Chapter 2

The Banking Sector

 Chapter Organisation
2.1 Introduction
2.2 Functions of Banks
2.3 Sources of Funds
2.4 Uses of Funds
 2.2 Functions of Bank
• Asset Management : A bank Restricts growth in
its lending activities to the level of funds available from its
depositor base.
• Liability Management: A bank actively raises
funds in the debt markets to fund new growth in lending.
• Commercial Bill Market: A very liquid
secondary market for the buying and selling of a money
market securities.
• Off Balance Sheet Business: Transactions
conducted by a bank that are currently a contingent
liability and therefore are not recorded on the balance
sheet.
 2.3 Sources of Funds
• Sources of funds appear in the balance sheet
as either liabilities or shareholders funds

• Banks offer a range of deposit and investment

products with different mixes of liquidity,
return, maturity and cash flow structure to
attract the savings of surplus entities
 2.3 Sources of Funds (cont.)
• Current deposits
– Funds held in a cheque account
– Highly liquid
– May be interest or non-interest bearing
• Call or demand deposits
– Funds held in savings accounts that can be
withdrawn on demand
– e.g. passbook account, electronic statement
account with ATM EFT and POS
 2.3 Sources of Funds (cont.)
• Term deposits
– Funds lodged in an account for a predetermined
period at a specified interest rate
• Term: one month to five years
• Loss of liquidity due to fixed maturity
• Higher interest rate than current or call accounts
• Generally fixed interest rate
 2.3 Sources of Funds (cont.)
• Negotiable certificates of deposit (CDs)
– Paper issued by a bank in its own name
– Issued at a discount to face value or Interest based
– Specifies repayment of the face value of the CD at
maturity
– Highly negotiable security
– Short term (30 to 180 days)
 2.3 Sources of Funds (cont.)
• Bill acceptance liabilities
– Bill of exchange
• A security issued into the money market at a discount
to the face value. The face value is repaid to the holder
at maturity
– Acceptance
• Issuer of bill agrees to pay bank face value of bill, plus a
fee, at maturity date
• Acceptance by bank guarantees flow of funds to its
customers without using its own funds
Essentials of Bill of exchange
 2.3 Sources of Funds (cont.)
• Debt liabilities
– Medium- to longer-term debt instruments issued
by a bank
• Debenture
– A bond supported by a form of security, being a charge over
the assets of the issuer (e.g. collateralised floating charge)
• Unsecured note
– A bond issued with no supporting security
 2.3 Sources of Funds (cont.)
• Foreign currency liabilities
– The issue of debt instruments into the
international capital markets that are
denominated in a foreign currency
• allows diversification of funding sources into
international markets
• facilitates matching of foreign exchange denominated
assets
• meet demand of corporate customers for foreign
exchange products
 2.3 Sources of Funds (cont.)
• Loan capital
– Sources of funds that have the characteristic of
both debt and equity (e.g. subordinated
debentures and subordinated notes)
• Subordinated means the holder of the security has a
claim on interest payments or the assets of the issuer,
after all other creditors have been paid (excluding
ordinary shareholders)
 2.4 Uses of Funds
• Uses of funds appear in the balance sheet as
assets
• The majority of bank assets are loans which
give rise to an entitlement to future cash
flows, i.e. interest and repayment of principal
• Lending to government
• Commercial lending
• Personal finance
 2.4 Uses of Funds (cont.)
• Lending to government
– Treasury notes
• Short-term discount securities issued by the
Commonwealth Government
– Treasury bonds
• Medium- to longer-term securities issued by the
commonwealth government that pay a specified
interest coupon stream
– State government debt securities
– Low risk and low return
 2.4 Uses of Funds (cont.)
• Commercial lending (business sector and
other financial intermediaries)
– Fixed-term loan
• A loan with negotiated terms and conditions
– Period of the loan
– Interest rates
» Fixed or variable rates set to a specified reference rate
(e.g. BBSW)
– Timing of interest payment
– Repayment of principal
 2.4 Uses of Funds (cont.)
– Overdraft
• A facility allowing a business’s operating account into
debit up to an agreed limit
– Bank bills held
• Bills of exchange (see slide 10) accepted and discounted
by a bank and held as assets
• A rollover facility is where a bank agrees to discount
new bills over a specified period as existing bills mature
– Leasing
 2.4 Uses of Funds (cont.)
• Personal finance
– Housing finance
• Mortgage
• Amortised loan
– Investment property
– Fixed-term loan
– Credit card
• Other bank assets (e.g. infrastructure, shares
in controlled entities)