Analysis of Financial Instruments and Institutions in Australia

This report provides an in-depth analysis of financial instruments and institutions in Australia, addressing three key tasks. Task 1 examines the main types of financial institutions as classified by the Reserve Bank of Australia (RBA), including authorized and non-authorized deposit-taking institutions, and funds and insurance managers, detailing their roles and responsibilities. Task 2 focuses on the performance of major Australian banks, such as ANZ, Commonwealth Bank, Westpac, and NAB, using financial indicators like revenue, net income, profit before tax, and loan impairment, to assess their performance in a transforming industry landscape. Task 3 explores the term structure of interest rates in Australia, illustrating the relationship between bond yields and maturities, and its significance in the fixed income world. The report uses data and charts to support the analysis, providing a comprehensive overview of the Australian financial landscape.

Running head: FINANCIAL INSTRUMENTS AND INSTITUTIONS
Financial instruments and institutions
Name of the Student
Name of the University
Author Note

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FINANCIAL INSTRUMENTS AND INSTITUTIONS
Table of Contents
Answer to task 1:........................................................................................................................2
Introduction:...............................................................................................................................2
Discussion:.................................................................................................................................2
Conclusion:................................................................................................................................4
Answer to task 2:........................................................................................................................4
Introduction:...............................................................................................................................4
Discussion:.................................................................................................................................4
Conclusion:................................................................................................................................8
Answer to task 3:........................................................................................................................8
Introduction:...............................................................................................................................8
Discussion:.................................................................................................................................8
Conclusion:..............................................................................................................................10
Reference list:...........................................................................................................................12

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Answer to task 1:
Introduction:
The report is prepared to identify the main types of financial institutions that are
classified by the Reserve Bank of Australia. For this purpose, the performance, roles and
responsibilities played by each financial institution have also been presented. The Reserve
Bank of Australia has divided the financial institutions in into three categories comprising of
non-authorized deposit taking institution, authorized deposit taking institution and funds and
insurance managers.
Discussion:
All the three categories of the financial institutions classified by RBA are explained
below:
Non-authorized deposit taking institute:
Different types of institutions that are classified as non-authorized institutions include
finance companies, money market corporations and securitizes. Finance companies
comprised of pastoral finance companies and general financiers and money market
Corporations include broker dealers. The function of finance companies is to raise funds from
retail investors and wholesale market using unsecured notes and debentures. Money market
Corporation on other hand has its operation primarily in wholesale market and provides
lending facilities to large corporations and bank along with some other services such as
capital market, capital finance, investment management and foreign exchange (rba.gov.au,
2019). Securitisers are the special purpose vehicle that uses pool of assets to issue securities.

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The credit enhancements of the securities are usually done by way of guarantee from third
parties.
Authorized deposit-taking institute:
Building societies, banks and credit unions are categorized as authorized deposit
taking institute, which are managed by APRA. Banks are the financial institution having the
function of providing wide range of financial services including insurance and fund
management services. Credit unions provide service to economy by way personal loan,
deposit and payment service to members. Building societies shave the same function as that
of credit unions (rba.gov.au, 2019).
Funds and insurance managers:
The type of financial institution that operates as insurance and fund managers include
life insurance companies, health insurance companies, approved deposit and superannuation
funds and general insurance companies all of which are regulated by APRA. The function of
Health Insurance Company is to provide insurance for covering the private cost of health and
investment is mainly done in government securities, loan and equities. Life insurance
companies provide accident, disability and life insurance, investment and superannuation,
annuities. Assets of this financial institution are invested mostly in securities and equities and
are managed on fiduciary basis in statutory funds. General insurance companies on other
hand provide motor vehicle, property and liability to employer by investing in government
securities, loan and deposit and equities. Other institutions operate as fund managers such as
public unit trust, approved and superannuation deposit funds, friendly societies, common
funds and cash management trust which are regulated by ASIC. Cash management trust is the
trust unit that is governed by trust deeds and their investment is generally confined to the
financial securities in the short-term money market (Viney & Phillips, 2012). Public unit trust

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are the trust that pool the funds of investors into certain types of assets such as market
investment, money, equities, cash, overseas securities and mortgage. The insurance
companies, bank subsidiaries and merchant banks do management of unit trust.
Conclusion:
The analysis of the different types of financial institutions classified by RBA depicts
that each of the institutions has different functions and objectives in terms of contribution to
the services to economy. Most of such institutions are regulated and supervised by the
authorized deposit-taking institute in Australia.
Answer to task 2:
Introduction:
The report intends to elucidate the performance of the major banks operating in
Australia by performing the analysis of data. In this study, four major banks operating in the
country has been chosen which comprise of The Australian and New Zealand banking group
limited, Common wealth bank of Australia, Westpac and National Australia bank. The
performance of these banks can be analyzed in terms of several financial indicators such as
revenue, net income earned, and profit before tax, interest, loan impairment and deposits.
Discussion:
The results of the major banks of Australia depicts that in the era of transformation of
industry, the growth seems to be challenging. There has been improvement in the margin and
loan impairment; however, the banks are facing the major change brought by operating and
regulatory environment in terms of rising level of capital, slowing growth revenue, increasing
remediation and legal cost. Different strategic initiatives and investments are pursued by the

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major banks as they seek to simplify, reorient and digitize their business model (Valverde et
al., 2016).
Provisions and profit before tax versus operating profit before tax:
(Source: Assets.kpmg, 2019)
The above chart shows that there was a continuous rise in the capital position of major
banks. Over half the year, there was a rise in the capital ration by 20 basis points, which was
reflected from the increased regulatory capital.

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Total capital versus return on equity
(Source: Assets.kpmg, 2019)
It is identified from the above chart that the returns on equity of the major Australian
banks have declined over the years. The new regulatory requirement has resulted in
increasing the capital level of banks for compressing industry returns.
Payout ratio versus dividend yield:
(Source: Assets.kpmg, 2019)

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The payment of dividend by the major banks in Australia remained largely flat with
only Common wealth bank of Australia recording an increase in the dividend payout ratio by
1 percent. There was an increase in dividend payout ratio by an average of 3%. The ratio for
ANZ bank decreased to 66.2% as against 70% and the ratio for NAB increasing to 96.9% as
against 79.9% in year 2017.
Net income and net interest margin
(Source: Assets.kpmg, 2019)
For improving the business efficiency of the major banks, they continued to intensify
their efforts. The operating expenses increased and such increase is mainly attributable to
increased legal and regulatory expenditure and cost of restructuring (Jotikasthira et al., 2015).
Furthermore, an increase in the net interest margin was reported by the major banks in year
2017 due to re pricing of interest and favorable movement in the housing loan and investment
loan in response to the increased regulatory requirement. In addition to this, the four major
banks reported an increase in the net interest income by 5%, which indicated an increase in 3
basis point in the year 2018 compared to 2017. This is increase in net income is attributable

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to factors such as deposit and mortgage repricing, decrease in cost of wholesale funding and
an increase in interest earning assets (Österholm, 2018).
Conclusion:
From the analysis of the above data pertaining to different performance indicators, it
can be inferred that the performance of banks improved in some aspects as a response to the
stringent legal and regulatory requirement. However, the expenses and costs of these banks
increased due to several factors along with slowing growth of revenue.
Answer to task 3:
Introduction:
In this report, the term structure of interest rates in Australia is demonstrated which
depicts the relationship between bond yield or interest rates and different maturities or term.
In the fixed income world, the term structure of interest rate is the most crucial benchmark
because of its role played in the economy and such interest rate is central to all the debt
securities (Kidwell et al., 2016).
Discussion:
The term structure is presented by the yield curve that helps in plotting the yield to
maturity of bonds with varying term to maturity. The Australian government bonds are used
in the Australia as the yield do not incorporate any risk premium and have essentially zero
probability of making default (Fernández and Tamayo, 2017).

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Australian term structure:
(Source: Pwc.com.au, 2019)
The collective expectations of market participants are reflected by the term structure
of interest rate along with changes in inflation, interest rate and assessment of the conditions
of monetary policy. It has been argued that the current and future short-term rates are helps in
determining the long-term interest rate. Moreover, such rates are determined in a way that
investors are indifferent between investing in a sequence of short-term bonds and long-term
bonds because the option return is same for investor. The term structure of interest rate is also
influenced by the compensation of investors for deterring the consumption today. The
interpretation and modeling of the term structure of interest rate becomes difficult because of
change in risk expectation, inflation and change in yield.

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Term structure interest rate:
(Source: rba.gov.au 2019)
The data presented above in table depicts that the valuation of zero coupon bands
have changed the yield of bonds until maturity value. It has caused reduction in the interest
level until the time of maturity.
A risk is associated with the reaction of the dollar of Australia when the rate of
Australian dollar falls below the US dollar. It assumes that investors are delighted about
making investment as long as they are required to make payment via the interest premium.
The pricing and arbitrage theories are developed by using interest rate derivatives and
modeling of the term structure of interest rate. The computation of term structure of interest
rate is dependent upon the forward rates that are measured by the maturity and time.
Conclusion:
The above report has analyzed the importance of value of bond in determining the
yield and the role played by the term structure of interest rate. The justification about the term

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structure of interest rate determined by the Reserve bank of Australia only if the computation
of interest rate is appropriately done using the models.

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Reference list:
Assets.kpmg. (2019). Retrieved 4 April 2019, from
https://assets.kpmg/content/dam/kpmg/au/pdf/2018/major-australian-banks-half-year-
2018-results-analysis.pdf
Fernández, A. and Tamayo, C.E., 2017. From institutions to financial development and
growth: what are the links?. Journal of Economic Surveys, 31(1), pp.17-57.
Introduction | RDP 2008-09: A Term Structure Decomposition of the Australian Yield Curve
| RBA. (2019). Reserve Bank of Australia. Retrieved 4 April 2019, from
https://www.rba.gov.au/publications/rdp/2008/2008-09/introduction.html
Jotikasthira, C., Le, A. and Lundblad, C., 2015. Why do term structures in different
currencies co-move?. Journal of Financial Economics, 115(1), pp.58-83.
Kidwell, D. S., Blackwell, D. W., Sias, R. W., & Whidbee, D. A. (2016). Financial
institutions, markets, and money. John Wiley & Sons.
Main Types of Financial Institutions. (2019). Reserve Bank of Australia. Retrieved 4 April
2019, from https://www.rba.gov.au/fin-stability/fin-inst/main-types-of-financial-
institutions.html#fn1
Österholm, P., 2018. The relation between treasury yields and corporate bond yield spreads in
Australia: Evidence from VARs. Finance Research Letters, 24, pp.186-192.
Pwc.com.au. (2019). Retrieved 4 April 2019, from https://www.pwc.com.au/banking-capital-
markets/banking-matters-major-banks-analysis-full-year-2018.pdf
Valverde, S.C., Solas, P.J.C. and Fernández, F.R. eds., 2016. Bank Funding, Financial
Instruments and Decision-Making in the Banking Industry. Springer.
Viney, C., & Phillips, P. (2012). Financial institutions, instruments & markets. McGraw-Hill
Australia.

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