Financial Institutions Management - Research Paper Example

 Financial Institutions Management Introduction Depository institutions are subject to a reserve requirement ratio (Madura, 2011 p.90). Some authors contend that the depository institutions are one of those institutions that are the most heavily watched and regulated in different part of the world (Koch and MacDonald, 2010 p.34). And with the passage of time, these financial institutions have not only increased vertically but also horizontally as well. in these days, not only banks but also credit unions and building societies also provide their services similar to one offered by the banks. They not only provide financial services to the locals but to the international clients as well (Rezaee, 2001 p.5). In addition to that, Berger et al (1995) provide that a bank’s market capital requirements as the capital ratio that increases the value of a bank in the absence of regulatory capital essentials. In the following parts of this paper, first depository institutions working in the Australia have been elaborated. It is followed by the ANZ De-composition analysis, highlighting the profit margin and other factors. Subsequent to that, it is followed by the calculation of the duration of ANZ’s assets and liabilities. Within that part, the evaluation has been added to define the impacts and representation of different terms. It is followed by the part yield curve mentioning the impact of a 10 basis point upward. Regulatory framework for depository institutions (500) There are two major depository institutions (DI) groups working in Australia. Banks and the non-bank depository institutions are authorized to deal with and provide related financial services. In Australia, the Australian Prudential Regulation Authority (APRA) is the central body authorizing the financial institutions to conduct the financial intermediation. With the passage of time, the size of banks has substantially increased by volume and number of banks and bank branches. Particularly in 2005, the Commonwealth Bank of Australia remained the largest bank having total assets of $ 258.93 billion and held first rank till the end of 2005. Subsequent to that, National Australia Bank, Westpac and ANZ Banking Group were secured second, third and fourth positions respectively. Banks have the largest depository institutions as far as their size is concerned as they offer and provide a wide range of different products and services to the customers. The significant distinction between the banks and savings and credit unions, known as non-banking depository institutions, is that the banks do not have limited or particular types of assets or liabilities rather banks own a variety of assets and liabilities. For example, the ANZ possessed total assets $ 594,488 and $ 531,703 million in 2011 and 2010 respectively. Aggregately, the institutions aggregate growth in the total assets was recorded around 11.81 percent during that period; total liabilities remained $ 556,634 and 397548 million in 2011 and 2010 respectively along with the total growth was 11.85 percent during that period. In addition to that, further difference between these segments includes the differences in operating features along with different profitability across the size classes. Commercial loan portfolio, higher business venture funding, capital intensive support for the giant multi-national banks are some of the key operating features differences exist between the banks and other credit and savings depository institutions. During the period from 1985 to 2005, the aggregate number of banks operating inside Australia has gone up from 13 to 49. During that period, the growth driving factors include the presence of relaxation of entry requirements and amendments in the regulatory framework and requirements of non-depository institutions. Over a period of time, the APRA has considerably revisited the regulatory policy pertaining to banking and other commercial-cum-financial activities in the country. The entry requirements relaxation has not only enabled the banking institutions but also facilitated the non-banking institutions to increase and strengthen their presence and operational performance in the industry during that period. In 2005, the Big 5 banks along with St George Bank owned 73.9 percent of the assets of all banks working in Australia. However, there are five major banks working and extending banking and commercial services in Australia. Till the month of November 2005, a total asset composition including cash and securities, $ 165 and 106 million respectively; other assets and loans retained $ 121, 571 and $ 709,569 million respectively. The single major reason behind this surge in the assets and liabilities of the banks was provided by the lending activity, which has been constantly increasing and providing a substantial boost to the commercial activities in the country. Moreover, there are six regional banks operating in Australia. Till the month end of November 2005, their asset composition highlighted that cash and securities ($ 13,459), loans ($90, 861) and other assets ($ 9, 648). Along with the major banks, the regional banks also availed lending services to gain and retain their market share in the industry. Building societies are a type of depository institutions usually operating on a cooperative basis. In this type of arrangements, the depositors are the members of the society and they are regulated through Banking Act to carry out their banking business along with they are subjected to corporations laws. From 1993 to 2004, the number of building societies has increased from 14 to 31 (Lange et al. 2007). On the other hand, credit unions are mutually cooperative organizations. In this kind of commercial arrangement, members are usually associated by a common bond, such as locality or trade union, in 2004, the five largest credit unions owned around 25 percent of total sector assets and till December 2004, there were 180 credit unions functional in Australia. ROE decomposition analysis for 2011 (Favorable and unfavorable aspects) (300) ANZ De-composition analysis   2010 2011   Profit Margin 40.84 37.81   Net Profit 16.91 17.63   Return on Assets 0.84653 0.90078   Return on Equity 13.549 14.4593   Return on Equity can be understood by appropriately evaluating the elements of this financial measure. Profit margin, net profit margin, return on assets are some of the basic components of this measure. They aggregately highlight the aggregate performance of equity in a particular period of time. The profit margin has comparatively declined from 2010 to 2011 and aggregately decline is 3.03(40.84-37.81). The obvious reasons are highlighted by the annual reports of the bank in which it is crystal clear that the bank has incurred more interest expenses in the year of 2011 in comparison with the year of 2010. However, the comparative analysis of interest income during both years shows that the bank has generated more interest revenue in the year of 2011 in comparison with the interest revenue earned during the year 2010. However, in contrast, the bank has produced more net profit margin in 2011; the aggregate increase 0.72(17.63-16.91) from 2010 to 2011. The closer analysis of annual reports provides that the ANZ bank has generated more profit for the year 2011 than the profit for the year 2010. Return on assets is measured by dividing annual net profit with total assets. This measure highlights that how much and to what extent management remains successful to generate amount of returns on the utilization of assets. This measure further suggests how management competitively manages the different aspect of strategic and tactical management aspects of businesses. The ANZ bank’s return on assets ratio shows that the management has remained competitive and successful by ensuring a growth rate in the rate. For example, from 2010 to 2011, return on assets has increased from 0.05425(0.90078-0.84653). Although the amount of return on assets remains less impressive but it has been successful to ensure a consistent growth over a period. Return on equity represents that how much return has been generated purely by the shareholder’s equity. The return on equity is measured through by dividing net income of period with the shareholder’s equity. The ANZ bank’s return on equity has increased from 2010 to 2011; during that period, the bank has increased its return 0.9103(14.4593-13.549). The main causes behind this increase are contributed by the increase in the annual profit in comparison with the annual profit of 2010. ANZ’s risk measures (comparative analysis 2011 and 2010) In 2010, the bank was unable to appropriately manage its credit risk. Credit risk is the risk of financial loss from the failure of ANZ’s counterparties and customers to honor fully the terms and conditions of a contract or a loan (ANZ Annual Report, 2010, p. 140). The management of the bank adopted two approaches to assessing the credit risk appearing from transactions: first, the larger and more complex credit transactions are evaluated on a judgemental credit basis. In this regard, rating models assist and provide a uniform and consistent but structured assessment along with the judgment required around the application of out-of-model factors. Moreover, credit approval for judgemental lending is specifically based on a dual approval basis, it is collectively performance by the business writer working in the business unit and independent credit officer (ANZ Annual Report, 2010, p.140); second, programmed credit assessment particularly covers business segments such as retail and some other small business lending areas. And this entire process refers to the automated assessment of credit related applications employing a collection of scoring procedures (application and behavioral ), policy rules and regulations and external credit reporting. Aggregately, this entire system of automated risk assessment process represents that sole approval discretions remain the norm including the assessors reviewing the decision tool recommendations. In addition to that, central and division credit risk teams carry out fundamental roles in portfolio management such as the validation and development of credit risk measurement systems, stress testing, loan asset quality reporting and the development of credit policies and procedures. Moreover, credit policies and procedures encompass all aspects of the credit life cycle such as transaction structuring, initial approval, risk grading, specialist policy topics, ongoing management and problem debt management (ANZ Annual Report, 2011. p.142). Also, the bank management’s grading system is essential for the management of credit risk, enabling to appropriately measure the probability of default (PD), the loss in the event of default (LGD) and the exposure at default (EAD) for all transactions. The ANZ bank’s management also uses the Group’s credit grading system, which has two distinct and separate dimensions: first, it measures the PD, which is denoted by a 27-grade Customer Credit Rating (CCR), representing the ability to repay debt. within the sphere of programmed credit assessment, the PD is particularly expressed as a score mapping back to the PD; second, the operational perspective of the management also measured the LGD, which is expressed through a Security Indicator (SI) existing between A to G. the report also mentions that the security related Sis are supported with a number of other Sis to appropriately cover circumstances where ANZ’s LGD research highlight particular transaction features have distinct recovery results. Within this background along with the programmed credit assessment sphere, exposures are amassed into large homogenous pools and subsequently, LGD is extended at the pool level. In 2010, the bank used two credit risk approaches for different customers and clients. For the larger clients and the small owners’ applications undergo different credit risk measures using both manual and automated tools for the purpose of decision making. In both years, the bank has used similar risk measures to manage the different types and circumstances relating to credit risk. This highlights the management is convinced that its credit risk policies and credit risk measures are adequate to appropriately manage the risks and their impacts over the business performance of the bank. The success of this credit policy can be comprehended by the level of loans and advances given in these two particular years and the amount set aside for the credit impairment. From 2010 to 2011, the bank has increased its loans and advances substantially to its clients. In the year of 2010, the bank extended a total of $ 351897 million and $ 396,337 million in the year of 2011. The aggregate increase was 12.62 percent from 2010 to 2011. In addition to that, the credit impairment amount was $ 1787 and $ 1237 million in 2010 and 2011 respectively. A total diminishment in the credit impairment was around 30.77 percent during that period. This highlights that the risk measures policies of the bank have not been dissatisfactory. Over a period of time, the bank with the support of such risk measures has ensured a consistent success of its credit risk management policies and steps and has avoided under-performance. With such risk measures, the bank has successfully maintained its existing market share by appropriately managing the risks with its strong credit risk policies and procedures. Recommendations However, certain recommendations are unavoidable. Although the bank has remained considerably successful in managing its different risks with its strong risk management policies and procedures, but it still needs to take into account certain other measures. For example, till this point of time, the global economy has not totally come out of the impacts of the global financial crisis of 2008; many economies including the United States of America, are struggling hard to ensure smooth journey on the recovery path. But they have not bee able to ensure that due to many reasons including the presence of debt crises in Europe especially in Italy, Greece and other countries. Under such circumstances, the bank must avoid excessive lending. The bank must show restrain in extending the credit facility to its clients. Already, it is mentioned the real estate market has become dormant and has been unable to maintain its vibrancy in the recent years (ANZ Annual Report, 2011, p.79). In this way, the bank would be able to avoid the possibility of facing major credit recovery crisis or chances of defaults in the event of any global uncertainty or other factors influence the growth of banking industry in Australia and other countries. Calculation Duration of Assets and Liabilities (200) Assets $ Duration Liquid assets 24,899   Due from other financial institutions 10 8,824 2.1 Trading securities 36,074 3.2 Derivative financial instruments 54,118 1.3 Available-for-sale assets 22,264 1 Net loans and advances 396,337 3.5 Customer's liability for acceptances 970 1.4 Shares in associates 3,513 1.6 Current tax assets 41 1.2 Deferred tax assets 599 1.25 Goodwill and other intangible assets 6,964 1.26 Investments backing policyholder liabilities 29,859 1.55 Other assets 7,901 2.5 Premises and equipment 2,125 2.69 Total assets 594,488   Total Assets Duration   2.863078 Liabilities     Due to other financial institutions 23,012 2.1 Deposits and other borrowings 368,729 2.4 Derivative financial instruments 50,088 3.2 Liability for acceptances 970 1.2 Due to controlled entities     Current tax liabilities 1,128 1.6 Deferred tax liabilities 28 2.5 Policyholder liabilities 27,503 1.2 External unit holder liabilities (life insurance funds) 5,033 1.1 Payables and other liabilities 10,251 1.1 Provisions 1,248 1.2 Bonds and notes 56,551 3.8 Loan capital 11,993 4.5 Total liabilities 556,534   Total liabilities Duration   2.165406                   Duration Gap= 2.86-(556534/594488)*2.16           Duration Gap=   0.838 Positive and negative gap duration description Positive gap duration indicates that the assets remain price sensitive than the price sensitive of liabilities. This indicates that the assets will be responding faster in comparison with the response of liabilities. However, this response remains on average and there can be no exact mechanism highlighting the accurate level of response. More specifically, when interest rates rise, assets will analogously fall and if the interest rates fall, the assets will proportionately less in value than liabilities. On the other hand, negative duration gap would highlight that liabilities remain more price responsive or sensitive than the assets. As a result, when interest rate rise (fall), assets will fall proportionately less in value that liabilities will enhanced (fall). As far as the ANZ’ duration gap is concerned, the bank faces the issue of higher average duration of assets which is greater than the average duration of liabilities. And the aggregate duration of ANZ is 0.838. This indicates that asset values change by more than liability values. Evaluating impacts of a 10 point basis upward shift of the yield curve on the market value of bank’s equity (300) Yield curve highlights the relationship between the interest rates and term to the maturity. In simple words, the yield curve is the market’s current view or reflection of interest rates for various terms to maturity. The impacts of increase in 10 basis points in the upward shift of the yield curve on the market value of ANZ’s equity would increase and stabilize the market value of bank’s equity. It would highlight that the bank’s equity is not showing any negative tendency but responds positively to the increase in the 10 basis points in the yield curve. Also, this indicates that the aggregate sentiment in the market are positive and investors and other members in the equity market remains positively optimistic about the existing stability of the market value of the bank equity. However, there would be other factors that could jeopardize the existence stability and increase in the bank’s equity. Currently, the global market is not in stable condition but faces the issues of uncertainty. In addition to that, the American economy is heavily struggling to ensure its recovery. However, internally bank’s management is having strong credit risk measures sufficient to manage the bank’s business and financial performance. The management of the bank uses excessive lending to the existing clients. This directly increases the chances of default. As a result, the market value of bank’s equity may not be able to sustain the impacts of such credit policies. Currently, the yield curve is representing the resilience of Australian equity market and its vibrancy. However, the global uncertainty, slow recovery phase after the events of global financial crisis of 2008, European debt crises, and unstable real estate condition in Australia indicate that the coming days may not bring a stable and vibrant economic activity. As a result, its impacts on the market value of ANZ’s equity cannot be avoided. References Berger, A. N.; Herring, R. J. & Segos, G. P. (1995). The role of capital in financial institutions. Journal of Banking and Finance. 19. 393-430. Koch, T.W., MacDonald, S.S. (2010). Bank Management. (7th Edn). Ohio: South-Western. Madura, J. (2011). Financial Markets and Institutions, Abridged. (9th edn). Ohio: South-Western. Rezaee, Z. (2001). Financial Institutions, Valuations, Mergers, and Acquisitions. New York: Wiley and Sons. ANZ Annual Report (2010). Annual Report of ANZ. Australia. ANZ Annual Report (2011). Annual Report of ANZ. Australia. Read More