Banking and Financial Institutions ACF-104 Guy Hargreaves Wechat: Guyhargreaves

Case study: ANZ Bank How does a real commercial bank operate?

Today’s goals Understand various components of an Australian commercial banking business Review of important functions of a commercial bank including liquidity, capital, margins, revenues, strategy by studying ANZ Form a sound understanding between the theory of banking and practice by studying ANZ bank case

ANZ Banking Group Top 20 global bank by market capitalisation One of four major banks in Australia Good commercial bank to study

Some ANZ shortcuts: Australia – means retail + small commercial in Australia New Zealand - means retail + small commercial in New Zealand APEA – Asia Pacific Europe Americas (ie all the rest!) IIB – Institutional Investment Bank ie all Commercial Wholesale Banking activities including Financial Markets, Corporate Banking etc

Sustainability important to ANZ

Elements of good banking

Global bank, regional strategy

Diversified income streams

Diversified balance sheet

Important numbers for ANZ Provisions: write down of loan value which flows through P&L PBP: profit before provisions ROE: return on equity CET1: Common Equity Tier 1 - % equity versus total assets ie regulatory capital APRA: ANZ’s banking regulator

FX matters to results Revenue generated in multiple currencies ie AUD, NZD, USD, GBP etc When revenue generated in non-AUD then AUD FX rate important If AUD FX rates held constant over the six months Revenue growth would have been 5.3% NPAT: Net Profit after Tax ROE: Return on Equity

Net Interest Margin NIM closely watched Difference between deposit rates and lending rates mainly NIM defined for: Business Assets Retail Assets Deposits NIM falling = more competition in market usually

Cost / Income closely watched

Return on RWA RWA: Risk Weighted Assets Regulatory Capital = RWA * BIS III % ratios BIS III % ratios set by Basel committees and managed by Bank Regulators Return on RWA = NPAT/RWA Gives properly adjusted sense of banks net earning margins adjusted for risk

Risk: Credit Provisions are losses expected to be made on defaulted or near defaulted loans Impaired Assets are financial assets that are under significant risk of having provisions made against them ANZ’s impairment trend is positive ie problem customers are being worked out of the bank

X-Sell is vital in commercial banking Customer acquisition costs are mostly fixed (not variable) Once a Customer has passed KYC (Know your Customer) rules then an account can be established Once an account is established ANZ wants to not just sell one product to the customer, but two or three or five!

Digital investment critical From zero in 2012 ANZ has grown mobile banking revenue massively Fending off the challenge from Silicon Valley which is using technology aggressively to poach bank customers Commercial banks MUST invest in FINTECH or risk being left behind like the old taxi industry (UBER)

Many factors impact Wholesale Banking ANZ Wholesale Bank was impacted by: Margins, counterparty credit risk charges (FVA), commodity prices, regulatory costs, trade finance volumes, FX rates etc etc

ANZ Banking Group Top 20 global bank by market capitalisation One of four major banks in Australia Good commercial bank to study

Areas covered so far Capital allocation: sustainability Commercial banks are interested in: Group, financial, treasury, risk, strategy, mortgages, portfolio Strategy: global, regional, local, technology Risk: diversified income, asset portfolio, provisions, impairments, FX exposures, Cost/Income, KYC, liquidity Financial: NPAT, ROE, RoRWA, NIM, X-sell, Regulatory: CET1, RoRWA, LCR

Wholesale Asia strategy

Asia wholesale is diversified ANZ wholesale bank’s Asia portfolio very well diversified across countries China, Singapore, Japan, Hong Kong biggest exposures In another 5-10 countries as well Good management of Country Risk

ANZ in China

Markets revenue customer driven Dodd Frank rules move financial markets towards customers and away from trading Customer revenues not reliant on market volatility Income variability lower when customer driven

Diversified markets income Financial markets income diversified across products: FX Rates Capital Markets Commodities Other

Market risk carefully managed Balance sheet usage low Market VAR $150-200k Low revenue volatility

Cost management

Continual investment Investing in: Risk management Security Operational risk Front office products Front office infrastructure

Provisions: collective and individual

Historical losses lag corp leverage

Truly diversified portfolio

Diversified agri portfolio

Mortgage data – important! Mortgages are THE core product of retail banks ANZ’s mortgage business is very healthy 60% of all Australian lending is mortgages LVR: Loan to Value Ratio ie the amount of mortgage outstanding / value of the property secured under the mortgage Average mortgage size AUD 376,000

Mortgage risk - low 45% of ANZ’s mortgage portfolio is secured by property at LVR < 60% Some mortgage LVRs 95%+ which is a bit risky usually requires a mortgage insurance policy

Mortgage losses very low For Australian mortgages ANZ losses (ie provisions that have turned into actual losses) 0.01% If mortgage NIM is 2% then losing 0.01% is very acceptable Losses are low because mortgages are secured by property at LVR of 60%-90% mainly If borrower defaults bank can sell the property and usually recover all loan payments due ie recovery of 100%

Why low mortgage losses?

Prudent lending processes ANZ has very strong and prudent mortgage lending practices From pre-application to fulfillment (paying out the loan money) the system checks and assesses all risks carefully Credit assessment very important

What more have we covered today Risk: Asia strategy, portfolio diversification Financial markets: customer focus, risk management, diversification of income, cost management Balance sheet management: diversification Mortgages: risk management, strategy, diversification

Good commercial banking Good commercial banking requires sound management practices Diversity: risk, income, geographies, business lines and products Financial: focus on NIM, NPAT, regulatory capital, provisions (risk management), costs Strategy: invest in technology, focus on strengths, understand your business, enter/exit business prudently Good banking = healthy banking system = healthy financial system able to withstand crises/shocks

Regulatory Capital – important!

Balance Sheet composition

Remember Basel BIS III? Increases Required Capital – Tier 1 up from 4% to 6% Introduces Leverage Ratio – ratio of Tier 1 capital divided by “total exposure” to be a minimum of 3% Introduces Liquidity Cover Ratio (LCR) – High quality liquid assets divided by net cash outflows over the next 30 days >100% Introduces Net Stable Funding Ratio – Long Term Stable Funding divided by Long Term Assets (> 1-year) > 100%

LCR is operating at ANZ