Australian Financial Institutions and Markets - Essay Example

Australian Financial s and Markets Introduction Australian banks have been a recent success story in the overall economy with financial deregulation and expansion of banks into other services spurring their recent growth. In 2004 the Australian Finance Industry made up 8.5% of the added value to the economy, generated over $62 billion dollars, and has enjoyed a staggering growth rate of 157% since 1985 (Axiss 2005, 5). The financial industry as a whole is massive, according to Axiss (2005,5), "It is a major driver of Australia's economic growth, considerably outweighing agriculture and mining combined, the two Industries traditionally associated with Australia's economic wellbeing." The success of banks has benefited the economy as a whole but has also affected various financial institutions, instruments and markets in Australia. 2. Institutions While banks are the major asset holding financial institutions in Australia there are other major players in this arena. The increase the economic power of the banks and deregulation of the 1980's has increased the market share over other financial institutions such as NBFI's(non-bank financial institution), super funds, and other managed fund accounts (Lewis and Wallace 1997, 76). According to Wallace (1997,77) there are 3 major reasons for these changes. "Large banks have an advantage in competition, Australian banks have significant advantages in the form of customer loyalty and extensive branch networks, with the record profits in the industry the banks have access to increasing amounts of capital and finally many of the newer banks in the industry had no clear strategy when they entered the market, giving the big 4 an advantage." Now that banks have come into the market they are competing on several different levels with other financial institutions, "insurance companies and superannuation funds compete directly in the market for managed funds, and their products compete directly with instruments provided by the funds management arms of banks (Wallace and Lewis, 1197, 233). However as noted by Wallace and Lewis (1197, 233) life insurance and superannuation funds still comprise 80% of the managed funds sector. 2.1 Insurance In 2002 the insurance industry in Australia held $173.9 billion in assets (Vinley 2003, 36). Insurance companies hold this large amount of assets because they have policy holders paying in monthly sums that may never be paid out or are paid out in smaller sums than were paid in. Insurance companies then use these assets to make money in financial markets through managed funds. Australian banks have sought to enter the insurance market and compete with the existing firms. According to the Wall Street Journal(2005,1), Commonwealth Bank, one of the big 4 banks in Australia recently reported a 50% gain in first half profit which was a result of their wealth management business and a steady result from their insurance arm. The ability of banks to expand into other financial services has affected the insurance industry as the Big 4 banks in Australia now compete with them. The insurance industry has now also begun to move into the domain of other financial services in order to maintain their asset base. Vinley (2003, 36) points out that insurance companies have seen a "decline in assets, but this has been offset by significant increases in their managed funds operations, particularly superannuation. The percentage share of superannuation assets has increased to 14.5 % from 1990-2002." 2.2 Superannuation In Australia, superannuation is paid into the funds by employer contributions under the Superannuation Guarantee Charge and by individuals as voluntary contributions (Frino 2005, 2). Superannuation funds make their money by charging small fees for asset management as well as making returns by investing the large amount of assets they have. As stated before insurance companies are now creeping into the superannuation market, but so are Australian banks. They have become one stop shopping for customers in the financial services industry. In addition banks can offer investment alternatives for extra retirement contributions over and above superannuation fund payments. However even with the banks entering the superannuation market "in the financial year 2000/2001, approximately 64% of all member contributions were made into retail superannuation funds and retail funds held 32% of the total superannuation assets. Thus, retail funds form a substantial part of the total assets under management (Frino 2005, 4). Axiss(2005) provides that, "Australia's fund management industry has the largest pool of funds under management in the Asia-Pacific region (ex Japan) - about A$ 700 billion - which is enticing international firms into the market, either by partnering with existing participants or on their own." 2.3 Mortgage Lending Mortgage lenders and brokers are also in direct competition with the banks for business. According to Deloitte (2005), "Independent brokers are facing increasing competition from banks which are beginning to establish their own franchised broker network via ANZ and CBA." While the nation's largest lenders are banks they are increasingly competing with independent brokerage firms. Deloitte mentions 3 things banks are doing to compete in this growing industry, "by reducing the amount of business being generated by independent brokers, concentrating on volume driven relationships to improve margins, and establishing franchised distribution to directly compete with brokers." 3. Instruments Financial intermediaries-i.e. banks, insurance, pension and finance companies obtain funds by issuing financial claims against themselves and investing those funds. (Fabozzi and Modigliani 1996, 22) The financial claims they issue against themselves are instruments such as bond or other investment instrument issues to the financial markets. For example, they may package loans together and sell them as a bond in global financial markets. With the increasing assets of banks there have recently been some massive market issues coming from Australian banks. According to Euroweek (2005, 1) "Four firms each targeted a different part of the instrument market, Westpac with a A$2bn equivalent global issue, Suncorp Metway with a A$2.5bn equivalent Euro market deal, Members Equity with a A$750m domestic issue, and non-conforming lender Liberty Financial with a A$1.15bn offering, the largest yet for the non-conforming sector." All of these were large bond instruments that investors could buy against a financial institution's assets and earn a return. Liberty Financial is a main player in the Australian mortgage lending market which is increasingly competing with banks. According to Axiss (2005), "The Australian securitised debt and corporate bonds market is expanding rapidly, bolstered by efficient clearing and settlement arrangements as well as a diversity of products being offered in the Asia-Pacific. Trends in this market compare well 'with the trends seen in the world's major debt markets. As of 2002, the total volume of debt on issue in the Australian bond market was A$ 235 billion - an increase of 40% from 1998." The growth of the Australian bond market can partly be attributed to a large growth in banks and other financial institutions, which are not only issuing bonds, but purchasing them as well. Other markets besides the bond market are also doing quite well. Axiss (2005) points out that, "The growth of Australia as a financial centre has seen a wide array of derivative products made available for trading, including futures, options and warrants." The issuing of instruments is only one of the ways that Australian banks interact with financial markets. 4. Financial Markets The funds that banks collect for themselves by issuing instruments are distributed in two ways, "directly by lending to consumers and businesses and by pooling funds to buy securities such as stocks and bonds (Fabozzi and Modigliani 1996, 22)." These stocks and bonds are purchased from financial markets. In addition Vinley (2003, 34) points out that, "money flows from financial institutions into financial markets such as capital markets, money markets, foreign exchange and derivative markets." Financial institutions also distribute money to financial markets by moving money from savers to borrowers. They do this in the money and capital markets. This works because "savers consume less than their income and borrowers consume more than their income, with interest rates being the driving force behind allocating funds" (Edmister 1986, 4). The large amount of assets that Australian banks have access to greatly affects financial markets in Australia and participates in financial markets globally by holding foreign investments or by issuing instruments in foreign stock markets. According to Axiss (2005), "The Sydney Futures Exchange (SFE) is the biggest financial futures market in the Asia Pacific region. Thus all the financial markets in Australia can be seen to be growing at a pace that finds no comparison in the region. Once again we must recognize the fact that the Japanese market is indeed a large market, but in terms of growth potential and current attractiveness Australia is clearly in the lead." So not only have the financial institutions been growing rapidly but the markets have experienced a large growth as well. This is due to the fact that "financial institutions and markets are inseparable in practice, because the markets are often created and operated by financial institutions" (Edmister 1986, 4). 5. Conclusion Institutions, instruments and financial markets are indivisible when you consider their effects on each other. Each in turn can affect the other because they are either in direct competition with each other for assets or customers or participants in the same financial markets, and have access to similar investments. Together these all help to drive the Australian financial system and overall have a large effect on the economy. The Big 4 Australian banks have long been the backbone of the financial system but Insurance, superannuation funds and other non-conventional financial institutions still hold a large amount of assets and use financial markets and instruments on a regular basis. The major trend shaping the future of these interactions is convergence. "In the future major pressure on banks is likely to be the phenomenon of convergence, which refers to the offering of financial services by institutions that are not traditionally part of the financial services industry. Convergence will put further pressure on bank profits and force banks to reconsider their range of products and to develop new delivery systems for their products" (Valentine, Ford, Copp 2005, 100). In some ways this is already happening, with financial deregulation banks got the opportunity to enter the domain of insurance and super funds, as well as to compete better with mortgage lenders. However as a result of this other financial institutions were able to expand their activities as well. Banks are no longer the only ones who can finance home loans, Australia post is using its giro post system to allow customers to do banking at their many locations, and insurance companies are increasing their superannuation fund activities. With continuing convergence in the market banks of the future may look a lot different and be in a much wider range of activities apart from just managing your cheque account and giving you a home loan. All aspects of your financial life can now be done at banks, and with banks expanding their investments in things like infrastructure a bank can now even be responsible for the road that you drive to work on. So it seems that the interactions will only continue to expand and change as time goes on. References Australian mortgage onslaught hits global securitisation. Euroweek, February 4, 2005. http://proquest.umi.com.ezp01.library.qut.edu.au/pqdwebdid=804773561&sid=4&Fmt=3&clientId=14394&RQT=309&VName=PQD (Accessed 17 April 2006). Axiss Australia. 2005. Australia: A Global Financial Services Centre. http://www.investaustralia.gov.au/media/IR_FS_BenchmarkReportAug05.pdf (Accessed 17 April 2006). Commonwealth Bank of Australia: Net Profit Soared 50% in Half On Home-Lending Growth. Wall Street Journal, February 10, 2005. http://proquest.umi.com.ezp01.library.qut.edu.au/pqdwebdid=791142291&sid=4&Fmt=3&clientId=14394&RQT=309&VName=PQD (Accessed 15 April 2006). Deloitte. 2005. The Australian Mortgage Industry, At the Crossroads 2005. Deloitte, http://www.deloitte.com/dtt/cda/doc/content/Australian%20Mortgage%20Industry%20Report.pdf Edmister, R. 1986. Financial Institutions, Markets and Management. 2nd ed. New York: McGraw Hill Fabozzi, F. and F. Modigliani. 1996. Capital Markets, Institutions and Instruments. 2nd ed. Upper Saddle River, NJ: Prentice-Hall. Frino, A., R. Heaney, and D. Service. 2005. Do Past Performance and Past Cash Flows Explain Current Cash Flows into Retail Superannuation Funds in Australia Australian Journal of Management, 30 (2): 229-235. (Accessed 15 April 2006). Lewis, M. and R. Wallace. Ed. 1997. The Australian Financial System: Evolution, Policy and Practice. Melbourne: Addison Wesley. Mishkin, F. and S. Eakins. 2006. Financial Markets and Institutions, 5th ed. Sydney: Pearson Addison Wesley. Valentine T., G. Ford and R. Copp. 2003. Financial Markets and Institutions in Australia. Frenchs Forest NSW: Prentice Hall. Vinley, C. 2003. Financial Institutions, Instruments, and Markets. 4th ed. North Ryde NSW: McGraw Hill. Read More