Australian financial system
Lending of Banks in Australia
1. select five groups of financial institutions (example life insurance is one group) in the Australian financial system, compare to the amount of assets owned by each of the different ‘groups’ of financial institutions in Australian financial system?
2. investigate the size and proportion of lending to the different sectors by the commercial banks. Has the proportion of lending changed over time?
3. where do the commercial banks source their funds? how has the funding structure to the commercial banks changed over the years?
NOTE – for sections 1 & 2 make sure you collect at least 5 years worth of data and the data must be current ( at the least extended to Dec 2016). these data are usually available from reserve bank, Australian prudential regulatory authority (APRA) or Australian Bureau of Statistics financial accounts
– you may consider presenting part wanting the table and plotting those figures on the line graph.
Part B – 550 words
during the recent months we witnessed many financial institutions suffered significant losses in their market value. There are views who argue the failure of a particular company/industry such as bank would be detrimental to the overall well-being of the economy. There are also views that bank should be allowed to fail.
1. List 2 arguments which support the view banks should be allowed to fail.
2. List 2 arguments which supports the view banks should ‘not’ be allowed to fail.
3. (current issue) What are some of the explanations offered in the media, the reason why banks have lost their market value in May in 2017
-NOTE there is no need for executive summary, introduction or conclusion for the assignment however it must be presented in essay form.
try to relate it to knowledge covered in units recommended textbook – Lange, Saunders & Cornett , Financial Institution Management, McGraw Hill pub.
Lending of Banks in Australia
Australian financial system
Commercial banks play significant roles in assisting businesses to grow and attain prosperity. Banks offer individual, as well as corporate lending products, inform of funds that help in supporting general business needs of different sectors. This paper presents a comparison of assets owned by various financial institutions in Australian financial system, the size, and a portion of lending by commercial banks has changed over time in Australia, the sources of funds for commercial banks, and arguments regarding the failure of banks.
Comparison of Amount of Assets Owned by Various Financial Institutions
The Australian financial system comprises of different players that engage in the borrowing and lending of funds as well as transfer of ownership of monetary rights. Five key players include commercial banks, building societies, credit unions, insurance companies, and superannuation which consist of pension funds. According to Australian Prudential Regulation Authority (2016), authorized deposit-taking institutions (ADIs) which include commercial banks, credit unions, and building societies together hold 79% of industry assets. Insurers, whose key player in the industry is life insurance holds a total asset of 12.7%. The superannuation sector owns 8.3% of the total industry assets.
Size and Proportion of Lending of Australian Commercial Banks
The banking system of Australia continues to benefit from the impressive asset performance in the industry. As a result, banks have become capable of lending to various sectors of the economy. In regards to lending to the housing sector, banks account for 60% of domestic lending to the housing sector. Banks, therefore, maintain a sound housing lending. The case is supported by a lower non-performing loan ratio of 0.9 percent (Reserve Bank of Australia, 2015). However, due to the overall pressure on the banks caused by a heightened risk in housing lending, housing loan portfolios remain low. Furthermore, banks occupy significant portions of lending to the businesses, which include lending to small and medium-sized businesses as well as large corporations. However, in business funding, factors such as reduced leverage and diversification of funding sources lower the reliance of businesses to bank funding. As a result, businesses tend to rely on equity and other debt markets thus lowering the proportion of banks to lend to businesses (Australian Centre for Financial Studies 2016). Additionally, the banks still dominate the market of personal loans. The majority of Australians rely on bank loans for funding of personal and family financial requirements such as education and purchasing of material wealth.
The lending proportions have experienced changes over time due to changes in economic conditions. For instance, the global financial crisis led to business failures and defaults. The situation resulted in some businesses to become less creditworthy due to weaker sales and decline in collateral value. As a result, the proportion of lending to businesses decreased. The scenario has made a lot of businesses to depend on internal funding sources such as retained earnings heavily. Corporate sectors have also diversified towards market-based funding, resulting in low lending of banks to the corporate sector (Australian Centre for Financial Studies 2016). Furthermore, competition from other lenders such particularly foreign banks has resulted to declined proportions of lending of Australian banks to the business loan market. Besides, there has been an increase in tightening of the lending criteria for development of residential property. The changes are as a result of strong concerns of an oversupply of apartments in some areas (Reserve Bank of Australia 2015). As a result, the demand for housing loans has significantly reduced.
Sources of Funds for Commercial Banks
Australian banks have diverse funding sources. The primary sources of funds are domestic deposits, asset securitization, retained earnings, and short-term and long-term wholesale funding. In regards to retained earnings, commercial banks earn fees from bank transactions which help in funding their businesses. Retained earnings can be collected from loan interest payments, overdraft fees, bonds, and securities. By the use of asset securitization, banks transform an illiquid asset into security based on the cash flows of the securitized asset (Nikolova, Rodionov & Mettaeva 2016). Domestic deposits are the deposits that local customers make on their bank accounts such as the savings deposits. Banks use the deposits to finance their operations. Wholesale funding refers to the foreign deposits, federal funds, brokerage deposits as well as the borrowings in the public debt market.
The funding structure of the Australian banking system has undergone significant changes over the years. The changes are attributed to the reassessment of financing risks by banks as well as the market and regulatory pressures. In particular, deposits have increasingly become the main source of funding. Also, drifts have occured from short-term wholesale funding towards long-term wholesale funding. The change is as a result of banks seeking to reduce the rollover risk associated with short-term wholesale funding (Reserve Bank of Australia 2012).
Arguments that Support Failure of Banks
Strong arguments exist which support the notion that banks should be allowed to fail. Some argue that basing on the principle of comparative advantage. Those in support of this idea claim that as much as banks provide diversified financial alternatives and offer convenience to firms and individuals, the advantages appear to be rather inconsequential when judged against the disadvantages of the major financial institutions. They further argue that banks are associated with inefficiencies, risks taken to create large returns to justify their organization scales, and ethical abuses in violation of some fiduciary obligations. Therefore, it would be so inappropriate for taxpayers to help in supporting the capitals of the financial institutions.
Additionally, others argue that financial institutions and their bosses have turned out to be influential and politically related enabling them to push governments to lessen the regulations while demanding taxpayers’ money when things fall apart. Therefore, they claim that the economic and social relationship between financial institutions and the public is not based on trust but a dissemination of risks and rewards (Moosa 2010). Morality is thus ignored by financial institutions, and therefore the banks should be not be saved from their peril.
Arguments supporting that Banks Should not be allowed to Fail
Parties that argue that banks should not be allowed to fail claim that banks play important roles in financial markets as they easily provide information concerning activities that may lead to valuable investments as well as funds for investments. They claim that when banks exhibit deteriorations of their balance sheets, there occur shortages of lendable funds thus lending declines. The shortage of lendable funds would then result in a decrease in investment spending. In the end, economic activities would slow down thus affecting the public as well private sectors.
Also, some who oppose the failure of banks argue that preventing banks from failing is necessary for maintaining the stability of the financial system (Labonte 2017). Some economists argue that banks play crucial roles in financial market segments which range from private securitization, derivatives that deal with third parties, and leverage investor financing. Therefore, when banks fail, other financial institutions would face difficulties in absorbing the failed banks’ businesses, which would lead to disruptions of flow of credit.
Reasons Why Banks Have Lost Their Market Value
Recently, Australian banks have faced a difficult environment due to the new levy that has been imposed by the government. The tax is perceived to erode the annual profits of banks and reduce the returns on equity (Somasundaram 2017). However, the cost of the levy is expected to borne by borrowers, shareholders, and employees. As a result, investors have started to move back to banks with the perception that the banks have been oversold. The situation has thus resulted in banks to lose their market values. Additionally, new regulations have been introduced which do not favor the banks as lenders. For instance, the stamp duty charged on lenders’ mortgage insurance has been abolished. The stamp duty is normally required by banks to lend to their first home buyers with limited deposits (Chung 2017). The change has resulted in a significance decrease in prices of houses, which is expected to cause a decline in revenue growth associated with housing loans.
sum up, the five key financial institutions include commercial banks, building
societies, credit unions, insurance companies, and superannuation. Australian
commercial banks lend funds to different sectors which include housing sectors,
business sectors as well as individuals. The major
sources of funds for banks are domestic deposits, asset securitization,
retained earnings, and short-term and long-term wholesale funding. Currently, strong
arguments exist regarding whether to let banks fail or not. Those in support
for bank failure argue that banks are associated
with ethical abuse and that the relationship between banks and the public is not based on trust but risks and rewards. However, those who claim that banks should
not be allowed to fail to argue that
banks help in supporting economic activities, and a failure of banks would
destabilize financial systems. Recently, Australian banks have lost their
market value due to the new levy that has been
imposed on them by the government, and the abolishment of the stamp duty
charged on lenders’ mortgage insurance.
Australian Centre for Financial Studies 2016, Lending to Small and Medium Enterprises. pp. 1- 14
Australian Prudential Regulation Authority 2016, Financial Sector Developments. [online] Available at: http://www.apra.gov.au/AboutAPRA/Publications/Pages/annualreport- 2015-16-CH3.html [Accessed 9 Jun. 2017].
Chung, F 2017, Capital City House Prices Fall 1.1 Per Cent in May. Australian Economy. [online] Available at: http://www.news.com.au/finance/economy/australian- economy/capital-city-house-prices-fall-11-per-cent-in-may/news- story/1673b01639bb27d8783c01113babb158 [Accessed 9 Jun. 2017].
Labonte, M 2017, Systematically Important or “Too Big to Fail” Financial Institutions. Congregational Research Service, pp. 1-33.
Moosa, I, The Myth of Too Big to Fail. Journal of Banking Regulation, Vol. 11, No. 4, pp. 319- 333.
Nikolova, LV, Rodionov, DG & Mottaeva, AB 2016, Securitization of Bank Assets as a Source of Financing the Innovation Activity. International Journal of Economics and Financial Issues, Vol. 6, No. 2, pp. 246-252.
Reserve Bank of Australia 2012, Banks’ Funding Costs and Lending Rates | Bulletin – March Quarter 2012 | RBA. [online] Reserve Bank of Australia. Available at: http://www.rba.gov.au/publications/bulletin/2012/mar/5.html [Accessed 9 Jun. 2017].
Reserve Bank of Australia 2015, The Australian Financial System | Financial Stability Review – October 2015 | RBA. [online] Reserve Bank of Australia. Available at: http://www.rba.gov.au/publications/bulletin/2012/mar/5.html [Accessed 9 Jun. 2017].
Reserve Bank of Australia. Available at: http://www.rba.gov.au/publications/fsr/2015/oct/aus-fin-sys.html [Accessed 9 Jun. 2017]. Somasundaram, N. 2017, Money and Markets: Australia’s Major Banks Lost $16.5 Billion in Value This Week After the Federal Budget. Business Insider Australia. [online] Available at: https://www.businessinsider.com.au/australian-major-banks-lost-16-5- billion-in-market-value-this-week-2017-5 [Accessed 9 Jun. 2017].