Transcript banking-and-financial-institutions-acf-104-haut-2016

ACF-104
Guy Hargreaves
WeChat: Guyhargreaves
Course goals
 To gain a fundamental understanding of banking
systems in developed economies
 To understand the different types of banks, particularly
commercial banks
 To understand the financial logic and concepts behind
the banking system
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Course Coverage
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Review financial system and financial intermediation principles
Review structure of banking systems in developed economies
Review typical commercial bank structures and departments
Discuss “good banking” principles; importance to commercial
bank management, regulators and the economy
Understand commercial bank products, risk management and
impact on bank financial structure
Appreciate the business of commercial banking
Review commercial bank regulation in the context of Basel
Review international banking systems
Study how an actual commercial bank – ANZ Bank – operates in
a developed economy
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Financial system
 The typical components of any Financial System:
1.
2.
3.
4.
Financial Assets
Borrowers and Savers of financial assets
Financial Intermediaries
Central Banks and regulators (set and manage the rules of
the financial system)
 Financial systems exist within individual countries
which have their own currency
 Currency blocks (eg EUR) can have common
components (eg European Central Bank)
5
Banking system
 A Banking System is that part of a financial system in
which regulated banks operate
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Does not include Capital Markets which are part of the
Financial Markets
Includes payments, Central Bank operations, bank loans/
deposits – any activity which involves a regulated bank
 Whether the activity is regulated (or not) is important

Unregulated activity is conducted outside of the support
provided by Central Bank regulated commercial banks
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Financial asset
 An asset is any “property” of value held or owned by an
individual or company
 A Financial Asset can be thought of as financial
property eg:
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Cash (money) in your wallet
Deposit with a bank
Corporate bond
Common share of a company
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Financial claim
 A Financial Claim is a contract created when a
Borrower accepts money from a Saver (or Lender)
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Borrower must pay that money back some time in the future
Borrower must pay interest or a return on that money
Can be Secured or Unsecured with the borrower’s assets
 Holder of financial claim has a Financial Asset
 Grantor of financial claim has a Financial Liability
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Financial intermediation
 Two fundamental parties to any financial system:
1. Borrowers (deficit units)
2. Savers (surplus units)
 Financial Intermediation is conducted by third
parties who take deposits from Savers and make
loans with those deposits to Borrowers
 Financial intermediation increases economic
efficiency by offering valuable transformative
services to both Borrowers and Savers
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Direct versus indirect finance
Retail / Wholesale
Commercial Banking
Investment
Banking
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Types of financial intermediaries
 Intermediaries are usually either:
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Regulated commercial banks (mostly)
Non bank financial institutions (NBFIs) eg Investment Banks
 Regulated banks are typically:
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Retail Commercial Banks
Wholesale Commercial Banks
 “Deposit-Taking Institutions” – eg banks
 “Non-Deposit-Taking Institutions – eg insurance
companies
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Financial markets
 “Places or platforms” where financial assets are bought
and sold
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Electronic or “over-the-counter” (OTC)
Open outcry exchanges are almost things of the past (eg
futures pits)
 Most significant financial markets conduct trade in:
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Securities (shares and bonds eg NYSE, Nasdaq)
Futures and derivatives (eg Chicago Mercantile Exchange /
Chicago Board of Trade)
Foreign exchange (largest cash market of them all ~USD5
trillion turnover per day)
Commodities (much of the physical trade is OTC)
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Financial market liquidity
 Market liquidity impacts a participant’s ability to:
1. Transact in a market at their time of choosing
2. Transact volume of choosing
3. Minimise transaction costs
 Increasing market liquidity grows volumes while
lowering per unit transactions costs
=> Increased economic efficiency
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The theory of banking
 Commercial banks perform three basic functions:
1. Size transformation
2. Maturity transformation
3. Risk transformation
 Commercial banks provide products and services at
the time of their customer’s choosing
 Because of the position of commercial banks within
the financial system, they also improve system
liquidity, reduce system cost and lower system risk
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Information asymmetry
 Financial market participants often have varying levels
of information –>Information Asymmetry
1.
2.
3.
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Some participants have Differing Information
Some participants have Inside Information
All participants have Imperfect Information
Inside Information is usually gained from private
sources and is illegal to use to trade (insider trading)
A key regulatory task is to prevent insider trading
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Moral hazard
 Moral hazard occurs in a contract when one of the
parties has an economic incentive to behave against
the interests of the other
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Classical example is a homeowner buying fire insurance just
before their home burns down
Insurance industry is large target of this behaviour
Commercial banks have a poor record of managing moral
hazard given large incentives to behave poorly
 Often arises in the Principal-Agent relationship where
the agent may act in its own interests rather than the
interests of its customer
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Adverse selection
 Adverse selection occurs when one party misuses an
information advantage when dealing with another
party
 Adverse selection can become a big problem in
commercial banking due to this information
asymmetry
 Better informed banks can tend to “exploit” less well
informed customers
 Compliance and Risk Management functions are being
heavily increased in banks today to prevent outcomes
like this
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Market efficiency
 While arbitrage in markets is now low, market prices
move daily in reaction to updated information that
impacts on risk premia
 Efficient markets hypothesis: the application of
rational expectations to financial markets so that the
equilibrium price of a security is always equal to its
fundamental value
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Most applicable to corporate securities – bonds/shares
Many players believe share prices are driven more by “Random
Walk”
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Shadow banking
 Shadow Banking is a banking-like system of financial
intermediation conducted by NBFIs
 As a result it is largely unregulated and is considered to
have contributed significantly to the 2007-9 global
financial crisis
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The history of money
 Before “money”, market participants used the Barter
System:
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Participants exchange goods and services directly for other goods
and services
Very inefficient because of high transactions costs, lack of price
transparency, minimal standardisation and costly/difficult to store
wealth
 “Commodity Money”, a fixed weight of grain, was used by
the Mesopotamians some 3,000 BC
 Commodity money was replaced by gold and silver, and
eventually by banknotes (first used in China during the
Song Dynasty circa 1,000 AD)
 Today we may be standing at the dawn of Cryptocurrency
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The uses of money
 Medium of exchange – widely accepted as payment for
goods and services
 Medium of valuation – widely accepted as method of
“relative” valuation of goods and services
 Store of value – confidence that participants can hold
money into the future to pay for goods and services in
a predictable way
 Standard of Deferred Payment - goods and services
consumed now can be paid for in the future with
money
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The properties of money
 To be a viable medium of exchange a monetary asset
needs various qualities:
1.
2.
3.
4.
5.
Acceptable to participants
Standardized quality
Durable
Valuable relative to its weight ie efficient to use
Divisible to accommodate various prices of goods and
services
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Money of today
 Governments around the globe today issue banknotes
and coins which derive value by government order or
“Fiat”
 Governments decree by law that all public and private
financial liabilities can be repaid by this “Fiat” money
– designating it as “legal tender”
 The right to issue (or print) money comes with
responsibility. Printing excessive banknotes or
expanding the Money Supply can cause inflation and
lead to collapse in trust in that money
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Money supply
 Monetary aggregates are measures of the quantity of
money in circulation – typically broader than simply
banknotes and coins:
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M1 is defined as banknotes, coins and on-call deposits
M2 is defined as M1 + most term deposits
 M1 and M2 is carefully watched by many markets to
monitor government trustworthiness!
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Definition for this course
 This course focuses on Commercial Banking
 Commercial banking can be thought of as any
regulated banking activity operated as a business
 For this course we will define commercial banking as:
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Retail banking (including Private banking)
Wholesale (or Corporate) banking
 Investment banking
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Important to note investment banking activity is not usually
regulated by a Central Bank
It is regulated when conducted by a regulated bank
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Two basic economic sectors
 Private sector – not controlled by the State
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Individuals
Private / public companies
Non-profits / charities
 Public sector – controlled by the State
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Federal government
State governments
Local governments
State owned enterprises
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Where does commercial banking fit?
 Private sector
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Individuals – banking licenses not generally available
Private / public companies – most commercial banks
Non-profits / charities – some banks eg Microfinance
 Public sector
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Federal government – Central Banks
State governments - no
Local governments - no
State owned enterprises – few SOE commercial banks remain
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Who are the savers / borrowers?
 Private sector
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Individuals – both savers and borrowers
Private / public companies – both savers and borrowers
Non-profits / charities – goal usually to be neither
 Public sector
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Federal government – mostly borrowers
State governments – mostly borrowers
Local governments – mostly borrowers
State owned enterprises – mostly borrowers
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Are commercial banks savers?
 Like any for-profit entity, commercial banks can be
savers and borrowers themselves
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Lending out profits not paid to shareholders
Borrowing for capital expenditure
 If a commercial bank is a saver / borrower, it will
conduct this activity with its own capital
 This activity is considered “proprietary” ie not
performed in the course of its financial intermediation
activity
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What makes up a banking system?
 Banking systems are usually made up of:
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Central Banks
Regulated commercial banks
 Retail (including Private) banks
 Wholesale banks
Payments systems
 Regulated banks deal in financial markets but markets are
not usually considered as part of the banking system
 Investment banks deal in financial and capital markets but
if unregulated they are not considered part of the banking
system
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What else do commercial banks do?
 Conduct operations in financial markets, eg
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Hedging risks for customers
Risk management for their own balance sheet
 Operate payments systems
 Facilitate trade flows
 Help with the conduct of monetary policy
 Support economic growth
 Assist in executing government development policies
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Payment systems
 A Payment System is any organised system established
to allow participants to transfer financial assets
between themselves
 Payments take place for many reasons:
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In exchange for goods and services
Creation or repayment of a financial liability/asset
 Commercial banks have historically played a key role
in payments systems
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Payment systems - RTGS
 “Interbank” payment systems use Real Time Gross
Settlement (RTGS) to transfer money between bank
participants
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Retail participants must hold some form of account with a
commercial bank in the payments system
To effect payment a participant will instruct its bank to
transfer money from that participant’s account to the proper
account of another participant at its own bank
The two banks “settle” the transaction through adjustment of
their own accounts held with the relevant Central Bank
Central Banks usually manage RTGS systems
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Payment systems - SWIFT
 International payment systems use Society for
Worldwide Interbank Financial Telecommunication
(SWIFT) to transfer money between participants
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SWIFT is does not alter the underlying mechanics of
individual domestic payment systems
SWIFT is simply a system that arranges domestic payments
between international participants
Unless the banks handling a SWIFT transaction are primary
deposit-taking institutions in the currency of the transaction,
instructions will be handled through a correspondent banking
arrangement
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Commercial banking customers
 Traditional commercial banking customers broadly
fall into categories of:
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Household savers, or borrowers for purchases of property or
smaller ticket personal goods (eg cars)
Corporate borrowers entering into bilateral or club loans for
capital expenditure (capex), working capital or M&A
Governments funding infrastructure or deficits
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Modern banking customers
 Post deregulation in the 1980s, the number and type of
bank customer has grown strongly
 Retail customers now also include:
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Financial market traders and speculators
Margin loan borrowers
Advisory customers (Private Banking, estate planning etc)
“Sub-prime” customers
Traditional deposit and consumer loan customers
Etc..
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Modern banking customers
 Wholesale commercial banking customers now also
include:
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Private Equity funds
Pension and Mutual funds
Hedge Funds
Mortgage and other originators
NBFIs
Traditional corporate borrowers
Corporate risk managers
Syndicated loan borrowers
Etc…
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Retail commercial banks
 Limited liability corporate organisations
 Focus at “retail level”
 Mortgage and savings products
 Mostly listed on the stock exchange
 Medium sized balance sheets
 Large number of smaller customers
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Wholesale commercial banks
 Limited liability corporate organisations
 Focus at “wholesale or corporate level”
 Offer corporate loans
 All listed on the stock exchange
 Large sized balance sheets
 Smaller number of larger customers
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Investment banks
 Investment banks are not usually regulated
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commercial banks
Focus at “wholesale / corporate level”
Offer Capital Markets products
Listed and unlisted
Volatile balance sheets
Smaller number of large customers
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Commercial bank departments
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Board of Directors
Management Office
Financial Control
Risk Management
Legal and Compliance
Operations
Human Resources
Information Technology
Financial Markets
Wholesale Banking
Retail Banking
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Board of Directors
 Approves strategy of the bank
 Appoints the Chief Executive Officer
 Approves financial statements, audit, compensation
etc
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Management Office
 Usually made up of:
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CEO – heads up and runs the bank
CFO – heads up finance function
CRO – heads up risk function
CTO – heads up IT function
COO – heads up operations function
Head of Financial Markets
Heads of Retail/Wholesale banking
 Develops bank strategy
 After Board approval it executes this strategy
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Financial Control
 Management reporting
 Financial accounts (quarterly / semi / annual)
 Regulatory reporting
 Tax and transfer pricing
 Daily P&L
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Risk Management
 Credit risk
 Market risk
 Liquidity risk
 Country risk
 Operational risk
 Reputational risk
 Special Asset Management
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Legal and Compliance
 Group legal
 Front Office legal
 Compliance
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Ensures bank staff follow policy and procedures
Protects the bank against money laundering and other
criminal activity
Prevents insider trading and other crimes
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Operations
 Cash settlements
 Securities settlements
 “Middle Office”
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Financial Markets
Corporate loan management
 Property management
 General logistics
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Human Resources
 Bank staff are commercial banking’s most valuable
asset
 Hiring, firing, training, team building
 Some commercial banks have aggressive firing policies
 Compensation policy critical for “good banking”
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Information Technology
 Front Office, Middle Office, Back Office computer
systems
 Commercial banks traditionally have used technology
to support operations rather than a competitive
weapon
 Many banks in 2015 stuck with outdated systems – big
problem!
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Financial Markets
 Salespeople
 Traders
 Structurers
 Quants (so-called “rocket scientists”)
 Treasury management
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Wholesale Banking
 Corporate Banking
 Project Finance
 Trade Finance
 Leasing
 Relationship management
 Cash management
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Retail Banking
 Deposit products
 Mortgage department
 Credit Cards and Debit Cards
 Consumer loans
 Branches and infrastructure
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Recall: the theory of banking
 Commercial banks perform three basic theoretical
functions:
Size transformation
2. Maturity transformation
3. Risk transformation
1.
 In addition, commercial banks provide products and
services at the time of their customer’s choosing
 Because of the positioning of commercial banks within
the financial system, they improve system liquidity,
reduce system cost and lower system risk
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Size transformation
 Unlikely a saver will deposit the exact amount of funds
with a retail bank that its borrower customer demands
on any given day
 Banks have multiple sources of liquidity to cover
mismatches in financial transaction size:
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Central bank liquidity windows
Interbank markets
Public money market or bond markets
 Banks can take a “portfolio management” approach to
size transformation as they have a broad base of saver
and borrower customers
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Maturity transformation
 Unlikely a saver will deposit funds with a commercial
bank to mature on the exact date that a borrower
customer wants its loan to mature
 Banks manage “asset-liability” maturity mismatch risk
as part of their capital and liquidity management
framework
 Banks also take a “portfolio management” approach to
maturity transformation as with size
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Risk transformation
 Unlikely a saver will wish to deposit all its funds with a
single borrower, instead looking to diversify its credit
risk across a broad range of borrowers
 Banks lend to a broad range of borrowers, offering
savers a diversified credit risk profile
 In addition, banks have a regulated capital structure
ensuring borrowers have a cushion against expected
and unexpected losses in the portfolio
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Credit creation
 Commercial banks have very privileged position in the
economy:
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Usually the most leveraged sector in he economy (15-30x
leveraged!)
Often the beneficiary of government deposit insurance /
guarantee schemes
Guaranteed access to Central Bank pools of liquidity at all
times
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Credit creation
 When a bank accepts a deposit it is required to hold a
certain amount (eg say 10%) in approved reserves
(deposits with Central Bank or government securities)
 The balance (90%) can be lent to new borrowers who
purchase goods and services from another economic
entity, who then might deposit the proceeds in another
bank
 That other bank will then retain the reserve
requirement and further lend the funds to borrower
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Theory of credit creation
Bank
$ Deposit
taken
$ Loan
made
$ Reserve
held
A
50.0000
45.0000
5.0000
B
45.0000
40.5000
4.5000
C
40.5000
36.4500
4.0500
D
36.4500
32.8050
3.6450
E
32.8050
29.5245
3.2805
…
…
…
…
500.000
450.000
50.000
Total
 Under a 10% Reserve Ratio for each $1 deposit taken the banking system can
create $10 in new deposits
 Credit Multiplier = Change in Deposits / Change in Reserves = 500 / 50 = 10
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Changing reserve requirements
Reserve
Ratio
$ Deposit
taken
$ Credit
Created
5%
50
1,000
10%
50
500
15%
50
333.3
 Reducing the reserve ratio from 10% to 5% allows the
banking system to create more new deposits, whereas
increasing it to 15% reduces the amount of new credit
creation possible
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Theory, what about in practice?
 Retail banking
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Size transformation
 Who deposits the exact $355,450 you might need to buy your
apartment? – no-one!
Maturity transformation
 Who makes 30-year deposits? – no-one!
Risk transformation
 Who creates diversified portfolios backed by capital and
supported by Central Banks? – well actually there are alternative
investments which is why the deposit market is so competitive
Credit creation
 Who leverages the money supply so effectively to create plentiful
liquidity for retail borrowers? – no-one with any stability other
than commercial banks
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Theory, what about in practice?
 Wholesale banking
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Size transformation
 Who deposits the exact $325.21m a company needs for its
acquisition? – no-one!
Maturity transformation
 Who makes 5-year deposits to fund corporate loans? – no-one!
Risk transformation
 As for Retail Banking
Credit creation
 As for Retail Banking
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Improving economic efficiency
 Banks lend money and take deposits at the time their
customers demand


This reduces risk for borrowers that need certainty of funds on
a specific day
And reduces opportunity costs for savers who might otherwise
take time to find a borrower and while missing out on interest
payments
 Banks reduce transaction, information and search
costs by exploiting their large size and reach

Larger turnover, larger fund flows reduces unit costs and
increases economic efficiency
66
Credit creation boosts growth
 Central Bank policy impacts growth in an economy
through commercial banks
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Altering the money supply alters interest rates, which flows
through commercial banks to the real economy and impacts
demand
Altering the Central Bank Reserve Ratio impacts on the supply
of credit from the commercial banking system to the real
economy
Commercial banks can choose to raise capital, which through
the credit multiplier can lift the supply of credit to an
economy
67
Capital allocation in an economy
 Commercial banks are amongst the most important
institutions in an economy when it comes to capital
allocation to different industries / sectors
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Lending reduced to twilight industries
Lending increased to new growing industries
Lending into increasing productivity, away from falling
productivity
Forced corporate restructurings
 Market based capital allocation drives developed
economies to become more efficient
68
Commercial banks in financial markets
 Financial markets are not part of the banking system, but
are critical for commercial banks
 Commercial banks operate in a number of financial
markets and derivatives
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Money markets
FX markets
Commodity markets
Syndicated loan markets
 Commercial banks are mostly users of bond and equity
(capital) markets

Investment banking businesses are more focused on arranging deals
in the capital markets
69
Commercial banking products
 Retail and wholesale commercial banks offer a wide
range of products and services – including:
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Current and chequing accounts
Term deposits
Consumer loans and mortgages
Credit and Debit Cards
Cash management services
Corporate and SME loans
Trade Finance
Financial market products and services
Online banking
71
Commercial bank payment products
 Commercial banks offer many ways for their clients to
instruct a payment:
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Cheques
Online transfers
Standing orders
Credit cards
Debit cards
ATMs
Smartphones
SMS
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Correspondent banking
 Commercial banks often hold accounts with other
domestic or international commercial banks


Nostro account: “our money held by you”
Vostro account: “your money held by us”
 When a bank holds an account with another bank it is
said to have a Correspondent Banking Relationship
 If a bank does not maintain an account with its Central
Bank it needs to have a correspondent banking
relationship with one that does
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Mortgage products
 One of the most basic banking products
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A bank lends money to a borrower to purchase a house,
apartment or other property
Only a portion of the property purchase price is lent (eg 50%)
– the balance is funded from savings of the borrower
The borrower repays loan principal and interest over an
agreed time frame (eg 30 years)
The bank takes a “mortgage” over the property which entitles
it to seize and sell the property to repay the loan if the
borrower defaults
 Banks are at the heart of retail property financing
across the globe
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Mortgage LVRs
 Mortgage “Loan to Value” (LVR) ratios are a carefully
watched measure of a commercial bank’s mortgage
portfolio
 High LVR’s mean if default rates in its mortgage
portfolio increase then a bank may suffer higher losses
in its portfolio
 LVR = Loan Amount / Value of property financed
 Typical LVRs range around 50-60%
75
Credit and debit cards
 A group of banks were responsible for the
development of widely used credit cards such as Visa
and Mastercard
 Card products offer the great convenience of being
cash-like and widely accepted
 Credit cards offer the holder an unsecured line of
credit that can be drawn to pay for goods and services
 Debit cards are accounts that must have positive fund
balances before they can be used to pay for goods and
services
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Corporate banking products
 Corporate banking customers range from SME to mid
market to large listed multinational companies
(MNCs)
 These customers have a range of commercial banking
needs including:
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Lease and hire purchase financing
Invoice and receivable discounting
Corporate loans and commercial paper (CP)
Project finance
77
Trade finance
 Commercial banks are central to the financing of trade
flows across the globe:
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Guaranteeing payments for exporters and importers through
correspondent banking relationships
Financing shipments of commodities around the globe
Working capital finance for trading companies
Inventory financing
78
Financial market products
 Commercial banks offer a range of financial market
products and services including:
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Foreign exchange and forwards
Money market products
Syndicated loans
Derivative risk management products
Repo products
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Money markets
 Short term debt financing and investment markets
 Terms usually less then 1-year
 Commercial banks usually deal in:
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
Treasury bills (for liquidity and capital management)
Commercial paper (CP) (corporate lending alternative)
Bankers’ acceptances (guarantee for future customer
payment)
Certificates of Deposit (marketable deposits)
Repurchase agreements (short term securities funding)
Federal Funds (reserve requirement management)
80
Bond markets
 Fixed income instruments which are debt securities
where the borrower (issuer) is required to repay
principal and interest based on a predetermined
schedule or rate over a fixed term


Investment banks usually arrange bond issues for larger
corporates (not a retail issuance product)
Commercial banks issue bonds as part of their liability
management process
81
Foreign exchange markets
 The exchange of an amount of money (or deposit) in
one currency for an amount of money (or deposit) in
another currency
 Commercial banks use the FX market:



As a source of liquidity for customer hedging and foreign
currency payment transactions
To manage their own asset/liability balance sheet risks
As a source of revenue from market making
82
Commodity markets
 Wholesale commercial banks have many customers
with exposure to commodity markets and prices
 Energy commodities such as oil and gas big for
commercial banks
 Metals, agricultural products also popular


Customer hedging almost all of the activity of commercial
banks in commodities
Harsh capital treatment for banks that trade in commodities
for their own book
83
Syndicated loans
 Loans where borrowers enter into a single loan
agreement with syndicates of banks - ranging from 5
banks to over 50 banks for very large deals



Very traditional business for commercial banks
Helpful when customer borrowing requirements become too
large for a single commercial bank to handle
Banks earn additional income from underwriting and
distributing syndicated loans
84
Good commercial banking
 Good commercial banking requires sound
management practices



Diversify: 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
86
Good commercial banking
 Set long term incentives, remove short term incentives


Encourage longer term behaviour by staff, management
Leads to better decisions = stable bank = strong share price
and high liquidity / access to capital
 Good banking = healthy banking system = healthy
financial system able to withstand crises/shocks
87
US commercial bank balance sheet
88
On or off balance sheet?
 If the item appears in the balance sheet financial
statement then it is “on balance sheet”
 Risks that do not appear in the balance sheet financial
statement are “off balance sheet” eg



Letters of Credit (LCs)
Guarantees
Counterparty credit risk on derivatives
 Banks need to hold regulatory capital against on and
off balance sheets exposures under BIS II and BIS II
89
Trading versus banking books
 Banks use two broad accounting regimes:


Banking book – holds corporate and retail loans on an
“accruals” basis; uses the “loan provision” model for potential
losses from defaults; no market risk
Trading book – holds securities and marketable instruments
on a “mark-to-market” basis; gains and losses in market value
brought to P&L daily; all market risk
 Whether a financial instrument is held in a banking
book or a trading book is critical to the way it is risk
managed
90
Market risk
 Interest rate risk:




Exposure through a financial instrument to movements in
interest rates
Fixed rate bonds, interest rate swaps, bond futures – anything
with a long dated fixed cashflow
“Delta” – the change in the $ value of that instrument for a
0.01% change in interest rates
VAR – “Value at Risk” how much the bank would lose if a
significant move in interest rates occurred
91
Market risk
 FX risk:




Exposure through a financial instrument to movements in
foreign exchange rates
Spot FX, foreign exchange swaps, FX futures
“Delta” – the change in the $ value of that instrument for a
certain change in FX rates
Included in firmwide VAR
92
Market risk -VAR
 Value at Risk (VAR) – banks look at 2-3 years of price
history and use probability models to determine to a
high degree of confidence how far a market can move
over say 1 or 5 days
 Traders are then given $ amounts they can potentially
gain or lose based on VAR – this sets the total amount
of a financial instrument a trader can have exposure to
in his/her trading book
93
Liquidity (gap) risk
 The ongoing ability of a commercial bank to refinance
its short term liabilities like deposits


Banks tend to “lend long” and “borrow short” – borrowers
want the certainty of funding for long periods whereas savers
don’t want to lock up their funds for long periods
Liquidity or gap risk is the risk savers will not redeposit their
savings when they mature, leaving the bank repaying deposits
whilst remaining invested in longer term loans
 Reinvestment or refinancing risk is the risk that when
a bank comes to refinance a deposit interest rates will
be higher – interest rate risk
94
Operational risk
 Operational risk is defined as “the risk of loss resulting
from inadequate or failed internal processes, people
and systems or from external events”
 Regulators and banks are working towards a consistent
and standardised way of measuring and holding
capital against this risk
 Causes of operational risk include internal and
external fraud, employment practices and work safety,
illegal business practices (eg money laundering) and
physical or system failures
95
Country risk
 Global commercial banks invest significant capital into
many countries around the world to support their local
operations
 Some of these countries are risky emerging markets
(eg Argentina) where there is a risk that the local
government introduces foreign exchange controls or
other measures that might be harmful to the bank
 Sovereign risk is not country risk – it is the risk a
sovereign will default on its debt
96
Reputational risk
 Banks have suffered scandals and bad media headlines
throughout history
 As a result many banks have seen their reputations
with customers, governments and other important
stakeholders suffer badly
 When a bank earns a poor reputation its WACC
increases as savers become reluctant to deposit, and
borrowers are less willing to do business with banks
that have behaved badly
97
Credit (default) risk
 Loans in the banking book and bonds in the trading book
both have credit default risk




The issuer will fail to repay a coupon or principal, or will go into
bankruptcy
Banks have Special Asset Management units which do nothing but
manage defaulted or near defaulted customers
Once in default, banks will often take control of the company as
“senior creditors”, sell all remaining company assets and use the
proceeds to repay “creditors” in order of seniority
If a bank receives less than it is owed following liquidation it has
suffered a recovery rate of < 100%
 Banks may make “provisions” in their balance sheets for
loans which they expect have a high chance of defaulting
98
Credit risk management tools
 Credit default risk management is a critical element of
commercial banking management
 “Credit Committees” (CC) establish maximum
exposure limits to individual, group and related
borrowers




Limits are set for loans, derivatives, settlement, FX and many
other financial products
CC monitors total exposure to the borrower or group
Bankers are forbidden to lend or trade in more volume with
the borrower or group than the limit set by CC
This prevents the bank from becoming overexposed to any
one borrower or group
99
Portfolio diversification
 Critical to bank credit default risk management is to
lend to a broad diversified set of borrowers
 Diversification means investing in a broad range of
borrowers so that risk can be reduced in the portfolio


“Don’t put all your eggs in one basket”!
Investing in $1 in each of 50 borrowers is far less risky than
investing $50 in just one borrower
100
Classical credit analysis
 Every commercial bank has a slightly different way of
performing credit analysis
 Many banks use the classical model of five “C”s





Character – is the borrower of good character eg have they
defaulted before or ever committed fraud?
Capital– is the borrower too leveraged?
Capacity - does the borrower have a strong capacity to repay
the loan? What is the earnings volatility of the borrower?
Conditions – what is the loan going to be used for? Does this
make sense?
Collateral – is the loan secured by specific assets or is it
unsecured?
101
Credit ratings (long term)
Standard & Poor’s
Moody’s
Fitch
Default Risk profile
AAA
Aaa
AAA
Investment Grade: extremely strong
AA+ | AA | AA-
Aa1 | Aa2 | Aa3
AA+ | AA | AA-
Investment Grade: very strong
A+ | A | A-
A1 | A2 | A3
A+ | A | A-
Investment Grade: strong
BBB+ | BBB | BBB-
Baa1 | Baa2 | Baa3
BBB+ | BBB | BBB-
Investment Grade: adequate
BB+ | BB | BB-
Ba1 | Ba2 | Ba3
BB+ | BB | BB-
High Yield : less vulnerable
B+ | B | B-
B1 | B2 | B3
B+ | B | B-
High Yield : more vulnerable
CCC
Caa1 | Caa2 | Caa3
CCC
High Yield : vulnerable
CC
Ca
CC
High Yield : highly vulnerable
C
C
C
High Yield : highly vulnerable +
SD
Selective default
D
D
Default
NR
NR
Not rated
 Credit ratings are a critical component of the efficient
operation of the fixed income market
102
Bank credit scoring
 Once a credit analysis is performed many banks score
or “rate” the loan or borrower
Standard & Poor’s
Moody’s
Commercial Bank
Default Risk profile
AAA
Aaa
R0
Investment Grade: extremely strong
AA+ | AA | AA-
Aa1 | Aa2 | Aa3
R1 R2 R3
Investment Grade: very strong
A+ | A | A-
A1 | A2 | A3
R4 R5 R6
Investment Grade: strong
BBB+ | BBB | BBB-
Baa1 | Baa2 | Baa3
R7 R8 R9
Investment Grade: adequate
BB+ | BB | BB-
Ba1 | Ba2 | Ba3
R10 R11 R12
High Yield : less vulnerable
B+ | B | B-
B1 | B2 | B3
R13 R14 R15
High Yield : more vulnerable
CCC
Caa1 | Caa2 | Caa3
R16 R17 R18
High Yield : vulnerable
CC
Ca
R19
High Yield : highly vulnerable
C
C
R20
High Yield : highly vulnerable +
SD
Selective default
D
D
Default
NR
NR
Not rated
103
Expected loss
 From the credit default risk analysis banks estimate
Probability of Default (PD), Loss Given Default (LGD)
 Expected Loss (EL) = PD x LGD x EAD



PD is the likelihood a borrower will default
LGD is the loss a bank expects if a borrower does default
EAD is Exposure at Default which is the loan amount plus
unpaid interest at default
 EL then feeds into the RAROC model to determine
whether the loan makes financial sense for the bank
104
Credit provisioning
 When a commercial bank expects to take a loss on a
loan it makes an individual credit provision
 Large banks routinely take collective provisions against
their overall portfolios
 A provision is the amount of a loan the banks expects
to lose
105
So how do banks make money?
 Like all businesses, banks have capital structures:






Equity capital
Hybrid capital
Subordinated debt
Long term bonds
Medium term notes
Short term deposits
Decreasing risk
Decreasing maturity
 Aim of commercial banks is to use this capital to invest
in assets which generate sufficient return to provide an
acceptable return on capital (RAROC)
107
Recall: banking products and services
 Commercial banks offer a wide range of products and
services









Current / chequing accounts
Term deposits
Consumer loans / mortgages
Credit / Debit Cards
Cash management services
Corporate / SME loans
Trade Finance
Financial market products
Online banking
- fees, liability raising
- liability raising
- asset raising
- fees, asset raising
- fees, asset / liability raising
- asset raising
- fees, asset raising
- fees, trading, spread
- access
108
Net Interest Margin
 Net Interest Margin or NIM is a measure of the net
income a bank is receiving on its loan portfolio
 Typically is does not include the cost of either equity
capital or operating costs of the bank
 NIM = (Interest received from loan portfolio - Interest
paid on deposit portfolio) / Total Loan Assets
109
The cost of capital
 The cost of commercial bank capital is an important
input into the economics of the business of banking
 Weighted Average Cost of Capital (WACC) is a closely
managed metric for banks



Banks with high WACC need to invest in higher returning
assets to generate acceptable returns
Higher returning assets are riskier
Riskier assets require more regulatory capital to be held
110
WACC example
Capital type
% of Capital Structure
Cost
Equity capital
6.0%
12.0%
Hybrid capital
2.0%
9.0%
Subordinated debt
2.0%
5.0%
Long term bonds
20.0%
4.0%
Medium term notes
10.0%
3.0%
Short term deposits
60.0%
1.0%
100.0%
WACC: 2.7%
Total:
 The bank will need its weighted average asset yield to be
greater than 2.7% to generate positive risk adjusted returns
111
RAROC
 Risk Adjusted Return on Capital (RAROC)
 Widely used metric in commercial banking to measure
the return generated from loan assets
 Commercial banks set minimum RAROC hurdles to
assist in their decision making processes
RAROC = Revenue – Cost – Expected Loss
Required Capital
112
RAROC
RAROC =
Revenue – Cost – Expected Loss
Required Capital
 Where:




Revenue is (Loan rate – WACC) * Loan Amount
Cost is the full operational cost of making the loan
Expected loss is the amount the bank must assume it will lose
from making the loan
Required capital is the amount of regulatory capital a bank
must hold when making the loan
113
Meeting return hurdles
 Assume a bank sets its RAROC hurdle at 12%
 An exporter requests a $100m 3-year loan for capital
expenditure:




The exporter is an “AA” rated company with a sound balance
sheet and good track record
The bank has an overall cost/income ratio of 40%
The bank needs to hold 8% capital against the loan
The bank’s WACC for the loan is 3%
=> What interest rate [I%] should the bank offer on this loan?
114
Meeting return hurdles
RAROC =




Revenue – Cost – Expected Loss
Required Capital
Revenue $R
= $100m * (I% – 3%)
Cost $C
= $R * 40%
Expected loss = PD * LGD * EAD where Probability of
Default for “AA” rated company for 5-years is 0.2% and Loss
Given Default is assumed to be 20% (recovery rate 80%)
Required capital RC = $100m * 8% = $8m
115
Meeting return hurdles
12%
=>
I%
= $R – ($R * 40%) – $100m * 0.2% * 20%
$8m
= $R * 60% - $0.04m
$8m
= ($100m * (I% - 3%) * 60% - $0.04m
$8m
=
=
(12% * $8m + $0.04m) + 3%
$60m
4.6667% (“Credit margin”: 167 basis points)
116
Meeting return hurdles
 Charging a “AA” rated company a credit margin of 167
basis points may be uncompetitive
 If customer wanted to pay a 50 basis point margin the
bank would have to accept RAROC of 3.25% or not do
the deal
 Banks often subsidise low RAROC lending in order to
“X-sell” higher margin products


Take a whole of relationship view on the customer
Aim to earn fees from derivative hedging income perhaps
117
Fee based income
 Commercial banks like fee-based revenue because
they do not have to set capital aside if there is no
residual credit or market risk
 Fees include:


Syndicated loan underwriting fees
Upfront derivative fees
118
Derivative business income
 Banks generate derivative revenues from trading and
“market making”
 Trading: take “long” or “short” positions in markets
through derivatives, similar to securities trading
 Market Making: provide prices to clients at any given
time of their choice

Aim to buy low / sell high by having clients transaction on
both sides of the “bid/offer” spread
119
Foreign Exchange income
 Bank FX divisions generate income from trading and




market making
FX markets are extremely efficient and bid/offer
spreads are very narrow
Volumes are HUGE though!
Complex FX derivatives are high margin generators for
banks
FX market was first to embrace e-markets platforms
and many customers can plug directly into markets
these days
120
The retail banking business
 The principles behind making money in the retail
business are similar to wholesale banking
 Retail bankers are allocated capital and look to make
loans, funded by deposits, to generate acceptable
RAROC
 Portfolio diversification is easier given there are many
smaller customers in the portfolio
121
The mortgage business
 By far the largest retail commercial banking business
in many economies
 Mortgage NIM often in the range of 1-3%
 RAROC, cost/income, efficiency are key drivers
 Mortgage product is very similar across many banks
122
Credit and debit cards
 Credit cards offer the holder an unsecured line of
credit that can be drawn to pay for goods and services
 Debit cards are accounts that must have positive fund
balances before they can used to pay for goods and
services
 Retailers that accept credit cards charged fees of up to
3% for each transaction
 Customers that don’t repay their cards monthly often
subject to huge interest rates eg 16%
123
Trade finance
 Trade finance products are typically short term,
uncommitted and secured



RAROC is high because banks don’t have to set aside capital
against “undrawn commitments”
Off-balance sheet products like Letters of Credit (LCs) can
have favourable capital treatment
Secured against trade flows eg crude oil cargos (LGD
significantly reduced
 Economics of trade finance often highly reliant on
commodity prices

With crude prices halving, if volumes remain unchanged
trade finance volumes will half
124
Key bank financial metrics
 Loan / Deposit ratio – measure of how much of banks loan book







is being funded by deposits
Tier 1 ratio – ratio of permanent capital to “risk weighted assets”
(RWAs)
Leverage Ratio – ratio of Tier 1 capital to total assets
Liquidity Coverage Ratio – ratio of outflows over a critical
timeframe (eg 30 days) to high quality liquid assets
Net Stable Funding Ratio – ratio of “stable funding” to long term
assets
Efficiency ratio – equivalent to the operating margin – ratio of
operating revenue (EBIT) to total revenue
ROE or ROA – traditional return metrics
Credit quality – loan loss ratios
125
Central Banks
 Central Banks play a critical role at the heart of every
currency’s financial system
 Responsible for oversight of monetary system
underpinning the currency
 Some Central Banks are also charged with oversight of
the deposit-taking and non deposit-taking financial
institutions in their financial system
 Most common goal of a Central Bank is to manage
monetary policy to foster growth without inflation
127
Major Central Banks
Country
Currency
Central Bank
USA
USD
Federal Reserve
UK
GBP
Bank of England
China
RMB
PBOC
Europe
EUR
ECB
Canada
CAD
Bank of Canada
Australia
AUD
Reserve Bank of Australia
Japan
JPY
Bank of Japan
Hong Kong
HKD
HK Monetary Authority
India
INR
Reserve Bank of India
Singapore
SGD
Mon Auth of Singapore
128
Central Bank roles
 Most common roles of a Central Bank are:





Control the issue of banknotes and coins
Control or influence the amount of credit creation within a
financial system
Act as “lender of last resort”
The Government’s banker
Oversee FX, gold and other reserves
 Effectively Central Banks control credit expansion,
liquidity and money supply of an economy
129
Central Bank monetary policy
 Monetary policy is the most important role of Central
Banks
 Governments tend to set objectives for monetary
policy – Central Banks take independent actions to try
and meet these objectives
 Price Stability (low or no inflation, and not deflation)
 Full employment (low unemployment)
 Stable economic growth (not too hot and not too cold)
 Financial market stability (FX, interest rates and the
financial system itself)
130
Monetary policy tools
 The major tools of a Central Banker are:



Open Market Operations (OMOs)
The Discount window
Reserve requirements
 Via these tools Central Banks can influence:



Short term interest rates
FX rates
Bank reserves
131
Open market operations
 The Central Bank will buy or sell government securities in
the open market to influence both interest rates and the
overall money supply





eg the US Federal Reserve (Fed) announces to the market its target
for the overnight Fed Funds rate
Fed Funds are interbank borrowings used to manage the reserves
they are required to hold at the Fed
If Fed Funds is higher than the Fed’s target rate it will inject money
into the banking system through “repo” lending transactions
As money is pushed into the system the Fed Funds rate falls to the
level targeted by the Fed The opposite happens if Fed Funds is
trading lower than the Fed’s target
Banks and financial markets use the Fed Funds rate as a base rate to
set other interest rates from
132
The discount window
 Eligible banks are able to access their Central Bank’s
Discount Window
 The discount window is a facility that allows banks to
borrow from the Central Bank by discounting
securities
 Discount window rates are typically higher than rates
targeted by Central Banks through their OMOs
 Discount windows are generally considered to be used
only in times of financial system stress
133
Reserve requirements
 Banks are required to hold a certain % (reserve ratio)
of their deposits in Reserve Assets, making these funds
unavailable for on-lending
 By increasing the reserve ratio Central Banks can force
banks to reduce their existing lending or reduce future
lending
134
The lender of last resort
 Central Banks through their discount window and
supervisory responsibilities are considered by some as
“lenders of last resort”




In a time of crises banks can access the discount window to
stay afloat when there might be a “run” on
This function is really about providing liquidity and not
solvency to a bank or group of banks
Solvency is the ability of a bank to ultimately meet all its
liabilities from its asset base with an acceptable level of equity
remaining
“Bank Liquidity” is the ability of a bank to reissue maturing
liabilities as and when they become due
135
The lender of last resort
 Many consider lender of last resort to introduce “moral
hazard” into the banking system

Banks have a perverse incentive to take excessive risk if they
feel their Central Bank will “bail them out”
 Banks arguably occupy the most privileged position in
the economy


Able to leverage their balance sheets (total assets / equity 1030x)
Able to tap their Central Banks for liquidity if business
becomes difficult
 Many economists and others argue for less regulated
“Free Banking” – this has its +ves and -ves
136
What is bank supervision?
 Banks occupy a highly privileged position in the
economy, being highly leveraged but with
“government guaranteed” liquidity!
 To ensure banks do not fall to moral hazard and they
are soundly run the regulators have established rules
around bank capital, liquidity and other risks
 Global standards for regulation have been set by the
Bank for International Settlements (BIS), based in
Basel, Switzerland
137
What is bank supervision?
 The Basel capital accords, negotiated amongst its 60
members, are supposed to set a standardised global
framework for sound bank management practices
 Being non-binding, the BIS I, II and incoming III
accords have not been adopted uniformly worldwide
leading to effects from the “law of unintended
consequences”
138
Goals of bank supervision
 Bank supervision aims to:




Minimise regulatory arbitrage (reduce to zero!
Watch bank leverage and liquidity carefully
Maintain system stability to avoid the discount window being
used
Create a stable financial system
139
Why do we need bank regulation?
 Financial systems suffer periods of instability

Business cycle, fundamental changes, technology can all cause
instability
 The banking sector is vulnerable to this instability due
to its in-built high leverage
 An unstable banking system can cause “bank runs”
when depositors lose confidence
 Central bank regulation of banks and the banking
system is vital to minimise the chances of banking
system instability and to protect bank customers
140
Types of bank regulation
 Bank regulations come in the form of either Systemic
Regulation of Prudential Regulation
 Systemic regulation is usually:


Government deposit insurance
Lender of last resort
 Prudential regulation is usually:



Capital rules
Liquidity rules
Code of conduct
141
History of bank regulation
 Each local financial system has its own history of bank
regulation
 Globally a number of major regulatory milestones have
had widespread impact:



1933 Glass-Steagall – separation of Investment and Corporate
Banking in the US (largely repealed in 1999)
1988 first Basel Capital Accord “BIS I”. Concept of Tier 1
(Equity) and Tier 2 (sub debt, hybrids, other) and Risk
Weighted Assets (RWAs). Tier 1 + Tier 2 capital = 8% * RWA
1996 second Basel Capital Accord “BIS II”. Three “Pillars” – 1:
capital, 2: supervisory review, 3: disclosure
142
BIS II
 Currently the “global” banking system is supposed to be
operating under BIS II
 Pillar 1:



Risk Weightings aligned to actual expected credit risk
Credit risk calculation could be “Standardised” or “Internal Ratings
Based”
Market and Operational risk also included
 Pillar 2:

Boosting regulatory powers to review and supervise banks
 Pillar 3:

More disclosure of risk, capital adequacy and risk management
143
Banking Crises
 Loss of confidence in a bank or number of banks
leading to bank run where depositors withdraw funds
rapidly
 Often associated with periods of poor lending
decisions leading to high loan portfolio loss provisions
 High leverage in the banking system means
confidence is fragile

Small loan losses can quickly turn into a banking crisis
144
BIS III
 Required Capital – increase required capital – Tier 1 up
from 4% to 6%
 Introduce Leverage Ratio – ratio of Tier 1 capital
divided by “total exposure” to be a minimum of 3%
 Introduce Liquidity Cover Ratio – High quality liquid
assets divided by net cash outflow over the next 30
days >100%
 Introduce Net Stable Funding Ratio – Long Term
Stable Funding divided by Long Term Assets (> 1-year)
> 100%
145
BIS III
 Introduce counter-cyclical capital buffers – increase capital
in good times so banks have more protection for bad times
 Strengthen risk frameworks across a lot of areas of the
banks eg:


Credit Valuation Adjustment (CVA) for swap counterparty risk
management
OTC derivative clearing through centralised exchanges
 BIS III is costly for banks and will be less efficient (ie a
burden for the global economy) - but should strengthen
the banking system
 Timetable for introduction 2011-19
146
International banking
 A series of locally regulated banks all owned by the
same company located in countries all over the globe
 Each local bank is either a “branch” or a “subsidiary” of
the “Head Office” bank


Each branch the same legal entity as the head office but
located at a different address ie another country
Each subsidiary is a separate company owned by the head
office bank
148
Branch versus subsidiary
 Because commercial bank branches are the same legal
entity as the head office they don’t need to be
separately capitalised


Each branch shares the same capital and is exactly as strong as
the head office
If a customer deals with a branch it is legally the same as
dealing with head office
 Subsidiaries need to either have their own capital or
they need to be fully guaranteed by the head office

Because head office can let a subsidiary fail customers of a
subsidiary require head office guarantees usually
149
International bank regulation
 Usually commercial banks are regulated by the Central
Bank or banking regulator in the country of the head
office

Eg Citibank would have branches in China but is regulated by
the Federal Reserve because it is a US based bank
 However local bank regulators want to also regulate
each branch or subsidiary because they do not want
failure of a bank in its head office country to impact on
the local banking system
=> very complicated regulation for International
commercial banks
150
International payments
 SWIFT connects local payment systems which simply
operate as normal


When an international payment is instructed banks simply
transfer funds between themselves in the local currency
If an FX transaction is required banks will handle that as part
of the overall payment
 Because international commercial banks can use their
local branches to make payments they are generally
more efficient at handling international payments
151
International bank departments
 International banks have mostly the same
departments as local or regional banks



Likely to have specialists who coordinate multinational
customer business across the globe
Country Risk and Operations departments are usually much
larger
Legal and regulatory functions are more complicated
152
International bank risk
 International banks have the same credit and market
risk functions as local banks

However with more financial markets businesses and
corporate bankers operating across the globe, international
banks often take on a wider array of risks
 Because international banks tend to be larger they
need more capital and become systemically important
banks

This means they require even more capital!
153
ANZ Banking Group
 Top 20 global bank
by market
capitalisation
 One of four major
banks in Australia
 Good commercial
bank to study
155
ANZ language used:
 Australia – means retail + small commercial business
customers in Australia
 New Zealand - means retail + small commercial
business customers 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
156
Elements of good banking
157
Global bank, regional strategy
158
Wholesale Asia strategy
159
ANZ in China
160
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!
161
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
162
FX matters to results
 Revenue generated in multiple




currencies ie AUD, NZD, USD,
GBP etc
When revenue generated in nonAUD 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
163
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
164
Diversified income streams
165
Diversified balance sheet
166
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
167
Cost / Income closely watched
168
Cost management
169
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
170
Provisions: collective and individual
171
Historical losses lag corp leverage
172
Truly diversified portfolio
173
Diversified agri portfolio
174
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
175
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
176
Diversified markets income
 Financial markets income
diversified across products:
 FX
 Rates
 Capital Markets
 Commodities
 Other
177
Market risk carefully managed
 Balance sheet usage low
 Market VAR $150-200k
 Low revenue volatility
178
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
179
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
180
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%
181
Why low mortgage losses?
182
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
183
Regulatory Capital – important!
184
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
185
Balance Sheet composition
186
LCR is operating at ANZ
187
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)
188
Sustainability important to ANZ
189