The Role, Functions and Activities of Financial Institutions
in the Australian Financial System
Financial institutions in Australia are divided into 3 groups: banks, NBFI's and fund managers.They transfer funds from surplus to deficit units, working either in intermediated (banks, NBFI's) or direct financing (fund managers). Intermediated financing is associated with retail banking and direct with wholesale. Being one of the major banks, ANZ is engaged in all kinds of financial activities in Australia.
It receives deposits from individuals and businesses. The bank vary offered interest rates on accounts with different levels of liquidity. The rates are higher for the less liquid accounts ie the ones with longer terms and more limited access for depositors. They also rise as the sum of a deposit increases.
The bank works with the both retail and wholesale sums. ANZ carries out lending function providing loans for various purposes (personal, housing, business).The interest rates on loans are fixed or variable and dependent on a length of the term. The rates are also connected with the level of credit risk faced by banks.
2. Overview of the financial institutions
3. Borrowing Function
4. Lending Function
The financial system of Australia is well-developed and versatile.
It incorporates a large number of financial institutions with each fulfilling its particular roles
They operate in different financial markets with different categories of clientele and with the different sizes of transactions.
This essay aims to discuss these issues on an example of the Australia and New Zealand Banking Group Ltd. (ANZ), one of the four major banks in Australia.
The Overview of the Financial Institutions
Within the Australian financial system such institutions as deposit-taking organisations and fund managers provide a wide range of financial services. They are divided into three groups: banks, non-banking financial institutions (NBFI's) and fund managers. One of their most primary roles is assistance in transferring money from surplus to deficit units. It is achieved by means of direct or intermediated financing.
Originally, banks and NBFI's are mainly engaged in intermediated financing (they receive deposits from customers and then at their own risk invest them in deficit units). Fund managers, on the contrary, work in a direct manner. They arrange direct transactions between two parties with investors taking the risk. Fund managers charge fees (share of transaction's amount ).
Transactions are distinguished by their sizes. Retail banking covers operations with small amounts of funds whereas the wholesale sector deals with large sums. Traditionally, intermediaries work in the retail sector and direct financing is in the wholesale banking.
These days, however, there are no such clear distinctions. Intermediated financing is often done in wholesale transactions (e.g. term deposits). In Australia, the first group of financial institutions, banks are represented by four major banks (ANZ, Commonwealth Bank, National Australia Bank and Westpac). They are the biggest retailers in the country. However, their sphere of activity also encompasses the wholesale banking.
Another group is made up of regional banks (St. George, Advance Bank, Bank of Melbourne,). They operate with retail size transactions. Operations are governed, regulated and controlled by the Reserve Bank of Australia - the Australia's central bank. The second group of financial institutions are NBFI's. They are financial intermediaries which carry functions of retail banks but are not licensed by the RBA and therefore cannot be called 'banks'. Those are building societies (Bendigo, Illawarra Mutual), credit unions and finance companies (AGS, CBCF, Esanda).
Since 1980 some NBFI's obtained licences and became banks (NSW Building Society Ltd. became Advance Bank, St George Building Society became St George Bank). Some finance companies do wholesale banking.
The last group of financial institutions are fund managers. They are merchant banks or money market corporations , investment banks and branch banks. All biggest merchant banks which operate in Australia are foreign owned (Société Generale, Toronto Dominion, Bankers Trust). Investment banks are also chiefly overseas (Hong Kong Bank of Australia, Chase Manhattan) with the exception of Macquarie Bank, the major Australian-owned fund manager.
Finally, there are branches of foreign banks (BNP, BNZ, Barclays). They are all basically engaged in wholesale banking, working with greater sums and big companies. Some, however, are present in the retail sector (Citibank, Deutsche Bank).
As mentioned above, the four major banks undertake both the retail and wholesale banking in Australia. They carry various kinds of borrowing and lending functions . The borrowed funds (liabilities of the banks) are presented in current accounts, call deposits, fixed-term deposits, passbooks and the like. These activities will be viewed on the example of the ANZ Banking Group.
Current accounts are highly liquid, i.e. depositors have unlimited access to their funds. The high level of liquidity results in excess costs for banks. As a consequence the banks offer low interest rates on such accounts. Besides, banks impose servicing and excess withdrawal fees. Banks even offer accounts with no interest paid at all for exchange of charging no fees.
For example, the 'Access' account with ANZ allows customers free access to funds either electronically (using ATM's and EFTPOS), at the counter or using cheques. This convenience , however, costs for customers in low interest rates. The bank calculates from 0.25% p.a. on account of $1000-1999 to 2.50 % p.a. if the account is $50,000 or more. Clients have to pay monthly servicing fees, fees for every withdrawal that is beyond the limit, fees for using non-ANZ ATM's, fees if the account falls below the indicated limit.
The bank offers also non-bearing interest and no fees (except for the use of other banks' ATM's) account 'Access Simplicity'.
Less liquid accounts where depositors do not have (or have very limited) access to their funds allow banks to pay higher interest on them. Fixed-term deposit is one of such accounts on offer. It assumes that a customer deposits money with the bank for a fixed period of time (from one month to several years) and receives higher interest rates but only in the case if the deposit is kept in the bank for the whole duration of the term. The premature withdrawal incurs financial penalty in the form of fees and no interest paid. Interest rates are significantly greater for these accounts. As an illustration $10,000 in a current 'Access' account with ANZ will yield 0.65% p.a. (minus fees), whilst the same amount kept one year in the 'Term Deposit' will earn 5.50% p.a. In addition, interest rates increase with the length of the term (e.g. 6.50% for the five-year deposit of $10,000).
Other accounts are cash management accounts and investment savings accounts. They also bear higher interest rates but require a certain minimum balance held. The rates are in direct proportion to amount of money. For example, ANZ Cash Management Account pays nominal rate 2.00% p.a. and effective 2.02% p.a. for the account of $10,000. The minimum opening balance is $5,000; the minimum balance for keeping an account is $1,000 and $2,000 for calculating interest. The rates increase after the sum of $20,000 (4.00% p.a. and 4.07% p.a.) and reach 5.25% p.a. and 5.38% p.a. with balance of $250,000 or over.
ANZ Bank promotes other ways of investments and fund management. For wholesale customers the bank proposes certificates of deposits (ANZ Investment Bank Bills). Bills value starts from $100,000. Terms vary from seven to 180 days. For instance, the bill with a face value of $100,000 and yield of 7.25% can be currently purchased for 30 days at $99,407.64.
Another investment opportunity is an 'ANZ Fixed Interest Trust'. Under this agreement the bank carries out both the direct and intermediated financing. Customers have an option to invest funds in securities directly (such as Government bonds, debentures, unsecured notes of major companies etc.) The bank charges fees from the amount of a transaction. Alternatively, clients can assign the bank to choose and make investment. The Fixed Interest Trust is arranged equally for the retail and wholesale sums. The minimum initial amount is $2,000. The payments are made on a half-yearly basis.
The other side of financial activity is lending raised funds to deficit units. Banks, NBFI's and fund managers are widely engaged in providing different kinds of lending services. This use of funds is reflected on the assets side of the institutions' balance sheets.
One of the most common activities is provision of loans. Loans are offered for all kinds of customers from individuals (housing and personal loans) and small businesses to governments and large companies (term loans, overdrafts, syndicated loans).
Housing loans have become an essential kind of banking activity in Australia. They are usually long-term loans up to 25 years. The interest rates can be either fixed or floating (variable). The borrower makes periodic repayments (with accrued interest) during the term, generally on a monthly basis. Loan issuers secure them by the mortgage over the financed property. In Australia, the market for housing loans is shared by most banks, NBFI's and by mortgage originators (Aussie Home Loans, RAMS). Along with other banks, ANZ offers a variety of housing loans. Home loans have fixed or variable interest rates. Fixed rates for ANZ Home Loan are from 7.50% p.a. - 1 year to 8.75% p.a. for 5 years. Variable interest rates are dependent on the economic situation reflecting the impact of inflation and other economic factors. Home loan with variable rates also allows borrowers to alter the repayment model (weekly, fortnightly and monthly). Presently the variable rate is 7.55% p.a.
Another option is 'Land Loan'; a subsidy for buying land and building property. The rate is variable, the same as for the Home Loan (7.55% p.a.). There are other services supplied in conjunction with the housing loan such as Home Improvement Loan (borrowing extra cash additionally to the initial home loan) for renovating or changing property purposes. The bank also offers home insurance, mortgage repayment insurance and other facilities.
The next significant group of loans are personal loans for special needs (e.g. to buy a motor vehicle). These loans can either be secured (e.g. mortgage of a vehicle) or unsecured. The loans are of short to medium terms. Being the source of relatively high risk for the banks, personal loans have higher interest rates. They are in proportional dependency to the term's length. The applicable rates can also be fixed or variable. The variable rate of the ANZ Personal loan is 11.75% p.a. Fixed rates are from 12.30% p.a. for one year to 13.00% p.a. for the term of five years. The loan is repaid monthly (including accrued interest).
Credit cards are the most popular kinds of personal loans. They simplified the process of borrowing and returning funds. They provide flexibility and convenience (such as cashless payments overseas). However, customers have to face high interest rates on outstanding balances. That is partly due to the fact that card issuers bear an excess credit risk. Along with the high rates, they impose annual fees on cardholders and charges on retail outlets. which accept credit cards.
Cards issued by ANZ Bank have rates from 12.95% p.a. for the Low Interest MasterCard (cardholders don't have interest-free days) to 15.95% for Free Days Visa or MasterCard.
Finally, banks and other financial institutions offer loans for business purposes. These are term loans, overdrafts, bill financing, leases etc. Term Loans are the most essential type of business loans. The loans are signed for a certain period (from one to five years). Before approving a loan, lenders investigate the credibility of the borrower, evaluate assets and liabilities, expected cash flow and the expediency of the project.
Generally, loan issuers demand security (mortgage on assets). ANZ, for instance offer business loans for small and medium enterprises with the maximum amount of $250,000. The loan requires security (mortgage of the residential property). Fixed interest rates are 7.9% p.a. for the terms of 1, 2 and 3 years, 8.7% p.a. for 4 and 8.8%p.a. for 5 years. The variable rate is at 7.8% p.a.
As seen from the essay financial institutions provide a whole spectrum of services catering for all categories of customers; from individuals to large companies. Their activities are seen in the borrowing and lending processes. Their growth and successful functioning lead to harmonious existence of the financial system, as well as contribute to the growth of the national economy as a whole.
Hunt, B., Terry Ch., Financial Institutions and Markets, Melbourne , Nelson ITP 1997