Overview of Financial Institutions and Their Functions

Hi everyone, welcome to our lecture today on the third topic. Today we will look at financial institutions. In particular, we will look at how different banks operate, we will look at how insurance companies operate, we will look at how investment banks, which are the modern banks, how they operate. As an overview, we will first look at different types of financial institutions. For example, we have ADIs, which are authorized deposit taking institutions. These institutions are allowed to take deposits from people and then lend out money. We will also look at non-ADIs. These are institutions that normally do not take deposits and they do not participate in lending. Instead, they provide different types of financial advice. They help out different corporations and even individuals with financial consultation or advice. Then we look at the main features of depository institutions, which are the traditional banks that take in deposits and they provide lending. We here look at how the banking industry evolved over time. We look at how regulations impacted the banking industry and its growth and how removing these regulations helped the banking industry grow at a higher rate. Then we discuss in detail the source of funds, which is basically how financial institutions find the money to lend. In other words, where do they source their funds from? And we also look at where do financial institutions invest these funds, which are basically the uses of funds. And finally, we look at different non-banking financial institutions, for example, insurance companies. And we look at how they operate, what are the different products they offer and how they invest the money that they collect. from the policy holders in different financial markets. First, we have deposit-taking financial institutions. They attract savings of depositors, so they collect money from general investors, and they make loans. Generally, we have commercial banks, which are the main financial institutions that are authorized deposit-taking institutions. We also have building societies. Building societies are again financial companies that provide loans for residential property. And we also have credit cooperatives. Credit cooperatives are employee-based credit corporations where different employees would contribute money into a common fund and that fund will be used to lend out money to the same members who require the money. For example, we have police credit union. where the police personnel would contribute money into a common fund and that fund will be used to lend out to other policemen who require the money. Then we also discussed non-deposit taking financial institutions. Now, These include investment banks which generally provide advice on mergers and acquisitions or initial public offering of shares of different companies. Then we have general insurance companies that provide general insurance such as car insurance, home content insurance etc. So policyholders will buy the insurance and they will pay premium to these insurance companies on a regular basis. The premium collected by the insurance companies will then be invested in different financial markets and we have a lot of discussion on that later on. And we also have superannuation funds where savings are accumulated by individuals to fund their retirement. What superannuation funds will normally do is they will collect money from employees or from individuals on a regular basis and they will then invest this money into the financial markets. once the employee or the individual retires that money will be forwarded to the individual to fund the retirement time of the individual or the employee. In authorized deposit taking institutions we have commercial banks, building societies and credit unions. Now they are authorized by the government. We also have non-ADIs. These non-ADIs are investment banks or merchant banks which mainly provide financial advice or financial consultation to companies or individuals. We also have general finance companies. We also have insurers and other managed funds where they provide different types of financial services such as investing into financial markets for general investors. This slide shows the different types of financial institutions that are operating in Australia. This data is fairly recent and this is as at March 2024. So as we can see here, banks comprise of 54.19%. This indicates that banks are the main financial institutions which own most of the assets in Australia. This is basically indicating financial assets. So for banks, you may be wondering what sort of financial assets they have. Well, the main financial assets that they have is loans. They give corporate loans or they give out home loans. And these are mainly the assets of banks. Then the second highest percentage is for superannuation funds. Superannuation funds are basically those institutions which collect money from employees. So employees receive salary and a part of their salary is set aside so that they can use this fund which they will accumulate over time when employees retire. So until employees retire that superannuation money is accumulated in their account and if you add up all the superannuation contributions of employees you would see that there is a very large sum of money which these superannuation funds would further invest in different sorts of financial markets for example in the stock market and so on. Therefore these superannuation funds usually have a lot of money and as of March 2024 they have about $3695.5 billion dollars and that is almost equivalent to 32 percent of these different types of financial institutions and then there are other financial institutions as you can see here which also have some money invested in financial assets main types of financial institutions would include banks now banks provide different types of services the core business of banks is to collect deposits and provide loans this is the main business of a bank or a commercial bank. In addition to that, they provide other services, for example, off balance sheet transactions, for example, underwriting and selling derivative products or even executing foreign exchange transactions, meaning we can buy or sell foreign currencies in a bank. Underwriting is buying unsold shares in initial public offering. For example, if a company wants to issue new shares and let's say they have issued 100,000 shares and out of that only 80,000 is sold, they have got 20,000 unsold shares. So a bank can provide some guarantee to this issuing company that whatever their unsold shares are, in this case 20,000, these will be purchased by the bank. The benefit of this is the company has the peace of mind that they will be able to raise their target capital. An example of a derivative product would be a forward contract. For example, a company needs to pay a U.S. company $20,000 in three months. So this company can approach a bank and buy this $20,000 in advance and at a favorable rate today. But the delivery will occur in three months time. Therefore, this is risk management or reducing financial risk for this company. which has to meet a liability of 20,000 US dollars in three months time. So this is another service that a commercial bank can provide to different corporations or businesses. Now we move our focus to how banking industry evolved over time. Now, when there was more regulations, the banking industry did not grow as fast as it should have. and this was before the 1980s when the banking industry was restricted from increasing their size at a quick rate. In the post 1980 period the banking industry was able to grow at a faster rate and we will discuss how this occurred. Now if we discuss the time period before the 1980s the banks mainly focused on asset management which basically means that the loan portfolio was tailored to match the available deposit. As an example, if a bank received a deposit of $100, the bank was able to make a loan of let's say $100 at the most. So If a bank only collected a deposit of 100, the loan was 100 at the most. In other words, whatever deposit the bank received, only that money could be used to make a loan. So the amount of loan a bank made was dependent on the amount of deposit available for the bank. In the post-1980 time period, the bank focused on more on liability management. In other words, the banks can set a target that they want to make a loan of $1,000. And to ensure that they're able to meet their target of making a loan of $1,000, the banks would try to find deposits. If they are able to find deposits, great. And if they're unable to find deposits, they will borrow the money directly from domestic and international capital markets mainly they will collect money from general investors both locally and internationally and they will ensure that they are able to collect one thousand dollars to make a loan of one thousand dollars therefore what we see today is banks grow at a very high rate and that is because banks after the regulations were removed in the 1980s are able to access the domestic and international capital markets to expand their loan size. Furthermore, after the regulations were removed, banks are able to provide many different types of financial services, for example, financial advice or financial consultation for different businesses and individuals. In addition to that, the banks are also able to participate in off-balance sheet activities, for example, selling derivative products. Taken together, these days, banks mainly focus on liability management. Therefore, they collect funds from different financial markets to ensure that their assets grow at a fast pace. And overall, they're able to provide additional services, which in sum increases their total revenue and helps banks grow. For a bank, the sources of funds appear in the balance sheet as either debt or equity. Now, a bank would normally fund all the loans using debt, which is deposits, and a part of the loans will also be funded by the owners of the bank, which are the shareholders, and that is called equity contribution. If we look at deposits, In most cases banks have different mix of deposits with different returns meaning different interest on those deposit accounts that banks have to pay. There are different maturities of deposits and different cash flow structure. In sum the banks always want to pay the deposit. a stable source of deposits which is they don't want high variance or they don't want deposits to go up and down on a regular basis they want stable source of deposits and they want constant deposit inflow to manage their liabilities if you look at different types of bank accounts first we have got current account current account is considered a business account And therefore the current account is considered highly liquid. The current account is used by businesses to pay different suppliers as an example. Let's say we have a construction company. And the construction company will pay the electrician. So the construction company will use its business account or current account to pay the electrician. If you look at the cash position of this current account let's say yesterday the account had $10,000 and after paying the electrician today the account currently has $500. Tomorrow Let's say the customers will pay the construction company and the account balance will go up to 20,000. So if you look at this timeline, the balance was 10,000 yesterday. today the balance is 500 so a big reduction in the balance and tomorrow the balance is likely to be twenty thousand so there is very large variance in this current account balance and therefore this is not a very stable source of fund for the bank Therefore, the bank does not benefit much from using this fund in the current account because they cannot lend out this money for a very long period of time because they always have to ensure that the account has enough liquidity to meet the demands of the business. Therefore, the bank does not provide much interest on these current accounts or business accounts. Similarly, if we consider demand deposits, which are savings accounts, mainly that individuals hold, the account balance can be withdrawn on demand and the money can be withdrawn directly from the bank or through ATMs or even FPOS machines, which are electronic fund transfer systems. even with demand deposits or saving accounts the interest rate is unlikely to be very high and the main reason for that is the account balances main vary by large quantities over time Having said that, the demand deposits or savings accounts are still more stable source of funding than current accounts. And this is mainly because the withdrawal patterns are more predictable for savings accounts, whereas the withdrawal pattern for current accounts are not quite predictable. If we consider term deposits, these are very stable source of funds for banks because they have a predetermined period for depositing the money. In other words, depositors would invest the money. for a fixed period of time and they would choose that period of time themselves for example the deposits can come in for three months or six months etc given that the deposit is held in the bank account for a specified period of time which is usually at least three months banks consider this more stable source of funding and therefore using this stable source of fund banks are able to lend money for a long period of time And banks do not need to arrange enough liquidity for these deposit accounts because these deposit accounts are unlikely to be withdrawn by the depositors before maturity. Therefore, banks often pay high interest rates on these term deposit accounts and as opposed to this, banks pay very low interest on business accounts whose balances can vary by large quantities and even savings accounts whose balances can also have very high variance. Furthermore, we have negotiable certificates of deposits, which are based on the balance sheet. Basically discount securities issued by banks to raise funding. Again, discount securities are liabilities for a bank. These are source of funds. These are liabilities just like deposit accounts because these money in the deposit accounts have been deposited by depositors or investors or savers. Banks will eventually have to pay off these liabilities. Therefore, these are considered debt. What are discount securities? Discount securities are securities that are sold at a value which is less than the face value of the security. What this means is, let's say today the bank is going to collect $90. The face value of the discount security is 100, which means one year later the bank will repay $100. Usually, discount securities or the CDs are short-term instruments. In particular, if we consider the negotiable certificates of deposits, they have a term of 30 days to 180 days. Next, we focus on bill acceptance liabilities and the first is bills of exchange. In bills of exchange, we usually have an issuer. which in most cases is a corporation which will issue this bill of exchange to the investors and we will call this bills in short so the issuer will issue bills to the investors These bills are financial instruments or financial contracts and the contractual terms are the issuer will receive money from the investor and the issuer will issue bills to the investor. And these are again discount securities which are short term instruments. What happens with bills of exchange is that the bank becomes an acceptor. In other words, the bank will accept the responsibility to repay the investors when the bills are due to be repaid. So over here the investors forward the money to the issuer or the corporation that requires the money but when the time comes to repay the investors the banks will do this on behalf of the corporations. So the investors have additional peace of mind that these bills will always be repaid because the bank is providing the guarantee that the bills will be repaid. Once the banks repay the bills, the banks themselves will collect the money from the corporation. separately so this is going to be a separate agreement between the bank and the issuer that once the money has been repaid to the investors the banks will collect their money from the corporation directly so this is the role where the bank becomes an acceptor and this improves the credit quality of the bills Alternatively, the bank can have the role of a Discounter. When the bank is the Discounter, the bank will purchase the bills directly from the corporation. So the corporations will directly issue the bills to the banks and the banks will forward the money directly to the corporation. After the money has been forwarded, the bank will use these bills and then they will resell the bills or Rediscount the bills and sell these to the general investors and when it is time to repay the bills the banks will pay the investors directly and The corporation will also pay the bank when it is due for them to pay the bank If you look at this discounted role of the bank At the end of the day, the bank does not use its own money to purchase the bills because after purchasing, the bank will sell these bills and collect all the money of their investment. Therefore, when a bank is a discounter, the bank does not use its own funds to complete the purchase or the exchange. Next there are debentures or bonds that are supported by a form of security. So when a bank needs funding, the bank can issue debentures and these debentures will be purchased by investors and these debentures will have a collateral. which is usually the mortgage loans that the bank has. The money will go from the investors to the bank initially and when it is time to repay the investors, if the bank defaults, the investors are still covered. what happens is the bank will sell these mortgages maybe to another bank and the bank will collect the money and the bank will pay off their liabilities that are due to the investors in short debentures have a form of security because in case of default the bank bank can use the collateral that they have pledged in order to collect the money and they will sell the collateral to other banks and arrange the money to pay off the investors who initially bought the debentures issued by the bank. Then there are unsecured notes as well. These are bonds with no security attached. Therefore these bonds for investors would be more risky. Therefore the investors would demand high rates of interest to buy these unsecured notes. Then the bank can have foreign currency liabilities. Let's say a bank. wants to make a loan of USD 50,000. In order to make this loan, the bank will collect USD 50,000 as deposits. the benefit of this is when these deposits are due the bank will collect the money in us dollars because the borrowers will repay the bank and then the bank can easily transfer this 50 000 usd to the deposit holders who the bank owes 50,000 USD to. The advantage here is there is no need to exchange the local currency into foreign currency or foreign currency into local currency and therefore the bank will not be exposed to any fluctuations in the foreign exchange rates. Furthermore, if banks are able to expand their business internationally, for example, if this is an Australian bank and if they are able to make a loan in the US markets, then their loan portfolio is more diverse, therefore their risk reduction would be greater. The banks can also use loan capital and shareholders equity. In most cases the shareholders equity will come from ordinary shareholders who are the ultimate owners of any organization. In most cases the bank would use eight percent. In fact as a minimum the banks need to use eight percent capital from the shareholders. others and the rest which is 92% of their total funding can come from debt. Here we have this idea of subordinated notes. Now subordinated notes are those that rank below all the other creditors in terms of repayment when the bank defaults. So if an investor purchases a subordinated note What will happen is once the bank defaults and if it defaults all other creditors will be repaid including employees and government. After that if there is any money left the subordinated note holders would receive their dues and after that whatever residual is there will go to the ultimate owners of the company or the bank in this case. which are the shareholders. In terms of uses of funds there is personal and housing finance. This is basically an asset for the bank because the bank will give out a loan for personal use or even buying a house. First we have investment property. So the borrowers would take out a loan to buy an investment property for rent. The borrowers may wait for the capital to increase which is an increase in the value of the property itself and then the borrower can sell the house for a capital gain in addition to the rental income there is fixed term loan in most cases the loans have a predefined maturity and for housing loans these are long-term loans usually 30 years or 25 years if we consider credit card these are loans for short-term use. Usually for credit cards, the interest rates are very high and there is an interest-free period as well, which can range between 30 days and 90 days. And then there is housing finance and any type of housing loan is considered mortgage. And it is an amortized loan, which means that with every repayment, which is done on a monthly basis, a part of the original loan amount, which is the principal is repaid. in addition to the interest if we consider commercial lending so this is a business loan or a term loan and this loan has got fixed or variable rates of interest if we consider variable rates the reference rate is bbsw which is bank bill swap rate This is a reference rate for the variable rate which is currently in the market. If the variable rate increases then this reference rate or the loan interest rate will increase which means borrowers will have to pay more interest and if the reference rate decreases then the borrowers will have to pay lower interest. With every payment there is usually a repayment of principal and also a repayment of the interest. With both of these lending facilities, the most important information is the hard information about the borrowers. In most cases, the banks would look at the credit score, which is an indication of the credit quality of the borrower. And if a borrower has got good credit score, the borrower would receive the loan. And if the borrower does not have good credit score, the borrower will not receive the loan. On top of that, the banks would normally lend 80%. of the value. This basically means that if a property has got a valuation of 100, the bank would lend 80 and the bank would ask the borrower to pay 20 from his own capital. And the main reason is, and the main reason is the banks want the borrower to have skin in the game. In other words, the bank also wants the borrowers to contribute capital in purchasing a property or an asset in addition to the bank such that the risk is diversified between the borrower and the bank in case the borrower is unable to repay the loan. This also ensures that the borrower does what is required to ensure that the repayment is made in a timely fashion and on a regular basis and therefore the bank's default risk or the risk that the borrower may not repay the bank will decrease. If we consider further types of commercial lending there is overdraft. So overdraft is a facility where an operating account for example the current account can be overdrawn. This is usually a short-term facility for example a business has to pay the employees but for some reason they do not have enough cash. Now this can occur when customers don't pay the business and if this occurs The business can overdraw some money from its regular current account and pay the employees on time. And when the customers pay the business, then the money is recovered and the money can be repaid to the bank. For bills of exchange, as we discussed before, the bank can become a discounter, which means the bank itself can buy these bills of exchange. And when the bank purchases these bills of exchange, these become the assets for the bank. If we revisit how bills of exchange work, we have a bank in the center and the bank receives the bills from the corporation. So the corporation in this case is the issuer of the bills and the bank purchases the bills and the bank will forward the money. and the bills will come to the bank therefore these bills become the asset for a bank in other words the bank has invested in the bills issued by the corporation so therefore this is a use of funds where does the bank get its money from well these bills can be rediscounted or sold out to investors So the investors will provide the bank the required capital and that is where the bank will get the money to invest into the bills. Then there is leasing. In this case what occurs is the bank will purchase an equipment and this equipment will be leased out to potential borrowers. Generally what happens is borrowers would borrow money from the bank directly and purchase an equipment for the business. However, in leasing, the bank will purchase the equipment and then the bank will lease out the equipment to the borrowers and will receive lease payments on a periodic basis. Then there is lending to the government. So banks can purchase short-term discount securities which are issued by the federal government. Again discount securities are securities that have a certain face value and are sold at a discounted value relative to the face value. And then there are long-term bonds that banks can also purchase and these are also issued by the federal government. The difference between discount securities and bonds is that in bonds there is interest coupon stream. The way a bond works is let's say the bond has a face value of 100 and the coupon payment is 10 percent every year and let's say the bond has a maturity of five years so every year So if we start at 0, 1, 2, 3, 4, and 5, every year 10% of 100, $10 will be the interest payment or the coupon. And at the end of the fifth year, in addition to the coupon for that year, the phase value will be received. So if you look at this payment structure in a bond. the total payment is 100 plus 50 in interest or coupon payments the future value is 150 in total and initially the investment for the investor is 100. So by investing 100 the future value of this investment becomes 150. The interest rate I have indicated here is actually a bit high than normal, which is why the income is quite high. But this is just to show you an example. The benefit of investing into government bonds is these are low risk bonds and therefore the returns or the interest rate is lower than corporate bonds then there are other bank assets now these are the fixed assets for a bank We can also consider these tangible assets, for example, the electronic network structure, all the buildings that banks own, etc. Banks can also buy shares in other entities, and those shares are also a bank's assets. Now we look at different non-banking financial institutions and here the first is investment banks and we have managed funds, insurance companies, general finance companies, building societies and credit unions. We will discuss each of these in detail but first let's take a look at investment banks. What do investment banks do? The main job of an investment bank is to provide financial advice or financial consultation. Normally, they have front office, middle office, and back office. The front office is where the main work happens, which is providing the advice or helping customers make trade and investments. And the middle office and the back office provide support to the front office. Investment banks are also considered innovators and deal makers. and they try to find corporate clients high net worth individuals and government clients and they bring together all these parties for business the main activities include advice on mergers and acquisitions for example facebook purchased whatsapp and in investment bank would have advised what should have been the value of this purchase and who should pay whom in this case Facebook would have paid whatsapp but what is a fair amount so that is something that the investment bank can advise portfolio restructuring investment banks can advise clients on where to raise their funds from what price to raise their funds you for example what should be the rate of interest etc. Investment banks can also provide financial risk management and services to clients so investment banks can advise clients on which products to buy or which derivative products to buy to reduce the financial risks etc. Occasionally investment banks can also provide loans to clients but this activity is very limited within investment banks in most cases their activities relate to off balance sheet advisory services mainly. The main source of funds for investment banks come from international money markets and capital markets and mostly the customers themselves would pay the investment bank for the services and their uses of funds are lending to clients which is usually not very big. The loans are usually made in the secondary market so the lending is done indirectly and the main focus of investment banks are off balance sheet advisory services. Then we have got managed funds. Managed funds would normally have a professional investment manager and the managed fund would attract savings from individual investors. After they receive the savings they would pool together the fund and they would have a large fund and that large fund would be invested in the financial markets. When we say money market, so that's a short-term financial market. So if we want to buy short-term instruments, we trade in the money market. And if we want to buy long-term instruments, we would trade in the capital market. In any case, the managed fund would pool together or combine all these investments from the savers and invest in the financial markets. And this is usually done by an expert who is a professional investment manager with extensive knowledge and skills. The benefit is that the managers would seek to maximize the return on investment portfolios for a given level of risk. The other advantage here is the managers would be able to invest in big amounts which individual investors may not be able to do. Therefore, if we invest our money in a managed fund, we are able to invest or become part of the investment in a large financial asset which otherwise as individuals we wouldn't be able to buy. Then there are different types of managed funds. There is cash management trusts which are most common. The managed fund will collect the cash and then invest on behalf of the investor. Then there are public unit trusts. In this case the managed fund itself will invest and as investors we can buy small units which are like shares of that managed fund itself so if this public unit trust which is a managed fund does well the price of the unit will increase and investors who own these units will be benefited And if the investment of this public unit trust declines in value, then the value of the unit will also decrease and the investors of these units will also incur a loss. Then there are superannuation funds, which are basically accumulation of savings of individuals, which are used for the retirement of the individuals or employees. The benefit is that there is usually a large pool of funds that can be used to purchase both. primary and secondary market securities. Then there are different risk and return choices for managed funds. Some managed funds have very high risk and pay high returns and there are other managed funds which are considered low risk and the returns are also low. One example of investing in a managed fund is let's say we want to buy a shopping mall. In most cases for individuals this is going to be very difficult. So what this individual can do is invest in a public unit trust which will also collect money from other individuals pull together all the funds and then use the total fund to purchase the shopping mall that way the individual who has purchased a unit in this managed fund which is the public unit trust will become an owner of the shopping mall why would you want to buy a shopping mall the returns are high this is the main reason why to buy a shopping mall and therefore one shortcut method is to buy a unit in a public unit trust which has an investment in a shopping mall therefore indirectly you also become part of the ownership of the shopping mall now we look at life and general insurance companies now insurance companies are usually life insurance companies or general insurance companies when we talk about life insurance companies These are related to insurance policies related to death of the policyholder or disability of the policyholder or trauma that a policyholder has received. So it's related to health or death. The way it works is the policyholder would purchase the insurance product and the insurance company promises that if there is an accident which is mentioned in the contract the insurance company will pay out a certain amount of money to the policy holder. Now if you think of the insurance company itself this policy is their liability. The policy is a liability because the insurance company has to pay out the insurance policy holder at a future time period. If you consider life insurance companies which is related to debt of the policy holder or payments related to this cause. The outflows are predictable because normally insurance companies would look at the life expectancy of a particular country and that would be used as a benchmark to understand when a likely payout is going to occur. Therefore, the premium that the insurance companies receive, this is basically the periodic payment that the policyholder has to make to the insurance company to buy this or to use this insurance product. So they will collect the premium, they will accumulate the premium and if we consider a life insurance company, they would invest all this premium in a long term financial security. The main reason why they want to invest in long term financial security is because their liabilities are long term. If we consider general insurance company, then we would see that the investments are relatively short term. So the premium that general insurance companies receive, that money is accumulated and then invested into short-term securities. And the main reason for that is for general insurance companies, liabilities are unpredictable. For example, motor vehicle insurance. These are highly risky insurance products which may have a high likelihood of a payout. And therefore, the general insurance companies invest their premium in short-term financial assets which are normally more liquid. Then we have general finance companies. General finance companies include both domestic and international financial markets. For example, Ford Credit, a car manufacturing company, sell credit card products and this is basically an additional business unit for the car manufacturing company and they make some money like banks do but they are not banks. They cannot take deposits and they cannot lend money like banks can because these general finance companies are not authorized deposit taking institutions but they can provide some sort of banking services or some sort of financial services why do these general finance companies receive their money from? Well, pretty much the same sources from general investors from the capital markets. What do they do with these funds? Some finance companies or general financiers who are authorized deposit taking institutions can lend out money and normally they would lend out money to individuals who possibly have higher risk because borrowers with good credit score would normally go to banks and they will borrow money from banks. If borrowers credit score only then they will go to smaller finance companies to borrow money. We also have building societies. Building societies are again another type of authorized deposit taking institutions and they will mainly lend for building residential property. Again these are smaller banks who would collect money and mainly lend for building residential properties. They are there to help the community in general and they are mostly located in regional areas. Billing societies have the same sort of sources of funds. So they collect the money from depositors and they will use the money to provide personal finance to individual borrowers etc. Another issue is about APRA. APRA is Australian Prudential Regulatory Authority. They are the regulators or the government regulators that ensure financial stability within the economic system. So the main issue here is APRA would ensure that the deposit taking institutions are collecting the deposits in the right way. And they're also making loans which are good quality loans. Therefore, APRA will regulate the banks. They will impose a lot of different policies which the banks have to follow. And the banks need to ensure that they're making loans that are of very good quality. and the money that they're using comes from depositors as well as the owners of the banks and that both equity capital and debt capital are used for making these loans. Because if these loans default and if the fault is the banks, meaning if the banks make bad loans and therefore the loans default so that The depositors are not the only ones losing money and the owners also have skin in the game and therefore the chances that the bank will default will be lower. Then we have credit unions as well. This is also a financial company that collects deposits and makes loans to individuals. Now the money in a credit union would come from members normally linked to a particular employee. for example shell employees credit union or police credit union so the members of that particular employment would contribute capital they will put together a fund and money from that fund will be used to loan out to other members of the same employment or industry. So the deposits come from members usually through payroll deductions. So every month when the salary is paid out a certain amount can be set aside as a contribution to the credit union and then the credit union can use that fund to invest in financial assets. For example discount financial securities and other securities such as shares or company stocks etc. In credit unions the primary use of funds is to provide funding to buy residential houses or even personal loans and credit cards and commercial lending is usually limited because the credit union would only provide personal loans which are to individuals and normally they would not lend out to corporations.

As an overview, we will first look at different types of financial institutions. For example, we have ADIs, which are authorized deposit taking institutions. These institutions are allowed to take deposits from people and then lend out money. We will also look at non-ADIs. These are institutions that normally do not take deposits and they do not participate in lending.

Instead, they provide different types of financial advice. They help out different corporations and even individuals with financial consultation or advice. Then we look at the main features of depository institutions, which are the traditional banks that take in deposits and they provide lending. We here look at how the banking industry evolved over time. We look at how regulations impacted the banking industry and its growth and how removing these regulations helped the banking industry grow at a higher rate.

Then we discuss in detail the source of funds, which is basically how financial institutions find the money to lend. In other words, where do they source their funds from? And we also look at where do financial institutions invest these funds, which are basically the uses of funds. And finally, we look at different non-banking financial institutions, for example, insurance companies.

And we look at how they operate, what are the different products they offer and how they invest the money that they collect. from the policy holders in different financial markets. First, we have deposit-taking financial institutions.

They attract savings of depositors, so they collect money from general investors, and they make loans. Generally, we have commercial banks, which are the main financial institutions that are authorized deposit-taking institutions. We also have building societies. Building societies are again financial companies that provide loans for residential property. And we also have credit cooperatives.

Credit cooperatives are employee-based credit corporations where different employees would contribute money into a common fund and that fund will be used to lend out money to the same members who require the money. For example, we have police credit union. where the police personnel would contribute money into a common fund and that fund will be used to lend out to other policemen who require the money. Then we also discussed non-deposit taking financial institutions. Now, These include investment banks which generally provide advice on mergers and acquisitions or initial public offering of shares of different companies.

Then we have general insurance companies that provide general insurance such as car insurance, home content insurance etc. So policyholders will buy the insurance and they will pay premium to these insurance companies on a regular basis. The premium collected by the insurance companies will then be invested in different financial markets and we have a lot of discussion on that later on. And we also have superannuation funds where savings are accumulated by individuals to fund their retirement. What superannuation funds will normally do is they will collect money from employees or from individuals on a regular basis and they will then invest this money into the financial markets.

once the employee or the individual retires that money will be forwarded to the individual to fund the retirement time of the individual or the employee. In authorized deposit taking institutions we have commercial banks, building societies and credit unions. Now they are authorized by the government. We also have non-ADIs.

These non-ADIs are investment banks or merchant banks which mainly provide financial advice or financial consultation to companies or individuals. We also have general finance companies. We also have insurers and other managed funds where they provide different types of financial services such as investing into financial markets for general investors.

This slide shows the different types of financial institutions that are operating in Australia. This data is fairly recent and this is as at March 2024. So as we can see here, banks comprise of 54.19%. This indicates that banks are the main financial institutions which own most of the assets in Australia. This is basically indicating financial assets. So for banks, you may be wondering what sort of financial assets they have.

Well, the main financial assets that they have is loans. They give corporate loans or they give out home loans. And these are mainly the assets of banks. Then the second highest percentage is for superannuation funds. Superannuation funds are basically those institutions which collect money from employees.

So employees receive salary and a part of their salary is set aside so that they can use this fund which they will accumulate over time when employees retire. So until employees retire that superannuation money is accumulated in their account and if you add up all the superannuation contributions of employees you would see that there is a very large sum of money which these superannuation funds would further invest in different sorts of financial markets for example in the stock market and so on. Therefore these superannuation funds usually have a lot of money and as of March 2024 they have about $3695.5 billion dollars and that is almost equivalent to 32 percent of these different types of financial institutions and then there are other financial institutions as you can see here which also have some money invested in financial assets main types of financial institutions would include banks now banks provide different types of services the core business of banks is to collect deposits and provide loans this is the main business of a bank or a commercial bank.

In addition to that, they provide other services, for example, off balance sheet transactions, for example, underwriting and selling derivative products or even executing foreign exchange transactions, meaning we can buy or sell foreign currencies in a bank. Underwriting is buying unsold shares in initial public offering. For example, if a company wants to issue new shares and let's say they have issued 100,000 shares and out of that only 80,000 is sold, they have got 20,000 unsold shares. So a bank can provide some guarantee to this issuing company that whatever their unsold shares are, in this case 20,000, these will be purchased by the bank.

The benefit of this is the company has the peace of mind that they will be able to raise their target capital. An example of a derivative product would be a forward contract. For example, a company needs to pay a U.S. company $20,000 in three months.

So this company can approach a bank and buy this $20,000 in advance and at a favorable rate today. But the delivery will occur in three months time. Therefore, this is risk management or reducing financial risk for this company.

which has to meet a liability of 20,000 US dollars in three months time. So this is another service that a commercial bank can provide to different corporations or businesses. Now we move our focus to how banking industry evolved over time. Now, when there was more regulations, the banking industry did not grow as fast as it should have. and this was before the 1980s when the banking industry was restricted from increasing their size at a quick rate.

In the post 1980 period the banking industry was able to grow at a faster rate and we will discuss how this occurred. Now if we discuss the time period before the 1980s the banks mainly focused on asset management which basically means that the loan portfolio was tailored to match the available deposit. As an example, if a bank received a deposit of $100, the bank was able to make a loan of let's say $100 at the most. So If a bank only collected a deposit of 100, the loan was 100 at the most.

In other words, whatever deposit the bank received, only that money could be used to make a loan. So the amount of loan a bank made was dependent on the amount of deposit available for the bank. In the post-1980 time period, the bank focused on more on liability management. In other words, the banks can set a target that they want to make a loan of $1,000.

And to ensure that they're able to meet their target of making a loan of $1,000, the banks would try to find deposits. If they are able to find deposits, great. And if they're unable to find deposits, they will borrow the money directly from domestic and international capital markets mainly they will collect money from general investors both locally and internationally and they will ensure that they are able to collect one thousand dollars to make a loan of one thousand dollars therefore what we see today is banks grow at a very high rate and that is because banks after the regulations were removed in the 1980s are able to access the domestic and international capital markets to expand their loan size. Furthermore, after the regulations were removed, banks are able to provide many different types of financial services, for example, financial advice or financial consultation for different businesses and individuals. In addition to that, the banks are also able to participate in off-balance sheet activities, for example, selling derivative products.

Taken together, these days, banks mainly focus on liability management. Therefore, they collect funds from different financial markets to ensure that their assets grow at a fast pace. And overall, they're able to provide additional services, which in sum increases their total revenue and helps banks grow.

For a bank, the sources of funds appear in the balance sheet as either debt or equity. Now, a bank would normally fund all the loans using debt, which is deposits, and a part of the loans will also be funded by the owners of the bank, which are the shareholders, and that is called equity contribution. If we look at deposits, In most cases banks have different mix of deposits with different returns meaning different interest on those deposit accounts that banks have to pay. There are different maturities of deposits and different cash flow structure. In sum the banks always want to pay the deposit.

a stable source of deposits which is they don't want high variance or they don't want deposits to go up and down on a regular basis they want stable source of deposits and they want constant deposit inflow to manage their liabilities if you look at different types of bank accounts first we have got current account current account is considered a business account And therefore the current account is considered highly liquid. The current account is used by businesses to pay different suppliers as an example. Let's say we have a construction company.

And the construction company will pay the electrician. So the construction company will use its business account or current account to pay the electrician. If you look at the cash position of this current account let's say yesterday the account had $10,000 and after paying the electrician today the account currently has $500.

Tomorrow Let's say the customers will pay the construction company and the account balance will go up to 20,000. So if you look at this timeline, the balance was 10,000 yesterday. today the balance is 500 so a big reduction in the balance and tomorrow the balance is likely to be twenty thousand so there is very large variance in this current account balance and therefore this is not a very stable source of fund for the bank Therefore, the bank does not benefit much from using this fund in the current account because they cannot lend out this money for a very long period of time because they always have to ensure that the account has enough liquidity to meet the demands of the business.

Therefore, the bank does not provide much interest on these current accounts or business accounts. Similarly, if we consider demand deposits, which are savings accounts, mainly that individuals hold, the account balance can be withdrawn on demand and the money can be withdrawn directly from the bank or through ATMs or even FPOS machines, which are electronic fund transfer systems. even with demand deposits or saving accounts the interest rate is unlikely to be very high and the main reason for that is the account balances main vary by large quantities over time Having said that, the demand deposits or savings accounts are still more stable source of funding than current accounts. And this is mainly because the withdrawal patterns are more predictable for savings accounts, whereas the withdrawal pattern for current accounts are not quite predictable. If we consider term deposits, these are very stable source of funds for banks because they have a predetermined period for depositing the money.

In other words, depositors would invest the money. for a fixed period of time and they would choose that period of time themselves for example the deposits can come in for three months or six months etc given that the deposit is held in the bank account for a specified period of time which is usually at least three months banks consider this more stable source of funding and therefore using this stable source of fund banks are able to lend money for a long period of time And banks do not need to arrange enough liquidity for these deposit accounts because these deposit accounts are unlikely to be withdrawn by the depositors before maturity. Therefore, banks often pay high interest rates on these term deposit accounts and as opposed to this, banks pay very low interest on business accounts whose balances can vary by large quantities and even savings accounts whose balances can also have very high variance. Furthermore, we have negotiable certificates of deposits, which are based on the balance sheet. Basically discount securities issued by banks to raise funding.

Again, discount securities are liabilities for a bank. These are source of funds. These are liabilities just like deposit accounts because these money in the deposit accounts have been deposited by depositors or investors or savers.

Banks will eventually have to pay off these liabilities. Therefore, these are considered debt. What are discount securities?

Discount securities are securities that are sold at a value which is less than the face value of the security. What this means is, let's say today the bank is going to collect $90. The face value of the discount security is 100, which means one year later the bank will repay $100. Usually, discount securities or the CDs are short-term instruments. In particular, if we consider the negotiable certificates of deposits, they have a term of 30 days to 180 days.

Next, we focus on bill acceptance liabilities and the first is bills of exchange. In bills of exchange, we usually have an issuer. which in most cases is a corporation which will issue this bill of exchange to the investors and we will call this bills in short so the issuer will issue bills to the investors These bills are financial instruments or financial contracts and the contractual terms are the issuer will receive money from the investor and the issuer will issue bills to the investor. And these are again discount securities which are short term instruments.

What happens with bills of exchange is that the bank becomes an acceptor. In other words, the bank will accept the responsibility to repay the investors when the bills are due to be repaid. So over here the investors forward the money to the issuer or the corporation that requires the money but when the time comes to repay the investors the banks will do this on behalf of the corporations.

So the investors have additional peace of mind that these bills will always be repaid because the bank is providing the guarantee that the bills will be repaid. Once the banks repay the bills, the banks themselves will collect the money from the corporation. separately so this is going to be a separate agreement between the bank and the issuer that once the money has been repaid to the investors the banks will collect their money from the corporation directly so this is the role where the bank becomes an acceptor and this improves the credit quality of the bills Alternatively, the bank can have the role of a Discounter.

When the bank is the Discounter, the bank will purchase the bills directly from the corporation. So the corporations will directly issue the bills to the banks and the banks will forward the money directly to the corporation. After the money has been forwarded, the bank will use these bills and then they will resell the bills or Rediscount the bills and sell these to the general investors and when it is time to repay the bills the banks will pay the investors directly and The corporation will also pay the bank when it is due for them to pay the bank If you look at this discounted role of the bank At the end of the day, the bank does not use its own money to purchase the bills because after purchasing, the bank will sell these bills and collect all the money of their investment. Therefore, when a bank is a discounter, the bank does not use its own funds to complete the purchase or the exchange. Next there are debentures or bonds that are supported by a form of security.

So when a bank needs funding, the bank can issue debentures and these debentures will be purchased by investors and these debentures will have a collateral. which is usually the mortgage loans that the bank has. The money will go from the investors to the bank initially and when it is time to repay the investors, if the bank defaults, the investors are still covered.

what happens is the bank will sell these mortgages maybe to another bank and the bank will collect the money and the bank will pay off their liabilities that are due to the investors in short debentures have a form of security because in case of default the bank bank can use the collateral that they have pledged in order to collect the money and they will sell the collateral to other banks and arrange the money to pay off the investors who initially bought the debentures issued by the bank. Then there are unsecured notes as well. These are bonds with no security attached.

Therefore these bonds for investors would be more risky. Therefore the investors would demand high rates of interest to buy these unsecured notes. Then the bank can have foreign currency liabilities.

Let's say a bank. wants to make a loan of USD 50,000. In order to make this loan, the bank will collect USD 50,000 as deposits.

the benefit of this is when these deposits are due the bank will collect the money in us dollars because the borrowers will repay the bank and then the bank can easily transfer this 50 000 usd to the deposit holders who the bank owes 50,000 USD to. The advantage here is there is no need to exchange the local currency into foreign currency or foreign currency into local currency and therefore the bank will not be exposed to any fluctuations in the foreign exchange rates. Furthermore, if banks are able to expand their business internationally, for example, if this is an Australian bank and if they are able to make a loan in the US markets, then their loan portfolio is more diverse, therefore their risk reduction would be greater.

The banks can also use loan capital and shareholders equity. In most cases the shareholders equity will come from ordinary shareholders who are the ultimate owners of any organization. In most cases the bank would use eight percent.

In fact as a minimum the banks need to use eight percent capital from the shareholders. others and the rest which is 92% of their total funding can come from debt. Here we have this idea of subordinated notes.

Now subordinated notes are those that rank below all the other creditors in terms of repayment when the bank defaults. So if an investor purchases a subordinated note What will happen is once the bank defaults and if it defaults all other creditors will be repaid including employees and government. After that if there is any money left the subordinated note holders would receive their dues and after that whatever residual is there will go to the ultimate owners of the company or the bank in this case. which are the shareholders.

In terms of uses of funds there is personal and housing finance. This is basically an asset for the bank because the bank will give out a loan for personal use or even buying a house. First we have investment property. So the borrowers would take out a loan to buy an investment property for rent.

The borrowers may wait for the capital to increase which is an increase in the value of the property itself and then the borrower can sell the house for a capital gain in addition to the rental income there is fixed term loan in most cases the loans have a predefined maturity and for housing loans these are long-term loans usually 30 years or 25 years if we consider credit card these are loans for short-term use. Usually for credit cards, the interest rates are very high and there is an interest-free period as well, which can range between 30 days and 90 days. And then there is housing finance and any type of housing loan is considered mortgage. And it is an amortized loan, which means that with every repayment, which is done on a monthly basis, a part of the original loan amount, which is the principal is repaid. in addition to the interest if we consider commercial lending so this is a business loan or a term loan and this loan has got fixed or variable rates of interest if we consider variable rates the reference rate is bbsw which is bank bill swap rate This is a reference rate for the variable rate which is currently in the market.

If the variable rate increases then this reference rate or the loan interest rate will increase which means borrowers will have to pay more interest and if the reference rate decreases then the borrowers will have to pay lower interest. With every payment there is usually a repayment of principal and also a repayment of the interest. With both of these lending facilities, the most important information is the hard information about the borrowers. In most cases, the banks would look at the credit score, which is an indication of the credit quality of the borrower. And if a borrower has got good credit score, the borrower would receive the loan.

And if the borrower does not have good credit score, the borrower will not receive the loan. On top of that, the banks would normally lend 80%. of the value. This basically means that if a property has got a valuation of 100, the bank would lend 80 and the bank would ask the borrower to pay 20 from his own capital. And the main reason is, and the main reason is the banks want the borrower to have skin in the game.

In other words, the bank also wants the borrowers to contribute capital in purchasing a property or an asset in addition to the bank such that the risk is diversified between the borrower and the bank in case the borrower is unable to repay the loan. This also ensures that the borrower does what is required to ensure that the repayment is made in a timely fashion and on a regular basis and therefore the bank's default risk or the risk that the borrower may not repay the bank will decrease. If we consider further types of commercial lending there is overdraft.

So overdraft is a facility where an operating account for example the current account can be overdrawn. This is usually a short-term facility for example a business has to pay the employees but for some reason they do not have enough cash. Now this can occur when customers don't pay the business and if this occurs The business can overdraw some money from its regular current account and pay the employees on time. And when the customers pay the business, then the money is recovered and the money can be repaid to the bank. For bills of exchange, as we discussed before, the bank can become a discounter, which means the bank itself can buy these bills of exchange.

And when the bank purchases these bills of exchange, these become the assets for the bank. If we revisit how bills of exchange work, we have a bank in the center and the bank receives the bills from the corporation. So the corporation in this case is the issuer of the bills and the bank purchases the bills and the bank will forward the money. and the bills will come to the bank therefore these bills become the asset for a bank in other words the bank has invested in the bills issued by the corporation so therefore this is a use of funds where does the bank get its money from well these bills can be rediscounted or sold out to investors So the investors will provide the bank the required capital and that is where the bank will get the money to invest into the bills. Then there is leasing.

In this case what occurs is the bank will purchase an equipment and this equipment will be leased out to potential borrowers. Generally what happens is borrowers would borrow money from the bank directly and purchase an equipment for the business. However, in leasing, the bank will purchase the equipment and then the bank will lease out the equipment to the borrowers and will receive lease payments on a periodic basis.

Then there is lending to the government. So banks can purchase short-term discount securities which are issued by the federal government. Again discount securities are securities that have a certain face value and are sold at a discounted value relative to the face value.

And then there are long-term bonds that banks can also purchase and these are also issued by the federal government. The difference between discount securities and bonds is that in bonds there is interest coupon stream. The way a bond works is let's say the bond has a face value of 100 and the coupon payment is 10 percent every year and let's say the bond has a maturity of five years so every year So if we start at 0, 1, 2, 3, 4, and 5, every year 10% of 100, $10 will be the interest payment or the coupon.

And at the end of the fifth year, in addition to the coupon for that year, the phase value will be received. So if you look at this payment structure in a bond. the total payment is 100 plus 50 in interest or coupon payments the future value is 150 in total and initially the investment for the investor is 100. So by investing 100 the future value of this investment becomes 150. The interest rate I have indicated here is actually a bit high than normal, which is why the income is quite high.

But this is just to show you an example. The benefit of investing into government bonds is these are low risk bonds and therefore the returns or the interest rate is lower than corporate bonds then there are other bank assets now these are the fixed assets for a bank We can also consider these tangible assets, for example, the electronic network structure, all the buildings that banks own, etc. Banks can also buy shares in other entities, and those shares are also a bank's assets. Now we look at different non-banking financial institutions and here the first is investment banks and we have managed funds, insurance companies, general finance companies, building societies and credit unions.

We will discuss each of these in detail but first let's take a look at investment banks. What do investment banks do? The main job of an investment bank is to provide financial advice or financial consultation.

Normally, they have front office, middle office, and back office. The front office is where the main work happens, which is providing the advice or helping customers make trade and investments. And the middle office and the back office provide support to the front office. Investment banks are also considered innovators and deal makers. and they try to find corporate clients high net worth individuals and government clients and they bring together all these parties for business the main activities include advice on mergers and acquisitions for example facebook purchased whatsapp and in investment bank would have advised what should have been the value of this purchase and who should pay whom in this case Facebook would have paid whatsapp but what is a fair amount so that is something that the investment bank can advise portfolio restructuring investment banks can advise clients on where to raise their funds from what price to raise their funds you for example what should be the rate of interest etc.

Investment banks can also provide financial risk management and services to clients so investment banks can advise clients on which products to buy or which derivative products to buy to reduce the financial risks etc. Occasionally investment banks can also provide loans to clients but this activity is very limited within investment banks in most cases their activities relate to off balance sheet advisory services mainly. The main source of funds for investment banks come from international money markets and capital markets and mostly the customers themselves would pay the investment bank for the services and their uses of funds are lending to clients which is usually not very big. The loans are usually made in the secondary market so the lending is done indirectly and the main focus of investment banks are off balance sheet advisory services. Then we have got managed funds.

Managed funds would normally have a professional investment manager and the managed fund would attract savings from individual investors. After they receive the savings they would pool together the fund and they would have a large fund and that large fund would be invested in the financial markets. When we say money market, so that's a short-term financial market. So if we want to buy short-term instruments, we trade in the money market. And if we want to buy long-term instruments, we would trade in the capital market.

In any case, the managed fund would pool together or combine all these investments from the savers and invest in the financial markets. And this is usually done by an expert who is a professional investment manager with extensive knowledge and skills. The benefit is that the managers would seek to maximize the return on investment portfolios for a given level of risk. The other advantage here is the managers would be able to invest in big amounts which individual investors may not be able to do.

Therefore, if we invest our money in a managed fund, we are able to invest or become part of the investment in a large financial asset which otherwise as individuals we wouldn't be able to buy. Then there are different types of managed funds. There is cash management trusts which are most common.

The managed fund will collect the cash and then invest on behalf of the investor. Then there are public unit trusts. In this case the managed fund itself will invest and as investors we can buy small units which are like shares of that managed fund itself so if this public unit trust which is a managed fund does well the price of the unit will increase and investors who own these units will be benefited And if the investment of this public unit trust declines in value, then the value of the unit will also decrease and the investors of these units will also incur a loss.

Then there are superannuation funds, which are basically accumulation of savings of individuals, which are used for the retirement of the individuals or employees. The benefit is that there is usually a large pool of funds that can be used to purchase both. primary and secondary market securities.

Then there are different risk and return choices for managed funds. Some managed funds have very high risk and pay high returns and there are other managed funds which are considered low risk and the returns are also low. One example of investing in a managed fund is let's say we want to buy a shopping mall.

In most cases for individuals this is going to be very difficult. So what this individual can do is invest in a public unit trust which will also collect money from other individuals pull together all the funds and then use the total fund to purchase the shopping mall that way the individual who has purchased a unit in this managed fund which is the public unit trust will become an owner of the shopping mall why would you want to buy a shopping mall the returns are high this is the main reason why to buy a shopping mall and therefore one shortcut method is to buy a unit in a public unit trust which has an investment in a shopping mall therefore indirectly you also become part of the ownership of the shopping mall now we look at life and general insurance companies now insurance companies are usually life insurance companies or general insurance companies when we talk about life insurance companies These are related to insurance policies related to death of the policyholder or disability of the policyholder or trauma that a policyholder has received. So it's related to health or death. The way it works is the policyholder would purchase the insurance product and the insurance company promises that if there is an accident which is mentioned in the contract the insurance company will pay out a certain amount of money to the policy holder.

Now if you think of the insurance company itself this policy is their liability. The policy is a liability because the insurance company has to pay out the insurance policy holder at a future time period. If you consider life insurance companies which is related to debt of the policy holder or payments related to this cause. The outflows are predictable because normally insurance companies would look at the life expectancy of a particular country and that would be used as a benchmark to understand when a likely payout is going to occur. Therefore, the premium that the insurance companies receive, this is basically the periodic payment that the policyholder has to make to the insurance company to buy this or to use this insurance product.

So they will collect the premium, they will accumulate the premium and if we consider a life insurance company, they would invest all this premium in a long term financial security. The main reason why they want to invest in long term financial security is because their liabilities are long term. If we consider general insurance company, then we would see that the investments are relatively short term.

So the premium that general insurance companies receive, that money is accumulated and then invested into short-term securities. And the main reason for that is for general insurance companies, liabilities are unpredictable. For example, motor vehicle insurance. These are highly risky insurance products which may have a high likelihood of a payout. And therefore, the general insurance companies invest their premium in short-term financial assets which are normally more liquid.

Then we have general finance companies. General finance companies include both domestic and international financial markets. For example, Ford Credit, a car manufacturing company, sell credit card products and this is basically an additional business unit for the car manufacturing company and they make some money like banks do but they are not banks.

They cannot take deposits and they cannot lend money like banks can because these general finance companies are not authorized deposit taking institutions but they can provide some sort of banking services or some sort of financial services why do these general finance companies receive their money from? Well, pretty much the same sources from general investors from the capital markets. What do they do with these funds?

Some finance companies or general financiers who are authorized deposit taking institutions can lend out money and normally they would lend out money to individuals who possibly have higher risk because borrowers with good credit score would normally go to banks and they will borrow money from banks. If borrowers credit score only then they will go to smaller finance companies to borrow money. We also have building societies. Building societies are again another type of authorized deposit taking institutions and they will mainly lend for building residential property.

Again these are smaller banks who would collect money and mainly lend for building residential properties. They are there to help the community in general and they are mostly located in regional areas. Billing societies have the same sort of sources of funds. So they collect the money from depositors and they will use the money to provide personal finance to individual borrowers etc.

Another issue is about APRA. APRA is Australian Prudential Regulatory Authority. They are the regulators or the government regulators that ensure financial stability within the economic system.

So the main issue here is APRA would ensure that the deposit taking institutions are collecting the deposits in the right way. And they're also making loans which are good quality loans. Therefore, APRA will regulate the banks. They will impose a lot of different policies which the banks have to follow.

And the banks need to ensure that they're making loans that are of very good quality. and the money that they're using comes from depositors as well as the owners of the banks and that both equity capital and debt capital are used for making these loans. Because if these loans default and if the fault is the banks, meaning if the banks make bad loans and therefore the loans default so that The depositors are not the only ones losing money and the owners also have skin in the game and therefore the chances that the bank will default will be lower. Then we have credit unions as well. This is also a financial company that collects deposits and makes loans to individuals.

Now the money in a credit union would come from members normally linked to a particular employee. for example shell employees credit union or police credit union so the members of that particular employment would contribute capital they will put together a fund and money from that fund will be used to loan out to other members of the same employment or industry. So the deposits come from members usually through payroll deductions. So every month when the salary is paid out a certain amount can be set aside as a contribution to the credit union and then the credit union can use that fund to invest in financial assets.

For example discount financial securities and other securities such as shares or company stocks etc. In credit unions the primary use of funds is to provide funding to buy residential houses or even personal loans and credit cards and commercial lending is usually limited because the credit union would only provide personal loans which are to individuals and normally they would not lend out to corporations.

Transcript for:Overview of Financial Institutions and Their Functions

Transcript for:
Overview of Financial Institutions and Their Functions