Financial Institutions

FINANCIAL MARKETS AND INSTITUTIONS

Topic 3
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Overview: Financial Institutions

Characteristics
Main types of
of depository
FIs
institutions

Source of
Uses of funds
funds

Non-bank
financial
institutions

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Main types of financial institutions

Deposit Taking Financial Institutions: attract the

savings of depositors through on-demand deposit and
term deposit accounts.
 e.g. commercial banks, building societies and credit
cooperatives.

Non Deposit Taking Financial Institutions: may

manage funds under contractual arrangements and
provide a wide range of financial services.
 e.g. Investment banks, general insurance companies and
superannuation funds.

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Main types of financial institutions

Insurers
ADIs Non-ADIs
and Funds
Investment banks
Commercial banks and Merchant Managed funds
Banks

Finance Life insurance

Building societies companies and offices and general
and credit general financiers insurance offices
And etc… And etc…

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In Vietnam (2022)
Number of
Type of institution
institutions

Commercial banks 44
State-Owned 4
Banks
Joint stock commercial banks 31
(47)
Wholly foreign-owned banks 9
Policy banks 2
Cooperative banks 1
Non-Bank credit institutions Finance companies 16
(26) Leasing companies 10
Micro-Finance Institutions (10)
Foreign Banks Branches (52)
Representative offices of Foreign
Credit institutions (63)
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Main types of financial institutions

Commercial banks
Commercial banks are the largest group of financial
institutions within a financial system.
The core business of banks is often described as the
gathering of savings (deposits) in order to provide loans for
investment.
They also provide a wide range of off-balance-sheet
transactions such a underwriting, issue of derivatives or
execute FX transactions.

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Characteristics of Commercial Banks

 Control a significant proportion of the financial assets within
the financial system and provide a full range of financial
services.
 In the modern financial system, the activities of commercial
banks are far less regulated than they have been
historically
 In a less regulated environment, commercial banks practise
‘liability management’ whereby shortfalls in loan demand
are borrowed on the capital markets
 The regulation of the banking sector attracted renewed
attention following the Global Financial Crisis (GFC)
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Characteristics of Commercial Banking

Importance of banks
 A high level of regulation prior to the mid-1980s constrained
banks’ development and led to a growth of non-bank
financial institutions
 With deregulation in the period after 1980, banks began to
practise liability management, where demand for loans was
met by borrowing rather than from available deposits or
equity
 Commercial banks hold the largest share of assets of all
institutions
 But even this understates the volume of business that
commercial banks undertake because it does not include
off-balance-sheet transactions
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Characteristics of Commercial Banking

Asset management (before the 1980s)

 Loans portfolio is tailored to match the available deposit
base

Liability management (1980s onwards)

 Deposit base and other funding sources are managed to
meet loan demand
 Borrow directly from domestic and international capital markets
 Provision of other financial services
 Off-balance-sheet (OBS) business
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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
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Sources of funds

Current account 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
 Includes passbook account, electronic statement account with ATM and
EFTPOS
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Sources of funds
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 owing to fixed maturity
 Higher interest rate than current or call accounts
 Generally fixed interest rate

Negotiable certificates of deposit (CDs)

 Paper issued by a bank in its own name
 Issued at a discount to face value
 Specifies repayment of the face value of the CD at
maturity
 Highly negotiable security
 Short term (30 to 180 days)
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Sources of funds

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
 Bank accepts primary liability to repay face value of bill to holder
 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

(cont.)
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Sources of funds

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) ( are backed only by the
creditworthiness and reputation of the issuer)
 Unsecured note
 A bond issued with no supporting security

(cont.)
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Sources of funds

Foreign currency liabilities

 Debt instruments issued 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
 Meets demand of corporate customers for foreign exchange products

(cont.)
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Sources of funds

Loan capital and shareholders’ equity

 Sources of funds that have characteristics 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)
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Uses of funds
Personal and housing finance
 Investment property
 Fixed-term loan
 Credit card
 Housing finance
 Mortgage
 Amortised loan (periodically lower the book value of a loan)

(cont.)
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Uses of funds

Commercial lending
 Involves bank assets invested in the business sector and
lending to other financial institutions
 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 payments
 Repayment of principal

(cont.)
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Uses of funds

Commercial lending
 Overdraft
 A facility allowing a business to take its operating account into debit up to an
agreed limit
 Bills of exchange
 Bank bills held
 Bills of exchange accepted and discounted by a bank and held as assets
 Commercial bills
 Bills of exchange issued directly by business to raise finance
 Rollover facility
 Bank agrees to discount new bills over a specified period as existing bills
mature
 Leasing
(cont.)
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Uses of funds
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

Other bank assets

 Include electronic network infrastructure and shares in
controlled entities
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Non-depository financial institutions

Operating alongside commercial banks are a range of non-
bank financial institutions. These include:

• Investment banks
• Managed funds
• Life insurance and general insurance offices
• Finance companies and general financiers
• Building societies and Credit unions
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Investment bank and merchant

banks (MM Corp)
Investment banks are innovators at the cutting edge of
developments in the financial system, often using the latest
theoretical work produced by finance scholars
The organisation of an investment bank is interesting:
 front office, middle office and back office
In Australia, investment banks or money market
corporations do not control a large share of the total assets
of financial institutions
However, they remain important as innovators and deal-
makers (cont.)
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Main types of financial institutions

Investment banks and merchant banks
(MM Corp)
Mainly provide off-balance-sheet (OBS) advisory services to
support corporate and government clients, e.g.:
 advice on mergers and acquisitions, portfolio restructuring,
finance and risk management
May also provide some loans to clients but are more likely to
advise on raising funds directly in capital markets.
They also execute FX transactions

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Investment banks

Sources of funds
 Mainly securities issued into international money markets
and capital markets

Uses of funds
 Limited lending to clients, usually on short-term basis
 These loans tend to be sold into the secondary market
 Primarily focused on off-balance-sheet advisory services
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Main types of financial institutions

Managed Funds
Life and general insurance
Finance companies
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Finance companies
Finance companies provide short- and intermediate-term credit to
consumers and small businesses. Although other financial institutions
provide this service, only finance companies specialize in it.
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Building societies

Sources of funds
 Mainly deposits from customers
Uses of funds
 Personal finance to individual borrowers
 Mainly housing finance
 Term loans and credit card finance

Regulation
 As they are ADIs (i.e. authorised by APRA to accept retail
deposits), regulation is by APRA with the same prudential
and reporting standards as banks
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Credit unions

Uses of funds
 Primarily personal finance to members
 Residential housing loans
 Personal loans and credit card facilities
 Limited commercial lending

Regulation
 As ADIs, they are regulated by APRA, which applies the
same prudential and reporting standards as for banks and
PBSs
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Summary
Banks are the dominant financial institution and have moved to liability
management
 Sources of funds include deposits (current, call and term deposits) and non-
deposit sources (bill acceptances, debt and foreign currency liabilities, OBS
business and other services)
 Uses of funds include government, commercial and personal lending
Non-bank financial institutions can be classified according to their assets and
liabilities and the type of services provided
 Investment banks provide advisory services to corporations and government
 Life insurance and general insurance offices are contractual savings institutions
that generate funds mainly on the receipt of premiums for insurance policies
 Finance companies issue debentures and unsecured notes and lend to
individuals and businesses
 Building societies and credit unions receive deposits from individuals and lend
for residential housing
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