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Topic 7 Flashcards

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1
Q

The 2 roles of financial institutions

A

To provide inter-mediation and the system of payments in the domestic and global economy

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2
Q

As financial institutions carry out their 2 roles, they allow for the safe and efficient …. (4 examples)

A
  1. Storage and management of money for individuals and individuals allowing consumption and trade.
  2. Cheque and bank draft deposit and clearing.
  3. Payments of large sums of money without the need for physical cash.
  4. Electronic transfers &payments (EFTPOS).
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3
Q

3 types of financial institutions

A
  1. ADIs - Authorised Deposit-taking Institutions.
  2. Non-ADI financial institutions.
  3. Insurers and fund managers.
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4
Q

3 examples of ADIs

A

Commercial banks, building societies, credit unions.

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5
Q

Who is the main regulator of ADIs?

A

APRA.

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6
Q

3 examples of non-ADI financial institutions

A

Investment/merchant banks, finance companies (GE capital), securitisers.

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7
Q

Who is the main regulator of non-ADI institutions?

A

ASIC

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8
Q

What do securitisers do?

A

They pool various types of assets and package them as asset-backed securities which are then sold to investors.

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9
Q

4 examples of insurers and fund managers

A

General and life insurance companies, superannuation funds, friendly societies, public unit and cash management trusts.

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10
Q

Main regulator of insurers and fund managers?

A

APRA, except for public unit & cash management trusts it’s ASIC.

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11
Q

Why are banks the most important ADI and financial institution?

A

Because they manage the most amount of money in Australia.

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12
Q

What are the two different types of banks?

A
  1. Commercial banks (retail banking).

2. Investment/merchant banks (wholesale banking).

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13
Q

How do banks make money?

A

They accept deposits from customers (liabilities) who they pay a return (interest). They then lend out this capital (assets) to borrowers at a higher rate.

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14
Q

Who do commercial banks service?

A

Individuals, households and SMEs.

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15
Q

What do investment banks do?

A

They take on higher risk activities, providing capital raising and risk management services and instruments for large businesses, public corporations and financial institutions (wholesale market).

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16
Q

Examples of things investment banks do? (4)

A
  1. IPOs.
  2. M and A (mergers and acquisitions).
  3. Large debt issuances.
  4. Capital underwriting services (helping to raise capital - e.g. Finding customers through advertisements).
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17
Q

Four pillars policy

A

Along standing policy since 1990 of the Australian Government which does not allow mergers or acquisitions among the 4 major commercial banks.

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18
Q

2 reasons for the 4 pillars policy?

A
  1. Ensure sufficient competition within the banking industry for the benefit of the general public.
  2. Prevent an undue concentration of banking risk.
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19
Q

Why do the 4 major banks disagree with the 4 pillars policy?

A

They say disallowing mergers and acquisitions impedes their ability to reach a size that enables them to compete internationally.

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20
Q

Australian deposits of $250,000 are what?

A

Are protected under the financial claims scheme operated by APRA, which provides explicit Deposit Insurance.

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21
Q

2 types of commercial bank liabilities (source of funds)

A
  1. Retail liabilities.

2. Wholesale liabilities.

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22
Q

Retail liabilities (3)

A

Savings accounts, transaction accounts, term deposits.

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23
Q

Wholesale liabilities (3)

A

Bank accepted bills, certificates of deposit, debt issuances.

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24
Q

2 types of commercial bank assets (uses of funds)

A
  1. Retail assets.

2. Wholesale assets.

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25
Retail assets (5)
Home loans, personal loans, car loans, credit cards, insurance.
26
Wholesale assets (4)
Overdrafts, leases, trade finance, term loans.
27
2 important functions of banks
1. Liquidity transformation. | 2. Asset and credit risk transformation.
28
Liquidity transformation (3)
Turning short term liabilities into long term assets. - is a primary source of liquidity risk for banks. - by managing and bearing this risk banks create liquidity for surplus and deficit units (lenders and borrowers).
29
Asset and credit risk transformation
Collecting and pooling small value, low risk deposits and turning them into larger value, higher risk loans. - a primary source of credit risk for banks. - in doing this, banks enable the transfer of capital from surplus to deficit units in the economy.
30
How do banks make money
By charging fees for their services and earning an interest spread (difference in interest paid between assets and liabilities).
31
What is the Interest Rate margin? (IRM)? (2)
The difference between interest earned from loans and interest paid on sources of funds. A measure of commercial bank profitability.
32
What 5 factors can affect the size of the IRM?
1. CAR and reserve requirements. 2. Product marginal costs. 3. Demand elasticity. 4. Fixed fees and commissions. 5. Returns on investment products.
33
As a banking market becomes more competitive, we would expect interest margins to become?
Narrower - would need to decrease deposit rate and reduce lending rates, meaning the banks earn less.
34
What is bank risk?
Uncertainty arising from cash flows of the bank assets and liabilities.
35
What are the 3 primary risks banks face?
1. Credit risk. 2. Interest rate risk. 3. Liquidity risk.
36
Credit risk (2)
Arises from the possibility of default in the bank loan book; causing a loss of a portion of all of loan principal and interest earnings. - measured by standard deviation of default rate.
37
Interest risk
Risk arises from unforeseen changes in the interest rate margin due to volatility in asset earnings and cost of funds. - measured by standard deviation of IRM.
38
Liquidity risk
Th possibility of not being able to meet required payments to depositors and creditors. - measured using the liquidity gap; difference between cash inflows and outflows.
39
Operational risk
The prospect of loss resulting from inadequate or failed procedures, systems or policies. - measured through VAR (value at risk).
40
Market risk
The possibility of an investor experiencing losses due to factors affecting the overall performance of the financial markets in which he or she is involved. - measured through VAR.
41
Why does banking experience the most extensive regulation?
Because it has the most wide spread repercussions upon the economy if it fails.
42
What does ADI regulation affect? (2)
The management and profitability of banks.
43
2 important areas of bank regulation that aim to minimise bank failure
1. Liquidity. | 2. Capital.
44
What are two objectives of such regulation?
1. Meet deposit withdrawals and daily requirements and maintain public and private sector confidence in the banks ability to do so. 2. Buffer against bank losses that arise from risk-taking.
45
Who mandates most capital and liquidity requirements?
APRA.
46
What does the Basel Committee of bank Supervision (BCBS) do? (2)
Sets out the Basel accords; a set of international banking Renault iron that aim to minimise credit risk. - Basel 3 is the latest set of regulations.
47
Liquidity
Refers to the availability of sufficient funds to meet day-to-day requirements.
48
What does liquidity management aim to ensure?
That banks have sufficient funds to meet their obligations.
49
Must must large banks have in terms of liquidity? (2)
A liquidity management strategy. | - their choice of strategy is flexible, however APRA maintains tight reporting controls.
50
What must smaller banks do in terms of liquidity?
They must maintain a minimum liquidity requirement of 9% of their total liabilities as liquid assets.
51
What 2 things does the management of bank liquidity involve?
1. Asset management. | 2. Liability management.
52
Asset management
Maintaining sufficient cash and non-cash assets that can be quickly converted to cash.
53
Liability management
Acquiring liquidity quickly and easily through debt, while ensuring diversification in creditor obligations.
54
What 4 roles does bank capital perform?
1. It provides a financial cushion or buffer against asset losses. 2. It helps maintain investor and public confidence. 3. It provides some protection to depositors. 4. It serves as a source of funds for asset expansion.
55
Who is APRA the primary regulator for? And what regulation do they provide?
ADIs. | Applies domestic and international capital adequacy regulation.
56
What must CAR be set at?
8%
57
Prudential statements define what constitutes capital?
1. Tier 1 capital. | 2. Tier 2 capital.
58
Tier 1 capital (2)
- consisting of paid up ordinary shares, reserves, retained earnings. - tier 1 capital must account for at least 6% of total risk-adjusted assets.
59
Tier 2 capital (2)
- reserve of securities, provision for doubtful debts. | - cannot be greater than 100% of tier 1 capital.
60
Different assets have different ____ ?
Risk weights for calculating how much capital must be held against them.
61
When there are tighter regulations what must banks do in terms of reserves?
They must hold more reserves to strengthen liquidity and capital adequacy relative to risk taking.
62
When there are relaxed regulations what must banks do in terms of reserves?
This means banks need less reserves that weaken their liquidity and capital adequacy relative to risk taking.
63
3 types of non-bank financial institutions (NBFIs)
1. Credit unions. 2. Building societies. 3. Finance companies.
64
Which of the 3 NBFIs are ADIs?
Credit unions and building societies.
65
Finance companies
Arms of large conglomerates and multinationals which provide short-term consumer credit such as store credit, personal, car loans and home loans. E.g. GE money.
66
Who do finance companies compete with?
The 4-pillar banks
67
What is a key difference between banks and NFBIs (except finance companies)?
Most NFBIs operate under a mutual or customer-owned structure.
68
4 characteristics of a mutual or customer-owned structure
1. There are no shareholders, just members, regulated by APRA. 2. Any profits/surplus belongs to members but are kept as retained earnings and are not paid out as dividends. 3. The surplus represents the major source of capital for NBFIs. 4. The objective is not for profit lending to provide personal and community based financial services.
69
What market do NFBIs operate in?
In the retail deposit taking and loan market as viable alternatives to commercial banks.

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