative products in terms of the Corporations Act 2001.
- They used to be called merchant banks (British term for an investment bank).
- In 2012, APRA revoked the use of the term “merchant bank” by these MMCs to enable customers to distinguish between authorized Dis carrying out banking business and MMCs (which are not authorized by APRA).
what are finance companies?
- Finance companies borrow mainly on financial markets, for example by issuing debentures and unsecured notes.
o Lend to businesses:
o Commercial lending and covers: ie, financial leasing of
vehicle fleets.
o Lend to persons:
o In the form of installment credit to finance retail sales by
others.
what are securitisers?
Securitisers are special purpose vehicles set up to perform securitization which allows FIs to fund their lending activities indirectly through capital markets rather than through deposits.
what are registered financial corporations?
- Collectively, MMCs and finance companies are referred to as Registered Financial Corporations.
- they are registered with APRA and have reporting requirements to
APRA. - MMCs and finance companies are regulated by ASIC in terms of the Corporations Act 2001.
- ASIC does not actually supervise these companies.
- ASIC is more concerned with the regulation of the markets in which the MMCs and finance companies operate
what are the types of insurers and fund managers?
- life insurance companies
- provide life accident and disability insurance, annuities, investment and superannuation products. Assets are managed in statutory funds on a fiduciary basis and are mostly invested in equities and debt securities - general insurance companies
- Provide insurance for property, motor vehicles, employers’ liability, etc. Assets are invested mainly in deposits and loans, government securities and equities. - superannuation and approved deposit funds- Superannuation funds accept and manage contributions from employers (incl. self-employed) and/or employees to provide retirement income benefits. Funds are controlled by trustees, who often use professional funds managers/advisers
what are commercial banks?
- Commercial banks are the largest and most diversified intermediaries on the basis of range of assets held and liabilities issued.
- Held approximately $6 trillion in financial assets. Accounted for more than 98% of all ADI assets.
*The largest four banks in Australia (also referred to as the ‘Big 4’) accounted for 70% of total banking assets: CBA, WBC, NAB, ANZ
what is the four pillars policy
Australian Government policy to maintain the separation of the four largest banks in Australia by rejecting any merger or acquisition between the four major banks.
what is wholesale banking?
- The provision of services by banks to other financial institutions.
- Also includes banking services offered to corporations and other large institutions, financial or otherwise
- Cash management services (acted as a broker rather than a dealer);
- Foreign exchange;
- Business-to-business payments;
- Trust services
- Custodial services (look after admin and document management) * Commercial lending, and trade finance.
*Traditionally excluded investment banking services such as stock offerings
what is retail banking?
- the provision of banking services to individuals
- focuses strictly on consumer markets (unlike wholesale banking) may extend to small & medium sized businesses
- a wide range of personal banking services including offering savings and checking accounts, bill paying services, as well as debit and credit cards
what are assets on the balance sheet?
*The bank’s assets represent the use of funds it has been able to attract which include:
- cash, liquid assets and due from other financial institutions
* Trading and investment securities
* Loans, advances and other receivables
* Fixed assets and all other assets
what are liabilities on the balance sheet?
- The bank’s liabilities record specific source of funds; non-owner claims on the bank’s assets which include:
- deposits and other borrowings
- On-demand and short-term deposits
- Money market borrowings
- Current accounts
- Savings accounts
- Investment savings accounts
- Certificates of deposit
- Debt issues
- Bills payable
- Provisions and other liabilities
- Loan Capital
what is equity on the balance sheet?
- The difference between the book value of a bank’s assets and liabilities which include:
- Preference shares
- Ordinary shares
- Retained earnings
- Reserves
what are off-balance sheet activities?
Two broad categories
1. Activities that generate revenue and/or expenses without the
creation or holding of an underlying asset or liability, e.g. cash
management
2. Activities that do not create an asset or liability at present, but
may create an asset or liability in the future,
Second category grouped into 4 subcategories
Direct credit substitute(eg, Guarantees)
Trade- and performance-related items (eg, Letters of credit) Commitments (eg, underwriting facilities, sales and repo
*
agreement)
Market-related transactions (eg, interest rate swap,
futures ,options
how is cash management an example of an off-balance sheet item
- FI acted as a broker (taking a fee for arranging for funds to be provided to borrowers without making loans or raising deposits)
- Rather than a dealer (making and holding loans and the funding source).
- Other examples of the trend in FIs to move towards more fee- based business : sales of financial products such as unit trusts, securities brokerage business. These transactions are off- balance sheet activities and do not impact the balance sheet.
how does income statement show financial performance
- Interest income/revenue
- eg, trading and investment securities; commercial loans; consumer and housing loans etc
interest expense - eg, paid to current accounts, saving accounts, investment saving accounts, fixed deposits, etc.
- Other operating income/revenue
- eg, non-interest income/revenue such as income/revenue from fees, services and commissions
- Other operating expenses
- eg, operating costs such as salaries, wages and benefits to employees
what are the return-risk trade offs?
- Results of lower risk may lead to deteriorating performance due to lower yields for more liquid securities
- Improving returns by taking up higher yield investment => higher risk
- Management, owner and regulatory perspectives
what are the performance indicators?
- Return on Asset (ROA): Net profit after tax / Total assets
* A bank’s profits are commonly expressed in terms of its return on
assets.
* Derived from Profit Margin x Asset Utilization yield - Return on Equity (ROE): After tax profit / Equity
* To judge how much a bank’s managers are able to earn on the
shareholder’s investment, we use the return on equity. * Derived from Return on Assets x Leverage Multiplier - Net interest margin
* The difference between the interest a bank receives on its securities and loans and the interest it pays on deposits and debt, divided by the total value of its earning assets. - Profit Margin: Operating profit after tax / Revenue
* Indicates the percentage of sales revenue that ends up as
profit, so it is the average profit on each dollar of sales.
* A useful measure of performance and gives some indication of pricing strategy or competition intensity. - Asset Utilisation yield: Revenue / Total Assets
* Reflects how much sale revenue is associated with a dollar of
assets.
* Useful to use with profit margin concurrently because they tend to move in opposite direction.
– Organizations with high turnover tend to have low margins and those with low turnover tend to have high margins.
– These extremes represent contrary marketing strategies or competitive pressures.
what is leverage?
Leverage is a measure of how much debt an investor assumes in making an investment.
Bank leverage is the ratio of the value of a bank’s assets to the value of its equity.
* A high ratio of assets to equity (high leverage) is a double-edged sword: Leverage can magnify relatively small ROAs into large ROEs, but it can do the same for losses.
what is leverage multiplier>
Leverage Multiplier: Total Assets/Equity
* Measures the proportion of equity funding in the
asset base.
* The higher the ratio, the smaller the shareholders’ funding of assets and the greater the proportion of total assets that must have been funded by debt