1. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 1 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter 2 The Banking Sector Websites: http://www.apra.gov.au http://www.asic.gov.au http://www.accc.gov.au

2. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 2 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Learning Objectives Evaluate the functions and activities of commercial banks Identify the main sources and uses of funds and reasons for changes Analyse the importance of changes in the role of banks on the financial system

3. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 3 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Learning Objectives (cont.) Examine the market structure of the banking sector Outline the nature and importance of banks off-balance-sheet (OBS) business Consider the regulation and prudential supervision of banks

4. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 4 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 2.1Introduction 2.2Functions of Banks 2.3Sources of Funds 2.4Uses of Funds 2.5Off-balance-sheet Business 2.6Regulation and Prudential Supervision 2.7Summary

5. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 5 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.1 Introduction Banking Act 1959 (Cwlth) – Authorises a financial institution to operate as a bank Three categories of banks – Incorporated banks: domestic and foreign – Unincorporated foreign bank branches – Foreign bank representative offices

6. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 6 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.1 Introduction (cont.) Importance of banks – Largest share of assets of all institutions  Share declined 1950s to mid-1980s due to regulation which constrained development of banks supported evolution and growth in NBFIs – Role in international financial markets – Increase in managed funds activities and OBS business

7. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 7 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.1 Introduction (cont.)

8. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 8 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 2.1Introduction 2.2Functions of Banks 2.3Sources of Funds 2.4Uses of Funds 2.5Off-balance-sheet Business 2.6Regulation and Prudential Supervision 2.7Summary

9. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 9 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.2 Functions of Banks Asset management (−1980s) – Loans portfolio is tailored to match the available deposit base Liability management (1980s−) – Deposit base and other funding sources are managed to fund loan demand  Commercial bill market  Provision of other financial services  OBS

10. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 10 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 2.1Introduction 2.2Functions of Banks 2.3Sources of Funds 2.4Uses of Funds 2.5Off-balance sheet Business 2.6Regulation and Prudential Supervision 2.7Summary

11. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 11 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds Sources of funds appear in the balance sheet as either liabilities or shareholders funds Banks offer a range of deposit and investment products with different mixes of liquidity, return, maturity and cash flow structure to attract the savings of surplus entities

12. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 12 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds (cont.) Current deposits – Funds held in a cheque account – Highly liquid – May be interest or non-interest bearing Call or demand deposits – Funds held in savings accounts that can be withdrawn on demand – e.g. passbook account, electronic statement account with ATM and EFTPOS

13. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 13 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds (cont.) Term deposits – Funds lodged in an account for a predetermined period at a specified interest rate  Term: one month to five years  Loss of liquidity due to fixed maturity  Higher interest rate than current or call accounts  Generally fixed interest rate

14. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 14 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds (cont.) Negotiable certificates of deposit (CDs) – Paper issued by a bank in its own name – Issued at a discount to face value – Specifies repayment of the face value of the CD at maturity – Highly negotiable security – Short term (30 to 180 days)

15. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 15 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds (cont.) Bill acceptance liabilities – Bill of exchange  A security issued into the money market at a discount to the face value. The face value is repaid to the holder at maturity – Acceptance  Issuer of bill agrees to pay bank face value of bill, plus a fee, at maturity date  Acceptance by bank guarantees flow of funds to its customers without using its own funds

16. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 16 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds (cont.) Debt liabilities – Medium- to longer-term debt instruments issued by a bank  Debenture A bond supported by a form of security, being a charge over the assets of the issuer (e.g. collateralised floating charge)  Unsecured note A bond issued with no supporting security

17. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 17 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds (cont.) Foreign currency liabilities – The issue of debt instruments into the international capital markets that are denominated in a foreign currency  allows diversification of funding sources into international markets  facilitates matching of foreign exchange denominated assets  meet demand of corporate customers for foreign exchange products

18. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 18 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.3 Sources of Funds (cont.) Loan capital – Sources of funds that have the characteristic of both debt and equity (e.g. subordinated debentures and subordinated notes)  Subordinated means the holder of the security has a claim on interest payments or the assets of the issuer, after all other creditors have been paid (excluding ordinary shareholders)

19. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 19 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 2.1Introduction 2.2Functions of Banks 2.3Sources of Funds 2.4Uses of Funds 2.5Off-balance-sheet Business 2.6Regulation and Prudential Supervision 2.7Summary

20. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 20 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.4 Uses of Funds Uses of funds appear in the balance sheet as assets The majority of bank assets are loans which give rise to an entitlement to future cash flows, i.e. interest and repayment of principal  Lending to government  Commercial lending  Personal finance

21. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 21 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.4 Uses of Funds (cont.) Lending to government – Treasury notes  Short-term discount securities issued by the Commonwealth Government – Treasury bonds  Medium- to longer-term securities issued by the commonwealth government that pay a specified interest coupon stream – State government debt securities – Low risk and low return

22. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 22 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.4 Uses of Funds (cont.) Commercial lending (business sector and other financial intermediaries) – Fixed-term loan  A loan with negotiated terms and conditions Period of the loan Interest rates – Fixed or variable rates set to a specified reference rate (e.g. BBSW) Timing of interest payment Repayment of principal

23. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 23 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.4 Uses of Funds (cont.) – Overdraft  A facility allowing a business’s operating account into debit up to an agreed limit – Bank bills held  Bills of exchange (see slide 15) accepted and discounted by a bank and held as assets  A rollover facility is where a bank agrees to discount new bills over a specified period as existing bills mature – Leasing

24. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 24 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.4 Uses of Funds (cont.) Personal finance – Housing finance  Mortgage  Amortised loan – Investment property – Fixed-term loan – Credit card Other bank assets (e.g. infrastructure, shares in controlled entities)

25. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 25 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 2.1Introduction 2.2Functions of Banks 2.3Sources of Funds 2.4Uses of Funds 2.5Off-balance-sheet Business 2.6Regulation and Prudential Supervision 2.7Summary

26. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 26 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.5 Off-balance-sheet Business OBS transactions are a significant part of a bank’s business OBS transactions include – Direct credit substitutes – Trade and performance-related items – Commitments – Market rate-related transactions

27. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 27 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.5 Off-balance-sheet Business (cont.) Direct credit substitutes – An undertaking by a bank to support the financial obligations of a client (e.g. ‘stand-by letter of credit’)  The bank acts as guarantor on behalf of a client for a fee  Client has a financial obligation to a third party  Bank is only required to make a payment if the client defaults on a payment to a third party

28. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 28 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.5 Off-balance-sheet Business (cont.) Trade and performance-related items – A form of guarantee provided by a bank to a third party, promising financial compensation for non-performance of commercial contract by a bank client  Examples Documentary letters of credit Performance guarantees

29. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 29 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.5 Off-balance-sheet Business (cont.) Commitments – The contractual financial obligations of a bank that are yet to be completed or delivered  Bank undertakes to advance funds or make a purchase of assets at some time in the future  Examples Forward purchases Underwriting

30. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 30 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.5 Off-balance-sheet Business (cont.) Market rate-related transactions – The use of derivative products to manage exposures to foreign exchange risk, interest rate risk, equity price risk and commodity risk, i.e. hedging – Examples  Futures, options, foreign exchange contracts, currency swaps, forward rate agreements (FRAs) – Also used for speculating

31. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 31 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.5 Off-balance-sheet Business (cont.) Volume of OBS business – At June 2001, the face value of OBS business undertaken by banks in Australia was over six times the level of total assets – Over 92% of OBS business is based on market rate-related transactions  Nature and size of contracts combined with the volatility and speed of contract repricing has resulted in extraordinary losses

32. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 32 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 2.1Introduction 2.2Functions of Banks 2.3Sources of Funds 2.4Uses of Funds 2.5Off-balance-sheet Business 2.6Regulation and Prudential Supervision 2.7Summary

33. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 33 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.6Regulation and Prudential Supervision Objectives of regulation and prudential supervision Wallis Report Capital adequacy requirements Liquidity management Other regulatory and supervisory controls

34. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 34 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Objectives of regulation and prudential supervision Reasons for regulation of banks – Importance of the banking sector for health of the economy Prudential supervision – Control of the money supply – The imposition and monitoring of standards designed to ensure the soundness and stability of the banking sector

35. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 35 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Wallis Report Inquiry into the Australian Financial System with a focus on – the effect of compulsory superannuation and changing savings patterns on customer needs – technology facilitating easy access to a greater range of financial products – the need for a change in regulatory framework motivated by financial market globalisation and the Campbell Report findings – the changing financial landscape due to the evolution of business needs, financial markets and products

36. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 36 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Wallis Report (cont.) Post-inquiry Regulatory Structure – Australian Securities and Investments Commission (ASIC)  Market integrity and consumer protection – Australian Prudential Regulation Authority (APRA)  New prudent regulator of deposit-taking institutions (previously RBA) – Australian Competition and Consumer Commission (ACCC)  Competition policy – RBA  System stability and monetary policy

37. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 37 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Capital adequacy requirements (cont.) Capital Standards – Bank for International Settlements (BIS) developed international capital adequacy requirements (1988) – Adopted in all major industrial countries (including Australia) – Banks required to hold minimum 8% capital to risk-weighted assets and OBS items

38. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 38 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Capital adequacy requirements (cont.) Capital measured in two tiers  Tier 1: core capital e.g. ordinary shares, general reserves, retained earnings tier 1 capital required to be at least 50% of bank’s required capital base  Tier 2: supplementary capital upper tier 2: e.g. asset revaluation reserves perpetual subordinated debt lower tier 2: e.g. term subordinated debt

39. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 39 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Capital adequacy requirements (cont.) Risk Weighting of Balance Sheet Assets  Asset risk weightings are based on the counterparty to the transaction 0% notes and coins, claims against central governments and central banks 20% claims against local governments, domestic banks and international banks 50% loans secured by residential mortgages 100%all other assets and claims against counterparties

40. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 40 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Capital adequacy requirements (cont.) Application of Asset Risk Weightings Asset type Asset value Risk weight Risk-weighted asset ($billion) (%) value ($billion) Cash and cwth govt securities 2 000 0 0 Loans to local govt 1 000 20 200 Housing loans24 000 5012 000 Loans to corporations20 000 10020 000 TOTAL 47 00032 200 Total capital requirement: 8% x $32 200 billion = $2576 billion Tier 1 capital requirement:$32 200 x 4% = $1288 billion To fund these assets, the bank requires $2576 in capital. The remaining $44 424 billion could be raised as liabilities

41. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 41 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Capital adequacy requirements (cont.) OBS Credit Conversion – STEP 1: Convert face value of OBS transactions to on-balance sheet equivalents  100%Direct credit substitutes, sales and repurchase agreements  50% Performance-related contingencies, note issuance facilities, underwriting  20% Trade-related contingencies, including documentary letters of credit, acceptance of trade bills  0%Commitments with residual maturity less than one year – STEP 2: Apply risk-weightings based on counterparty

42. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 42 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Capital adequacy requirements (cont.) OBS Credit Conversion OBS items Face value Credit conversion Credit of contract ($m)factor (%) equivalent ($m) Financial guarantees issued 700 100700 on behalf of corporations Performance bonds for 500 50250 state governments Housing loan approvals 2000 100 2000 Documentary letters of credit 250 20 50 issued for corporations TOTAL 3450 3000 The asset risk-weightings are then applied to the credit equivalent column (as per the on-balance- sheet items)

43. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 43 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Liquidity management Liquidity – Access to sufficient funds for a bank to meet its business operating commitments APS210-Liquidity – Replaced PAR and LGS – Emphasis on bank’s own internal liquidity management practices – APRA reserves the right to specify minimum level of liquid assets

44. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 44 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Other regulatory and supervisory controls Risk management systems certification Audit Disclosure and transparency Large exposure Foreign currency exposures Ownership and control

45. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 45 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 2.1Introduction 2.2Functions of Banks 2.3Sources of Funds 2.4Uses of Funds 2.5Off-balance-sheet Business 2.6Regulation and Prudential Supervision 2.7Summary

46. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 46 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.7 Summary Banks are the dominant institution and have moved to liability management Sources of funds include deposits (current, call and term deposits) and non-deposit sources (bill acceptances, debt and foreign currency liabilities, OBS business and other services) Uses of funds include government, commercial and personal lending

47. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 47 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 2.7 Summary (cont.) OBS transactions are a major part of a bank’s business and include – direct credit substitutes – trade and performance-related items – commitments – market rate-related transactions APRA’s bank prudential supervision requirements include capital adequacy, liquidity management and other controls