{"HashCode":1610746136,"Height":9999999.0,"Width":9999999.0,"Placement":"Header","Index":"Primary","Section":1,"Top":0.0,"Left":0.0}
TOPIC 3: FINANCIAL INSTITUTIONS
Aim
The aim of this topic is to provide an introduction to depository taking and non-depository taking financial institutions. You will be introduced to a wide range of commercial banks and non-bank financial institutions.
Learning objectives
After working through this topic, you should be able to:
1. Understand the current institutional features in the financial system.
2. Evaluate the functions and activities of commercial banks within the financial system.
3. Identify the main sources and uses of funds of commercial banks
4. Understand different types of non-bank financial institutions, including investment banks, life insurance offices and general insurance offices, finance companies and general financiers, as well as building societies and credit unions, and analyse the significant changes that have occurred in these sectors.
________________
Objective 1
Understand the current institutional features in the financial system.
The Australian financial system comprises a range of different types of financial institutions providing financial intermediation or other financial services.
From this table, a number of observations can be made concerning the institutional structure of the Australian financial system. These include:
1. The dominant role of banks with the commercial banks, as a group, comprising more than 50% of the total assets of all financial systems. During the period of regulation banks, the share of financial assets fell, however, following deregulation it did increase.
2. Both building societies and credit unions are very small in terms of percentage share of financial assets. However, there are a large number of individual institutions with approximately 30 building societies and 320 credit unions. The decline in percentage share of financial assets owned by building societies has been particularly due to the conversion of a number of building societies into banks.
3. Life offices and superannuation funds, as a group, have experienced a significant increase in the share of financial assets they control. The percentage share of life offices has declined in recent years while superannuation funds have represented one of the fastest growing sectors of the financial system. This is particularly due to government wages and taxation policy.
4. Other forms of managed funds, particularly public unit trusts, have also grown significantly as retail investors have turned toward equity and other types of managed investments and away from traditional forms of investment such as bank deposits.
The main types of managed funds are cash management trusts, public unit trusts, superannuation funds (pension funds), statutory funds of life offices, common funds and friendly societies. Managed funds may be categorised by their investment risk profile, being capital guaranteed funds, capital stable funds, balanced growth funds, managed or capital growth funds.
5. Mortgage originators and securitisation vehicles have only become recognised as a type of financial institution in recent years. Officially, the Reserve Bank did not collect statistics on them until December 1996. Mortgage originators have experienced considerable recent growth in the 90’s but shrank following the Global Financial Crisis. Mortgage originators make housing loans and then sell these loans to securitisation vehicles set up as separate entities by financial institutions. Funds are raised through the issue of mortgage-backed securities by the securitisation vehicles.
Main Types of Financial Institutions as at December 2021 (Latest Data)
Type of institution
Main supervisor/ regulator
Number of institutions
Total assets ($b)
Percentage share
Banks
APRA
96
5531.3
46.53%
Building societies and credit unions
APRA
36
50.6
0.43%
Non-ADI Financial Institutions
Money market corporations (broker-dealers)
ASIC
5[4]
29.3
0.25%
Finance companies
ASIC
102[4]
295.5
2.49%
Securitisers
–
160.6
1.35%
Insurers and Funds Managers
Life insurance companies
APRA
27
93.4
0.79%
General insurance companies
APRA
93
250.3
2.11%
Health insurance companies
APRA
34
17.9
0.15%
Superannuation and approved deposit funds
APRA
1,651
3011
25.33%
Public unit trusts
ASIC
–
449.3
3.78%
Cash management trusts
ASIC
–
33.2
0.28%
Common funds
State and territory authorities
–
10.3
0.09%
Friendly societies
APRA
11
7.5
0.06%
Source: http://www.rba.gov.au/fin-stability/fin-inst/main-types-of-financial-institutions.html#fn3
Objective 2
Evaluate the functions and activities of commercial banks within the financial system.
Commercial banks are the largest group of financial institutions within a financial system and therefore they are very important in facilitating the flow of funds between savers and borrowers. The core business of banks is often described as the gathering of savings (deposits) in order to provide loans for investment. The traditional image of banks as passive receivers of deposits through which they fund their various loans and other investments has changed since deregulation. For example, banks provide a wide range of off-balance-sheet transactions such underwriting where for instance the bank will commit to purchase unsold share after the stocks were issued to the market. The bank can also act as guarantor on some financial products such as money market bills (“bank bills”). A wide range of non-bank financial institutions has evolved within the financial system in response to changing market regulation and to meet particular needs of market participants.
Objective 3
Identify the main sources and uses of funds of commercial banks
Main sources of funds of commercial banks
Banks now actively manage their sources of funds (liabilities). They offer a diversity of products with different return, risk, liquidity and cash-flow attributes to attract new and diversified funding sources. Sources of funds include current deposits, call or demand deposits, term deposits, negotiable certificates of deposit, bill acceptance liabilities, debt liabilities, foreign currency liabilities, loan capital and shareholder equity.
Main uses of funds of commercial banks
Commercial banks now apply a liability management approach to funding growth in their balance sheets. Under this approach, a bank will (1) encourage depositors to lodge savings with the bank, and (2) borrow in the domestic and international money markets and capital markets to obtain sufficient funds to meet forecast loan demand. The use of funds is represented as assets on a bank’s balance sheet. Bank lending is categorised as personal and housing lending, commercial lending and lending to government. Personal finance is provided to individuals and includes housing loans, investment property loans, fixed-term loans, personal overdrafts and credit card finance. Banks invest in the business sector by granting commercial loans. Commercial loan assets include overdraft facilities, commercial bills held, term loans and lease finance. While banks may lend some funds directly to government, their main claim is through the purchase of government securities such as Treasury notes and Treasury bonds.
Objective 3
After working through this section, you should understand different types of non-bank financial institutions, including investment banks, life insurance offices and general insurance offices, finance companies and general financiers, as well as building societies and credit unions, and analyse the significant changes that have occurred in these sectors.
1.3.1 Investment Banks
A wide range of non-bank financial institutions has evolved within the financial system in response to changing market regulation and to meet particular needs of market participants. Investment banks play an extremely important role in the provision of innovative products and advisory services to corporations, high-net-worth individuals and government. The structure of investment banks is characterised by a division of activities between front office (trading, investment banking, investment management, research), middle office (risk measurement, risk management) and back office (accounting, audit, compliance).
Investment banks raise funds in the capital markets, but are less inclined to provide intermediated finance for their clients; rather, they advise their clients and assist them in obtaining funds directly from the domestic and international money markets and capital markets.
Investment banks specialise in the provision of off-balance-sheet products and advisory services, including operating as foreign exchange dealers, advising clients on how to raise funds in the capital markets, acting as underwriters and assisting clients with the placement of new equity and debt issues, advising clients on balance-sheet restructuring, evaluating and advising on corporate mergers and acquisitions, identifying and advising on potential spin-offs, advising clients on project finance and structured finance, providing risk management services and advising clients on venture capital.
An investment bank may advise a corporation on all aspects of a merger and acquisition proposal. This is a situation in which one company seeks to take over another company. The merger may be friendly or hostile, and strategically may be a horizontal takeover, a vertical takeover or a conglomerate takeover. The merger will seek to achieve synergy benefits, such as economies of scale, finance advantages, competitive growth opportunities and business diversification.
1.3.2 life insurance offices and general insurance offices
Life insurance offices are contractual savings institutions. They generate funds primarily from the receipt of premiums paid for insurance policies written. Life insurance offices are also major providers of superannuation savings products. Whole-of-life insurance policies include an insurance risk component and an investment component. The policy will accumulate a surrender value over time. A term-life policy provides life insurance cover for a specified period. If the policyholder dies during that period, a predetermined amount is paid to the named beneficiary. Related insurance policies include total and permanent disablement insurance, trauma insurance, income protection insurance and business overheads insurance. The regulator of life insurance offices is APRA.
General insurance offices also generate funds from premiums paid on insurance policies. General insurance policies include house and contents insurance. Policyholders need to be aware of the co-insurance clause and the amount of public liability cover. Motor vehicle insurance includes comprehensive, third-party fire and theft, third party only and compulsory third-party insurance.
1.3.3 Finance companies and general financiers
Finance companies provide loans to individuals and businesses, including lease finance, floor plan financing and factoring. Deregulation of commercial banks has resulted in a significant decline in finance companies. Many finance companies are now operated by manufacturers, such as car companies, to finance sales of their product.
1.3.4 building societies and credit unions
The majority of building society funds are deposits from customers. Residential housing is the main form of lending. Credit unions’ funds are sourced primarily from deposits of members. Housing loans, personal loans and credit card finance are available to their members. A defining characteristic of a credit union is the common bond of association of its members, usually based on employment, industry or community.