MONASH
BUSINESS
SCHOOL
Lecture 1
UNIT ADMINISTRATION & INTRODUCTION
BFF2401 Commercial banking and finance
PART I
UNIT ADMINISTRATION
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BUSINESS
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UNIT ADMINISTRATION
▪
▪
▪
▪
▪
▪
▪
▪
Contacting staff
Course objectives
Resources
Course delivery
Unit assessment
Other matters
Unit big picture
Tips for success in BFF2401
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CONTACTING STAFF
▪ Your tutor:
– Tutorial schedule and staff contact details (emails and
consultation schedule) will be posted on Moodle.
▪ Chief examiner/Lecturer:
– Dr Tram Vu
– Email: tram.vu@monash.edu
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COURSE OBJECTIVES
Develop an understanding of:
▪ the Australian banking system as well as the banking system across
the world.
▪ banks’ operations and items on their balance sheet (including loan
pricing, liability management, capital management) and off-balance
sheet activities.
▪ different aspects of banks’ risk management such as credit risk,
interest rate risk, liquidity risk.
▪ banking regulations in Australia and worldwide.
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RESOURCES
▪ Textbook:
– Saunders, A., Cornett, M. M., & Erhemjamts, O. (2021). Financial
Institutions Management: A Risk Management Approach (10th
ed.). McGraw-Hill.
– E-book also available (see link on Moodle)
▪ Moodle:
– Materials used in class together with other information of
importance to students will be published online.
– Materials on Moodle include: pre-lecture readings, information of
mid-semester test, assignments, lecture slides, tutorial questions
and solutions (brief guide only), weekly lecture summary, and
other useful references.
– Discussion board has been created to facilitate general student
enquiries and peer discussion.
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COURSE DELIVERY - Lectures
▪ Lectures:
– One 2-hour lecture per week from week 1 to week 12
(except week 6)
▪ The lecture is recorded via Echo360 (link on Moodle).
▪ Students can view lecture recordings in their own suitable time
(lectures should be viewed before students attempt tutorial questions
of a related topic).
– Purpose: to introduce key concepts and theories, supported
by practical examples and applications
– Requirement: lecture notes, prescribed readings before and
after lectures, note-taking and attempting activities
introduced in lectures (e.g. calculations, H5P quizzes)
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COURSE STRUCTURE - Tutorials
▪ Tutorials:
– One 1-hour tutorial per week from week 1 to week 12 (oncampus as per Allocate+)
– Purpose: to help students further understand the lecture by
going through the tutorial solutions
– Requirement: prepare problems before tutorials and review
after tutorials, participate in tutorials (by actively answering
questions, sharing insights, discussing with other students
about relevant materials)
– Please ensure that you know your tutor name and their
contact details
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UNIT ASSESSMENT (100% Within semester)
Assessment Task
Online posts (Weekly)
Online quizzes
Mid-semester test (MST)
Individual assignment
Value
10%
Due Date
Weeks 2 to 12
30%
Weeks 3, 10 and 12
30%
Tuesday 29 August
2PM (Week 6)
30%
Group or
Individual
Individual
Individual
Individual
Tuesday 19
September (Week 9)
Individual
9
Learning
Outcomes
Condition for Use of
Generative Artificial
Intelligence (AI)
1-6
Generative AI tools
cannot be used in this
assessment task.
1-6
Generative AI tools
cannot be used in this
assessment task.
1-6
Generative AI tools
cannot be used in this
assessment task.
1-6
Generative AI tools are
restricted for certain
functions in this
assessment task.
MONASH
BUSINESS
SCHOOL
REFERENCING
▪ https://www.monash.edu/rlo/research-writingassignments/referencing-and-academic-integrity/citing-andreferencing
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COMMUNICATION AND FEEDBACK
▪
▪
▪
▪
Feedback during tutorials
Staff consultations
E-mail contacts
Moodle discussion board
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UNIT BIG PICTURE
Capital adequacy
requirements
BANK REGULATION
BANK
PERFORMANCE
BANK
RISKS
Interest
rate risk
Credit risk
Liquidity
risk
BANK
OPERATIONS
On-balance
sheet
Asset
Liability
(e.g. Loans)
Equity
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Off-balance
sheet
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TIPS FOR SUCCESS IN BFF2401
– Before listening to the weekly lecture, have a quick look at the
pre-lecture readings and textbook chapters to gain a general idea
of the topic.
– While listening to the lecture, take notes and attempt the activities
introduced by the lecturer, refer to textbook where needed, and
finally go through the lecture summary to ensure you cover all key
points.
– Then attempt the tutorial questions of that topic, and bring your
answers to tutorials for discussion. If required, you can further
review your answers using the tutorial solutions.
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TIPS FOR SUCCESS IN BFF2401 (cont’d)
▪ Post a reply to the weekly forum discussion topic
before the due date.
▪ Study both theory as well as practical problems.
▪ Consult with your tutor or lecturer promptly once you are
having difficulties.
▪ Think about and prepare a revision plan well ahead of
mid-semester test time.
▪ Make an early start on the individual and group
assignments.
▪ Utilise the discussion forum.
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PART II
TOPIC 1
INTRODUCTION TO
COMMERCIAL BANKING AND FINANCE
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BUSINESS
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LEARNING MAP - WEEK 1
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LECTURE 1 - OUTLINE
I.
Overview of the Australian financial system and
banking system
II. Specialness of financial institutions
III. Changing dynamics of specialness
IV. Bank motivation
V. Issues in global and Australian banking since 2007
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LEARNING OBJECTIVES
▪ Identify the main institutions in the Australian financial
system including the banking sector (LO1)
▪ Discuss the functions of banks – what banks do for their
customers (LO2,3)
▪ Explain bank motivation - their long-term objective of
maximizing shareholder value and the risk-return tradeoff for banks (LO4)
▪ Outline the recent issues which have impacted on the
global and Australian banking environment (LO5)
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REFERENCES
▪ Saunders, A., Cornett, M. M., & Erhemjamts, O. (2021).
Financial Institutions Management: A Risk Management
Approach (10th ed.). McGraw-Hill.
– Chapters 1 and 2
▪ Australian Prudential Regulatory Authority (APRA)
www.apra.gov.au
▪ Reserve Bank of Australia (RBA)
www.rba.gov.au
▪ ANZ 2022 Annual Report
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LECTURE OUTLINE
I.
II.
III.
IV.
V.
Overview of the Australian financial system and
banking system
Specialness of financial institutions
Changing dynamics of specialness
Bank motivation
Issues in global and Australian banking since 2007
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FINANCIAL SYSTEM
▪ The role of the financial system is to facilitate financial
transactions through the creation, sale and transfer of
financial assets.
▪ Its three components include:
– Financial Institutions
– Financial Markets
– Financial Instruments
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FINANCIAL SYSTEM - INSTITUTIONS
▪ Reserve Bank of Australia (RBA)
▪ Authorised Deposit-Taking Institutions (ADIs)
Banks, Building Societies & Credit Unions
▪ Financial Corporations Act Institutions
Money market corporations, Finance companies,
General financiers, Pastoral finance companies
▪ Life offices and Superannuation companies
▪ Other managed funds
Cash management trusts, Friendly societies, Unit trusts
▪ Other financial institutions
General insurers, Securitisation vehicles
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AUSTRALIAN FINANCIAL INSTITUTIONS
Source: Lange et al. (2015)
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AUSTRALIAN BANKING SECTOR
▪ In Australia a bank is defined by the Banking Act 1959.
▪ The words bank, banker or banking can only be used by
a firm if it is approved by the Australian Prudential
Regulation Authority (APRA).
▪ Australian banks must be authorised by APRA,
authorised banks can use these words in their name or to
describe or to advertise their business.
▪ Other firms which can use these words in some
circumstances are credit unions, building societies and
foreign banks.
▪ Generally referred to as Authorised Deposit-taking
Institutions (ADIs)
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AUSTRALIAN BANKING SECTOR
ADI registers as of 21 Dec 2022 (see www.apra.gov.au):
▪ Australian-owned deposit-taking institutions (81)
Major banks – Australia and New Zealand Banking Group Ltd (ANZ);
Commonwealth Bank of Australia (CBA); National Australia Bank Ltd
(NAB) and Westpac Banking Corporation (WBC).
Other domestic banks – e.g. Bendigo and Adelaide Bank Ltd,
Macquarie Bank Ltd, Bank of Queensland Ltd.
Credit unions – e.g. First Choice Credit Unions Ltd, Railways Credit
Union Ltd.
▪ Foreign subsidiary banks (6)
e.g. HSBC Bank Australia Ltd, Bank of China (Australia) Ltd,
Rabobank Australia Ltd.
▪ Branches of foreign banks (49)
e.g. Royal Bank of Canada, State Bank of India, Mizuho Bank Ltd.
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BANK ASSET SIZE ($ Million)
Sep 2019
ADIs
Banks
Major banks
Other domestic banks
Foreign subsidiary banks
Foreign branch banks
All banks
Credit unions and building societies
Other ADIs
All ADIs
Sep 2020
Sep 2021
Sep 2022
3,716,354 3,832,970 3,949,945 4,377,763
505,532
561,743
693,129
849,034
165,683
180,863
188,402
185,511
558,733
619,346
592,901
724,596
4,946,302 5,194,922 5,424,376 6,136,905
50,826
48,108
50,450
53,173
5,238
6,763
8,520
9,301
5,002,367 5,249,793 5,483,346 6,199,378
Source: Adapted from APRA, Statistical Publications: Quarterly Authorised Deposittaking Institution Performance Statistics (published 6 Dec 2022)
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BANK ASSET MARKET SHARE (Percentage)
Sep 2019
Sep 2020
Sep 2021
Sep 2022
ADIs
Banks
Major banks
74.29%
73.01%
72.04%
70.62%
Other domestic banks
10.11%
10.70%
12.64%
13.70%
3.31%
3.45%
3.44%
2.99%
Foreign branch banks
11.17%
11.80%
10.81%
11.69%
All banks
98.88%
98.95%
98.92%
98.99%
Credit unions and building societies
1.02%
0.92%
0.92%
0.86%
Other ADIs
0.10%
0.13%
0.16%
0.15%
100.00%
100.00%
100.00%
100.00%
Foreign subsidiary banks
All ADIs
Source: Adapted from APRA, Statistical Publications: Quarterly Authorised Deposittaking Institution Performance Statistics (published 6 Dec 2022)
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AUSTRALIA BANKING SECTOR
▪ As of Sep 2022, Commonwealth Bank of Australia was
the largest bank in terms of total assets ($1,215,260
million)
▪ Ranks 2, 3 and 4 were taken by Westpac Banking
Corporation, National Australia Bank, and ANZ Banking
Group respectively.
▪ These 'Big 4‘ banks held 71% of the assets of all ADIs in
Australia as of Sep 2022, which points towards a highly
concentrated industry.
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OPERATIONAL FOCUS OF BANKS
▪ Big 4 banks:
– National focus
– Offer complete corporate and retail banking services in Australia
and New Zealand
– Also operate in the South Pacific, Asia, USA and the UK
▪ Smaller (regional) banks:
– Regional, mainly retail, focus with operations across state borders
– Large proportion of assets invested in residential housing loans
due to their building society origins
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BANKS: PERFORMANCE OF BIG 4
▪ Full-service provision by the ‘Big 4’ has led to enhanced
margins.
▪ Enhanced margins led to:
– Higher performance, as reflected in their return on shareholders’
funds
– Greater cost efficiencies
▪ Unlike their international competitors, the ‘Big 4’
performed well even during GFC.
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BANKS: PERFORMANCE OF BIG 4
atio of earnings after ta
to shareholders e uity
ustralia
anada
apan
U
U
uro area
umber of banks
ustralia 4 , anada
, euro area
4 , United ingdom 4 and United tates
cludes minority interests reporting periods vary
ources
B
lobal
,
apan
arket ntelligence
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BANKS: PERFORMANCE OF BIG 4
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BANK REGULATORS – see week 3
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LECTURE 1 - OUTLINE
I.
Overview of the Australian financial system and
banking system
II. Specialness of financial institutions
III. Changing dynamics of specialness
IV. Bank motivation
V. Issues in global and Australian banking since 2007
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MONASH
BUSINESS
SCHOOL
FINANCIAL INSTITUTIONS’ SPECIALNESS
▪ Without financial institutions:
– excess savings could only be held as cash, physical assets or
invested in corporate securities.
– the flow of funds is likely to be low.
– little or no monitoring would occur.
– risk of investments would increase.
▪ Real world: covenants partially alleviate these problems.
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FINANCIAL INSTITUTIONS’ SPECIALNESS
▪ Households might find direct investments in corporate
securities unattractive because of:
1. monitoring/information costs
2. liquidity costs
3. price risk.
▪ Financial institutions stand between households and
the corporate sector.
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FINANCIAL INSTITUTIONS’ SPECIALNESS
▪ Financial institutions fulfill two major functions:
– Brokerage function:
▪ economies of scale
– Intermediation (asset-transformation) function:
▪ primary securities
▪ secondary securities
▪ Financial institutions are better able to resolve the costs
facing an individual making a direct investment.
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INTERMEDIATION – ON-BALANCE SHEET
$’s
Surplus Units
$’s
Intermediary
Contract/Security
Deficit Units
Contract/Security
Deposits
(Bank Liabilities)
Loans
(Bank Assets)
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BANK BALANCE SHEET
ASSETS
Liquid assets
Loans
Other assets
Total (A)
LIABILITIES AND
EQUITY
Deposits
Other liabilities
Equity
Total (L+E)
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BANK BALANCE SHEET: ANZ 2022 (p. 110)
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BANK BALANCE SHEET: ANZ 2022 (p. 110)
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1. MONITORING COSTS (INFORMATION COSTS)
▪ Agency costs: costs relating to the risk that firm owners
and managers use savers' funds in a way that is not in
the best interest of the savers
▪ Principal–Agent problem
▪ Agglomeration of funds resolves the following problems:
– greater incentive for information collection and
monitoring activities (free-rider problem and delegated
monitor)
– development of new secondary securities to more
effectively monitor
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2. LIQUIDITY RISK and 3. PRICE RISK
▪ Financial institutions provide secondary claims to
household savers: high liquidity.
▪ FIs are able to diversify some of their portfolio risks.
Example: bank can offer highly liquid demand deposits
while investing in risky loans as assets.
▪ As long as an FI is sufficiently large to gain from
diversification and monitoring, its financial claims are
likely to be viewed as liquid and attractive to small savers
compared to direct investments.
▪ Less diversified institutions carry:
– Higher default risk
– More highly illiquid claims.
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OTHER ASPECTS OF SPECIALNESS
Reduced transaction costs
▪ Economies of scale in transaction costs:
– purchase of assets in bulk
– lower buy–sell spreads
Maturity intermediation
▪ Maturity intermediation services
▪ Ability to manage the risk caused by the maturity
mismatch between assets & liabilities
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OTHER ASPECTS OF SPECIALNESS
Transmission of monetary policy
▪ nstitutions’ liabilities play significant role in the
transmission of monetary policy
▪ Money supply in Australia:
– M1: currency + bank current deposits
– M3: M1 + all other ADI deposits (including CDs)
– Broad Money: M3 + non-deposit borrowings from all financial
institutions less currency and bank deposits by registered FIs and
cash management trusts.
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OTHER ASPECTS OF SPECIALNESS
Credit allocation
▪
Financial institutions are the major source of finance in
particular sectors of an economy:
– In a number of countries, including Australia: residential real
estate
Intergenerational wealth transfer or time intermediation
▪
Wealth transfer between youth and old age
▪
Facilitated through life insurance and superannuation
funds
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OTHER ASPECTS OF SPECIALNESS
Payment services
▪
Services:
– Cheque clearing
– ATMs
– Debit cards
Denomination intermediation
▪
Giving individuals indirect access to large denomination
markets (by buying shares in a managed fund)
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MONASH
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LECTURE 1 - OUTLINE
I.
Overview of the Australian financial system and
banking system
II. Specialness of financial institutions
III. Changing dynamics of specialness
IV. Bank motivation
V. Issues in global and Australian banking since 2007
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BUSINESS
SCHOOL
CHANGING DYNAMICS OF SPECIALNESS
▪ Demands for special features of financial services
change due to changing preferences, macroeconomic
conditions and technology.
▪ Changing regulations can increase or decrease net
regulatory burden faced in supplying financial services in
any given area.
▪ Financial institutions are required to respond quickly to
changes in order to survive.
▪ Activity barriers within an institution may add to the
regulatory burden.
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CHANGING DYNAMICS OF SPECIALNESS
Table 1-2: Percentage shares of assets of financial institutions in the US, 1860-2018
Source: Saunders et al. (2021, page 16)
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CHANGING DYNAMICS OF SPECIALNESS: FUTURE TRENDS
▪ Potential secular trend away from intermediation
▪ Changed borrower preferences in terms of risk and return
▪ Decline in the relative costs of direct securities
investment
▪ In Australia, banks are moving across traditional product
boundaries and lines.
▪ Banks are growing via mergers and acquisitions.
▪ Fast evolution of direct financial markets
▪ Growing sophistication of investors
▪ Falling costs of information acquisition
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LECTURE 1 - OUTLINE
I.
Overview of the Australian financial system and
banking system
II. Specialness of financial institutions
III. Changing dynamics of specialness
IV. Bank motivation
V. Issues in global and Australian banking since 2007
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SCHOOL
BANK MOTIVATION
“To be one of the world’s great companies, helping our customers, communities
and people to prosper and grow. Our strategy seeks to deliver on this vision by
providing superior returns for our shareholders, building deep and enduring
customer relationships, being a leader in the community and being a place
where the best people want to work.” Westpac Annual Report 2013
“This year we maintained our disciplined approach to home loan growth,
focusing on customers who want to buy and own their own home. We have
deliberately foregone short-term revenue growth and higher margins, particularly
in the investor and interest-only segments. This focus has driven better riskadjusted returns and is in the long-term interest of shareholders.” ANZ Annual
Report 2018
“We remain focused on growing revenue responsibly and committed to our
automation and simplification initiatives to help reshape our business, deliver
easy personalised services to our customers and sustainably grow returns for
our shareholders over the long-term.” ANZ Annual Report 2022
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MEASURING SHAREHOLDER VALUE / WEALTH
▪ A firm’s shareholder value refers to the wealth accruing to
shareholders from their ownership of shares in that firm’s
dividends and capital gain.
(a) Practical measures of SHW:
– Share prices
– Market capitalisation = number of shares issued x share price
(b) Theoretical measure of shareholder wealth
– Requires a mathematical model
– resent value of e pected future Fs discounted at investors’
required rate of return
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THEORETICAL MEASURE
PV (share) =
PV (expected future cash flows)
𝐶𝐹1
𝐶𝐹2
𝑃0 =
+
1+𝑟
1+𝑟
𝐶𝐹𝑛
+ ⋯+
2
1+𝑟
𝑛
Assuming the shareholder expects:
▪ cash benefits of $18 per year per share
▪ to sell the share for $100 in 3 years’time
▪ a required rate of return of 15% per annum
𝑃0 =? ? ?
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SHAREHOLDER VALUE
▪ Hence shareholder wealth/value is influenced by:
– Current and expected CFs
– Timing of the CFs
–
isk and risk appetite of investors this affects investors’ re uired
rate of return)
▪ Management must actively take risks within parameters
set by the board in order to maximise shareholder value,
the risk-return trade-off.
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RISK-RETURN TRADE-OFF
▪
▪
▪
▪
Credit risk
Liquidity risk
Interest rate risk in the banking book
Market risk
– interest rate risk (trading book)
– equity price risk
– commodity price risk
– foreign exchange risk
▪ Operational risk
▪ Insolvency risk
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ASPECTS OF RISK
▪ Risk = uncertainty
▪ A risk situation has
– an expected outcome
– a range of possible actual outcomes
▪ Upside to risk
– Actual outcome is better than expected
▪ Downside to risk
– Actual outcome is worse than expected
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RISK DEPICTION
To measure risk = measure the volatility
or range of possible values the variable
The statistician’s view may take, measure this with the
- standard deviation, or
- variance
Note: risk is not measured
by expected loss
Possible
actual
values
Downside
= returns less than expected
Expected value
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Upside
= returns better than expected
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The share price is a market measure
of shareholder value
More expected returns =
more shareholder value
Shareholder
value
(if risk does not change)
Expected return
Low expected return
High expected return
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But the share market is risk averse so
the share price falls when risk increases
Shareholder
value
More risk = less
shareholder value
(if returns do not change)
Volatility
Low risk
High risk
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At the point where the two marginal effects are equal, the bank must
stop taking on more risk. This is the optimum level of risk and
expected return and so will maximise shareholder value.
Shareholder
value
Optimum = risk-return
mix at which shareholder
value is maximised
Low risk
Low expected return
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High risk
High expected return
MONASH
BUSINESS
SCHOOL
LECTURE 1 - OUTLINE
I.
Overview of the Australian financial system and
banking system
II. Specialness of financial institutions
III. Changing dynamics of specialness
IV. Bank motivation
V. Issues in global and Australian banking since 2007
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MONASH
BUSINESS
SCHOOL
GLOBAL FINANCIAL CRISIS (GFC)
▪ In August 2007, several US hedge funds with big investments in
CDOs (Collateralised Debt Obligations) announced substantial
losses following an increase in subprime borrower default rates.
▪ Financial markets started to wonder about
– the true value of CDO securities,
– which banks and financial institutions had invested in CDOs,
guaranteed CDOs or lent to other institutions with large CDO
investments,
– which banks still held large amounts of sub-prime loans.
▪ Overall markets lost confidence in their ability to assess credit risk.
▪ Financial institutions in the US, UK and Europe were in trouble.
▪ Basel 2 commenced on January 1, 2008.
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THE IMPACT OF THE GFC
▪ As interest rates/yields increased and funding availability
decreased, banks were reluctant to lend to each other.
▪ The globalisation of financial markets spread rapidly from
the US to other big financial centres.
–
–
–
–
–
Short-term finance was largely unavailable.
Securitisation markets closed.
Funding costs increased.
Share markets became more volatile.
Margin loan borrowers faced margin calls, often forcing further
share sales and lower share prices.
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THE IMPACT OF THE GFC
Recent financial crisis leads to the focus on enterprise risk
management (ERM).
▪ Prior to the crisis, the focus was on processes and
systems.
▪ After the crisis, attention shifted to building a strong risk
culture that is supported by government arrangements.
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Post-GFC: 2008-2012
▪ Governments and central banks responded by:
– Reducing interest rates,
– Lending money to financial institutions to increase liquidity,
– Nationalising or taking equity positions in some banks (e.g. in UK
- Northern Rock and all banks in Iceland),
– Providing guaranteed deposits and bank funding,
– Implementing “stimulus packages”
▪ Australia was fortunate in that its banks experienced little
credit default problems and its overall economy remained
positive.
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MORE RECENT ISSUES - GLOBAL
▪ FinTech:
– Financial technology, or FinTech, refers to the use of technology
to deliver financial solutions in a manner that competes with
traditional financial methods.
– Services include cryptocurrencies (for example, bitcoin) and
blockchain.
▪ Climate change risk:
– Transition, physical, and litigation risks
▪ Rising inflation and interest rates, declining house prices,
geo-political tensions
▪ See:
https://www.rba.gov.au/publications/fsr/2022/oct/globalfinancial-environment.html
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MORE RECENT ISSUES – AUSTRALIA
▪ Banks’ profitability has been supported by strong credit
growth and low levels of non-performing loans
▪ Banks have large capital buffers that can be used to
absorb losses, and stress tests suggest they should
remain above minimum capital levels even in a prolonged
recession
▪ Banks' liquidity positions have strengthened
considerably
▪ Some smaller ADIs could record sizeable losses, but are
well capitalised
▪ There remain some longer-term challenges to address
as the economy recovers: climate change, IT (cyber)
risks, risk culture and governance issues.
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MORE RECENT ISSUES (cont’d)
See:
▪ https://www.rba.gov.au/publications/fsr/2022/oct/australianfinancial-system.html
▪ https://www.apra.gov.au/news-and-publications/aprastrengthens-transparency-on-remuneration-and-bankdisclosures
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LECTURE 1 - SUMMARY
I.
Overview of the Australian financial system and
banking system
II. Specialness of financial institutions
III. Changing dynamics of specialness
IV. Bank motivation
V. Issues in global and Australian banking since 2007
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BUSINESS
SCHOOL
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MONASH
BUSINESS
SCHOOL