1. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-1 Chapter 3 Non-bank Financial Institutions (NBFIs) Website: www.apra.gov.au

2. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-2 Learning Objectives Understand the role of NBFIs in the financial system Outline the financial products and services provided by NBFIs Describe NBFIs’ principal sources and uses of funds

3. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-3 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

4. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-4 3.1Investment and Merchant Banks Evolved under regulation Are not authorised banks and are officially classified as ‘money market corporations’ Share of total assets declined from 7% in 1990 to 3% in 2005 Sources of funds –Mainly short-term securities issued in money markets and capital markets –Mainly offshore due to parent companies, globalisation and deregulation of FOREX markets, and outside jurisdiction of local regulator and capital requirements

5. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-5 3.1Investment and Merchant Banks (cont.) Uses of funds –Primarily loans to large corporations and governments; often short-term, wholesale finance –Little direct involvement in household sector except through cash management and unit trust products –Share of total financial assets declined to about 3%, reflecting growing importance of OBS business

6. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-6 3.1Investment and Merchant Banks (cont.) Off-balance-sheet business –Innovative products and services in provision of advice, management and funding services generating their main income from fees, e.g.  FOREX dealers, advice on raising funds, underwriting equity/debt issues, shares placements, balance-sheet restructuring, venture capital  Mergers and acquisitions—takeover company seeks to gain control over a target company Horizontal, vertical, conglomerate and hostile takeovers Synergies, economic/legal/accounting/tax considerations Analysis, valuation, negotiation, due diligence

7. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-7 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

8. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-8 3.2Life Insurance Offices Share of total assets declined from 11% in 1990 to 7% in 2005 Sources of funds –Premiums paid and policyholders or beneficiaries receive payment upon death/disablement or at a nominated maturity date, subject to policy terms –Superannuation/retirement contributions  Inflow of funds is regular, predictable and long term –Life insurance policies  Whole-of-life, term-life, total and permanent disablement, trauma, income protection, business overheads

9. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-9 3.2Life Insurance Offices (cont.) Uses of funds –Outflow of funds quite predictable and stable and thus invest mainly in long-term securities –$216 billion in statutory funds as at March 2005  63% held in equities and unit trusts  13% invested in long-term securities  10% held in cash and short-term investments  8% invested overseas Regulation  Supervised by APRA, which applies the same capital and liquidity management requirements as for banks  Life Insurance Act 1995 (Cwlth)—licensing and control

10. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-10 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

11. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-11 3.3General Insurance Offices Insurer pays the insured a predetermined amount if some prespecified event occurs Share of total assets declined from 4% in 1990 to 3% in 2005 Sources of funds –Contractual premiums paid in advance for  House and content Co-insurance, public liability insurance  Motor vehicle insurance Comprehensive; third party, fire and theft; third party; compulsory third party –Inflow of funds not as stable as life offices

12. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-12 3.3General Insurance Offices (cont.) Uses of funds –Generally shorter-term, highly marketable securities, due to the less predictable nature of the risks underwritten –Examples  Money market securities, such as bills of exchange, commercial paper and certificates of deposit

13. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-13 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

14. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-14 3.4Superannuation Funds Savings accumulated to fund an individual’s retirement Share of assets increased from 11% in 1990 to 16% in 2005 APRA classifies superannuation funds as  Corporate funds  Industry funds  Public sector funds  Retail funds  Small APRA funds  Self-managed funds

15. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-15 3.4Superannuation Funds (cont.) Classification by sources of funds –Corporate, industry and public sector funds  Corporate funds provide benefits to employees of a specific company  Industry funds provide benefits to employees working within a particular industry  Public sector funds provide benefits to government employees and can be under-funded  Can be contributory (employer and employee contribute) or non-contributory (only employer contributes)

16. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-16 3.4Superannuation Funds (cont.) Classification by sources of funds (cont.) –Compulsory funds  Legislation requiring employers contribute a defined amount to employees’ superannuation accounts  Australian employers not paying the mandatory 9% into employees’ superannuation funds must pay the superannuation guarantee fund (SGC) –Rollover funds  Hold eligible termination payments (ETP) within the regulated superannuation environment  ETPs are superannuation funds due on termination of employment plus related redundancy payments

17. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-17 3.4Superannuation Funds (cont.) Classification by sources of funds (cont.) –Private (or personal) superannuation funds  Retail funds—offer superannuation products to the public on a commercial basis  Small APRA funds—have less than 5 members and are regulated by APRA  Self-managed funds—have less than 5 members and are regulated by the ATO  Retail, small APRA and self-managed superannuation funds represent 56% of total superannuation funds Savings plan—regular contributions by an individual Single-premium scheme—single up-front contribution

18. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-18 3.4Superannuation Funds (cont.) Types of superannuation funds by investment –Capital guaranteed funds  Value of contributions guaranteed, but not future earnings  Investments are low risk, low return, e.g. government and semi-government securities, bank bills, debentures and cash deposits –Capital stable funds  Contributions are mostly protected by investments in low risk securities  Investments as per capital-guaranteed fund plus property

19. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-19 3.4Superannuation Funds (cont.) Types of superannuation funds by investment (cont.) –Balanced growth funds  Investments in longer-term income streams supported by limited capital growth  Investments include domestic and foreign equities –Managed growth (or capital growth) funds  Invest for greater return through capital growth and less through income streams  Investments include a greater proportion of domestic and foreign equities

20. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-20 3.4Superannuation Funds (cont.) Types of superannuation funds by investment (cont.) –Defined benefit funds  Amount paid to employee on retirement is based on a defined formula  Risk lies with employer who must make good any shortfall –Accumulation funds  Amount of funds available at retirement consists of contributions plus earnings less taxes and expenses

21. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-21 3.4Superannuation Funds (cont.) Regulation –Legislation directly impacting on the operation of superannuation funds is  Superannuation Industry (Supervision) Act 1993 (Cwlth) (SIS)  Income tax Assessment Act 1936 –Concessional tax treatment of fund contributions and earnings –Reasonable Benefit Limit (RBL)  Amount of concessionally taxed superannuation funds allowable—lump-sum and pension limits

22. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-22 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

23. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-23 3.5Finance Companies and General Financiers Emerged largely due to previously highly regulated banking sector to circumvent restrictions on interest rates and lending Sector can be classified into –Diversified finance companies –Manufacturer-affiliated companies, e.g. Ford Credit –Niche specialists, e.g motor vehicle and lease financing

24. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-24 3.5Finance Companies and General Financiers (cont.) Sector share of total assets has declined from 7% in 1990 to less than 3% in 2005 as commercial banks are more competitive in deregulated environment Sources of funds –Issue of debentures and unsecured notes –Borrowings from related corporations and banks –Borrowing direct from domestic and international money and capital markets

25. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-25 3.5Finance Companies and General Financiers (cont.) Uses of funds –Loans to individuals, possibly higher risk –Lease financing –Loans to small- and medium-sized businesses (e.g. bills finance, term loans, floor plan financing, factoring and accounts receivable financing)

26. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-26 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

27. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-27 3.6 Permanent Building Societies (PBS) Sector structure –During regulation PBS gained market share at the expense of savings banks –Since deregulation the sector share of total assets declined from 3% in 1990 to 0.6% in 2005. In response some PBS have:  Merged to rationalise costs  Become banks, e.g. Challenge Bank and Advance Bank  Improved technology for service and cost reasons  Diversified activities and products offered to savers and borrowers

28. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-28 3.6 Permanent Building Societies (PBS) (cont.) Sources of funds –Mainly deposits from customers Uses of funds –Personal finance to individual borrowers  Mainly housing finance  Term loans and credit card finance Regulation –As ADIs (i.e. authorised by APRA to accept retail deposits), regulation is by APRA with the same prudential and reporting standards as banks

29. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-29 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

30. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-30 3.7Credit Cooperatives Also known as credit unions Common bond of association often exists between members due to employment, industry or community (e.g. Shell Employees’ Credit Union) Share of total assets stable at 1.1% Sources of funds  Mainly deposits from members (payroll deductions)  Other credit unions and the issue of promissory notes and other securities

31. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-31 3.7Credit Cooperatives (cont.) Uses of funds –Primarily personal finance to members  Residential housing loans  Personal loans and credit card facilities  Limited commercial lending Regulation –As an ADI, regulated by APRA, which applies the same prudential and reporting standards as banks and PBS

32. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-32 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

33. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-33 3.8Managed Funds Investment vehicle for investing the pooled savings of individuals in various asset classes in domestic and international money and capital markets by fund managers –Mutual fund (USA)  Managed funds established under a corporate structure; investors purchase shares in the fund –Trust fund (Australia and UK)  Managed funds established under a trust deed, managed by a trustee or responsible entity  Investors in the fund obtain a right to the assets of the fund and a share of the income and capital gains (losses) derived

34. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-34 3.8Managed Funds (cont.) Growth in sector driven by deregulation, ageing populations and more educated investors Sources of funds –Funding derived from specific contractual commitments of investors  Periodic payments to the fund, e.g. superannuation  Single payment or premium, e.g. insurance policy –Total assets $993 billion as at March 2005  More than $745 (75%) managed by life insurance offices and superannuation funds –Funds under management 36% of total assets of all financial institutions

35. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-35 3.8Managed Funds (cont.) Uses of funds –Large funds typically allocate a portion of the total asset portfolio to several professional fund managers for risk- and performance-management purposes –Professional managers invest in asset types authorised under the trust deed of a particular fund

36. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-36 3.8Managed Funds (cont.) Main categories of managed funds –Superannuation funds—discussed in section 3.4  72% ($711 billion) of total funds under management –Public unit trusts  Investors purchase a share in the trust in the form of a ‘unit’  The trustee invests the pooled funds received from investors  Unit holders receive a return in the form of income and/ or capital gain  Listed trusts Units quoted and sold on the ASX (more liquid)—mainly property trusts  Unlisted trusts units sold back to trustee after giving the required notice (less liquid)—mainly equity trusts

37. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-37 3.8Managed Funds (cont.) Main categories of managed funds (cont.) –Public unit trusts (cont.)  19% ($197 billion) of total funds under management  Types of unit trusts and share of total assets: Property trusts (37%) Equity trusts (50%) Mortgage trusts (3%) Other (including fixed-interest trusts) (10%)

38. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-38 3.8Managed Funds (cont.) Main categories of managed funds (cont.) –Cash management trusts  Investment funds established under a trust deed, specifying the trust’s investments  Generally invest in short-term money-market instruments  Provide high liquidity for the investor  Provide retail investors access to the wholesale market Cash and deposits 56%, bills of exchange 20%, promissory notes 15%, other assets 10%  3.5% ($35 billion) of total funds under management

39. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-39 3.8Managed Funds (cont.) Main categories of managed funds (cont.) –Statutory funds of life offices  Funds established within a life insurance office that hold and separate assets backing policyholder liabilities from other assets of the life office  3.4% ($34 billion) of total funds under management –Common funds  Operated by trustee companies, they pool funds of beneficiaries and invest in specified asset classes  Differ from unit trusts in that units are not issued  E.g. solicitors offering mortgage trusts  1% ($10 billion) of total funds under management

40. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-40 3.8Managed Funds (cont.) Main categories of managed funds (cont.) –Friendly societies  Mutual organisations that provide investment and other services (insurance, sickness, unemployment benefits) to members  Investment products include the issue of bonds that invest in assets classes like cash, fixed-interest, equities and property  0.6% ($6 billion) of total funds under management

41. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-41 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

42. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-42 3.9Export FinanceCorporations Government authorities that provide financial support and services to exporting corporations Official Australian export credit agency is Export Finance and Insurance Corporation (EFIC)

43. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-43 3.9Export Finance Corporations (cont.) EFIC facilitates export trade by providing trade insurance and financial services and products, which may not be available from other financial institutions –Insures Australian exporters against non-payment –Guarantees trade finance for the purchase of Australian goods and services –Insures Australian firms against political risk of overseas investments –Indemnifies financial transactions of insurers that provide bonds/guarantees to overseas buyers and provide performance bonds in support of Australian export contracts

44. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-44 Chapter Organisation 3.1Investment and Merchant Banks 3.2Life Insurance Offices 3.3General Insurance Offices 3.4Superannuation Funds 3.5Finance Companies and GeneralFinanciers 3.6Permanent Building Societies 3.7Credit Cooperatives 3.8Managed Funds 3.9Export Finance Corporations 3.10 Summary

45. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-45 3.10Summary NBFIs can be classified according to their assets and liabilities and the type of services provided Money market corporations provide advisory services to corporations and government Life insurance and general insurance offices are contractual savings institutions that generate funds mainly on the receipt of premiums for insurance policies Superannuation funds facilitate saving by individuals for their retirement

46. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 3-46 3.10Summary (cont.) Finance companies issue debentures and unsecured notes and lend to individuals and businesses PBS and credit unions receive deposits from individuals and lend for residential housing Managed funds provide access to wholesale investment markets for pooled savings EFIC provides insurance and financial services and products for exporters