Financial Risk Management: Profitability Measures for Australian Banks

This report provides a comprehensive analysis of financial risk management within the Australian banking sector, focusing on the four major banks: Commonwealth Bank, ANZ, NAB, and Westpac. The report begins by identifying the primary sources and uses of funds for banks in Australia, supported by data from a selected bank's latest financial report. It then ranks the banks based on key metrics such as total assets, total equity, market capitalization, and profit before tax, followed by an in-depth examination of their financial performance using profitability ratios. The analysis extends to evaluating the banks' overall financial positions, including debt-equity ratios and capital adequacy, and assesses credit quality through internal and external ratings. Furthermore, the report explores various financial measures, including changes in deposits, operating income, net profit, and earnings per share. The report also discusses the Australian Prudential Regulation Framework (APRA), its role in guiding regulation and supervision, and its impact on the banking sector. Finally, the report calculates and interprets return on assets and return on equity to evaluate the banks' profitability and efficiency.

Running head: FINANCIAL RISK MANAGEMENT PROTECTING THE ENTERPRISE
Financial risk management protecting the enterprise
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Table of Contents
Answer 1....................................................................................................................................2
Question 2..................................................................................................................................3
Question 3..................................................................................................................................7
Question 4..................................................................................................................................8
Reference..................................................................................................................................10

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Answer 1
The major sources of funds in Australia include the following:
 Local deposits- these include deposits and advances from local sources including
local corporations and domestic sources.
 Local wholesale funding- Wholesale funding is a major source of finance employed
by Australian banks. It is an additional source of funding that is employed by banks to
finance operations and enable risk management. Local wholesale funding sources
include federal funds public funds that include state and local municipalities.
 Inter sale wholesale funding- Inter sale wholesale funding includes sources of funds
that represents foreign deposits, federal funds and brokered deposits (Cavusgil et al,
2014).
The major uses of funds include:
 Loans and advances - Loans and advances are the most important applications of
funds in banks.
 Interbank lending - Sometimes banks lend money to other banks in case of meeting
shortage requirements and other emergency requirements.
 Foreign currency and foreign currency assets-foreign currency and foreign currency
assets are important applications of funds as they promote a source of foreign
exchange (Petty et al. 2015).
 Cash and deposits with the RBA-The RBA includes the Reserve Bank of Australia. It
conducts the monetary policy of Australia .The banks are required to keep a certain
percentage of liquid cash of their deposits with the reserve bank of Australia (Tissot
and Gadanecz 2018)

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In reference to the question above the bank that can be discussed in the above is the
commonwealth bank. The major sources of funds include proceeds from sale investments to
the amount of $ 49392 million. Another important source of funds includes deposits and
other public borrowings, to the extent of 39821 million dollars. The applications of funds
include to the extents of purchase of investments that include $ 54608 million dollars. It also
includes investments to the net increase in loans, bills discounted and other receivables, to the
amount of $ 38744 million dollars (Commbank.com.au 2018).
Question 2
a. Ranking the banks
 Total asset – based on the amount of total asset commonwealth bank will be ranked 1,
Australia and New Zealand Banking Group Limited (ANZ) will be ranked 2, Westpac
bank will be ranked 3 and National Australia Bank (NAB) will be ranked 4
(Westpac.com.au 2018).
 Total equity - based on the amount of total equity commonwealth bank will be ranked
1, Westpac bank will be ranked 2, ANZ will be ranked 3, and NAB will be ranked 4
(Capital.nab.com.au 2018).
 Market capitalization – based on the amount of market capitalization commonwealth
bank will be ranked 1, ANZ will be ranked 2, NAB will be ranked 3 and Westpac
bank will be ranked 4.

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 Profit before tax – based on the amount of market capitalization commonwealth bank
will be ranked 1, Westpac bank will be ranked 2, ANZ will be ranked 3 and NAB will
be ranked 4 (Anz.com.au 2018).
b. Financial performance and measures for Profit and loss
For analysing the financial performance of the banks ratio measure has been used. Net
profit ratio has been used for analysing the bank’s performances and it is computed through
dividing the operating profit of the banks by net profit. It can be identified from the above
table that net profit margin of NAB is highest among all. After that, commonwealth bank
comes 2nd, Westpac bank comes 3rd and ANZ comes 4th (Anz.com.au 2018).
c. Overall financial position
Looking at the balance sheets of the banks it is found that if the debt equity ratios of
the banks are taken into consideration except Westpac Bank all other bank’s debt equity ratio
are almost same as it ranges from 14.19 to 14.36. However, the Westpac Bank’s position is
quite better as its debt equity ratio is 12.89 (Westpac.com.au 2018). It indicates that Westpac
Bank’s capital structure involve less amount of debt as compared to other banks. On the other
hand, debt ratio that states the percentage of assets financed through borrowings for all the
banks are same at 0.93. Therefore, financial positions of all the banks are almost same only
with the exception that Westpac bank is in slightly better position.
d. Capital measure

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The capital adequacy ratio measures amount of the bank’s capital in comparison to
the amount of risk weighted credit exposure. The risk weightage procedure considers the
associated riskiness of different types of the credit exposure of the bank and incorporates the
impact of the off balance sheet contracts with regard to credit risk. Higher level of capital
adequacy ratio indicates that the company is less exposed to unexpected looses and it can
absorb higher level of unexpected losses before it becomes insolvent (Capital.nab.com.au
2018). It can be identified from the above table that among all the banks ANZ is in best
position followed by Westpac Bank, Commonwealth Bank and NAB with regard to capital
measure.
e. Credit quality measures
ANZ –
Internal rating Moody’s rating Standards & Poors rating
Strong credit profile Aaa - Baa3 AAA - BBB
Satisfactory risk Ba1 - Ba3 BB+ - BB
Sub-standard but not past due nor impaired B1 - Caa B+ - CCC
Commonwealth Bank –
Solid credit rating of the company provided by S & P, Moody’s and Fitch is AA- / Aa3 / AA
NAB –

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 Senior investment grade: widely matches with Standard & Poor’s ratings of AAA to
A- (internal rating 1 to 5).
 Investment grade: widely matches with Standard & Poor’s ratings of BBB+ to BBB-
(internal rating 6 to 11).
 Sub-investment grade: widely matches with Standard & Poor’s ratings of BB+ up to
but not including defaulted or impaired (internal rating 12 to 23)
Westpac Bank –
Rating Agency Long term Short term Outlook
Fitch Ratings AA- F1+ Stable
Moody's Investor Services Aa3 P-1 Stable
S&P Global Ratings AA- A-1+ Negative
f. Other financial measures
ANZ – deposits and various other borrowings of the company increased significantly from $
23,128 million to $ 30,904 million (Anz.com.au 2018).
Commonwealth Bank – operating income of the bank has been increased from $ 24,578
million to $ 26,121
NAB – Net profit of the bank significantly increased from $ 357 million to $ 5,288 million.
Westpac Bank – earnings per share has been reduced from 116.8 cents to 121.2 cents
(Westpac.com.au 2018).

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Question 3
a) The Australian prudential regulation framework guides the regulation and supervision
through this framework that was developed in 2003-04. This framework identifies the risks
that are involved and provides a supervisory action in order to keep the risk in accepted
levels. Since the introduction of this framework, this has made a significant evolution in
terms of incorporating new risks, changing environments and changing international
standards.
The scope of this framework is broad. It covers a range of activities, supporting
procedures, systems, processes and guidelines that are necessary to form the assessment of
risk and form supervision strategies (Apra.gov.au 2018).
There are five parts of Australian Prudential Regulatory Framework for prudential
supervision that includes:
 Entity risk assessment
 Supervision outcomes and responses
 Supervisory activities
 Quality assurance within the framework
 Supporting material and infrastructure
The Australian prudential regulation framework is established for the purpose of
regulating bodies in the financial sector. It provides the balance of objectives of financial
safety and efficiency. It provides the competition, contestability and competitive neutrality. It
tries to balance these objectives and promote financial system in Australia.
The specific industry act that coves banking, general insurance, life insurance and
superannuation make this broad mandate and also sets out objectives with respect to licensing
and supervision of the industry. The primary objective of ARPA is to protect depositor by

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promoting the management of regulated institutions in each industry. It also helps in
promoting the financial stability in amore encompassing manner. In addition to the following,
the ARPA also publishes financial reports, contracts and grants as well (ABC News 2018).
The Australian prudential regulation authority’s current asset growth is regulating
investor growth fewer than ten percent a year. It places a more stringent approach on lending
standards. APRA also suggested an additional spending limit that requires banks to keep
interest only loan less than thirty percent than mortgage portfolio. The APRA has placed
banks to provide assurance on the safety of lending standards APRA referred that the ten
percent of the speed limit will not be applicable, and the boards will confirm that:
 The policies on lending meet APRA’s guidance on serviceability.
 The practices on lending must be strengthened where it is required.
 The lending has been below the investor growth of the loan sector for the last six
months.
The major banks are required to keep a stringent check on asset lending those impacts
its overall asset usability. According to the APRA framework, it is pretty evident that the
banks will have a more tough time in meeting requirements. This will impact the growth of
the banking sector in an adverse way and affect the Australian economy as well in a negative
fashion (Apra.gov.au 2018).
Question 4
Profit margin = net profit / sales = 21
Asset utilization = sales / total asset = 11
Equity multiplier = total asset / total equity = 12

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Therefore, Return on asset = net profit / total asset = 0.21/0.11 = 2.31%
Return on equity = 19.32 calculated as follows –
Sales / total equity = 0.11/12 = 0.0092
Net profit / total equity = 0.21*0.0092 = 0.19%
Return on assets indicates the ability of the company to generate revenue from each
dollar of assets. On the other hand, return on equity represents the ability of the company to
create return for its shareholders.

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Reference
ABC News., 2018. Bank regulator relaxes investor loan 'speed limit', boards made
accountable. [online] Available at: http://www.abc.net.au/news/2018-04-26/bank-regulator-
relaxes-investor-lending-speed-limit/9698560 [Accessed 31 Aug. 2018].
Anz.com.au., 2018. ANZ Personal Banking | Accounts, credit cards, loans, insurance | ANZ.
[online] Available at: https://www.anz.com.au/personal/ [Accessed 31 Aug. 2018].
Apra.gov.au., 2018. APRA. [online] Apra.gov.au. Available at: https://www.apra.gov.au/
[Accessed 31 Aug. 2018].
Capital.nab.com.au., 2018. [online] Available at: https://capital.nab.com.au/docs/NAB-2017-
annual-financial-report.pdf [Accessed 31 Aug. 2018].
Cavusgil, S.T., Knight, G., Riesenberger, J.R., Rammal, H.G. and Rose, E.L.,
2014. International business. Pearson Australia.
Commbank.com.au., 2018. [online] Commbank.com.au. Available at:
https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/annual-
reports/annual_report_2017_14_aug_2017.pdf [Accessed 31 Aug. 2018].
Petty, J.W., Titman, S., Keown, A.J., Martin, P., Martin, J.D. and Burrow, M.,
2015. Financial management: Principles and applications. Pearson Higher Education AU.
Tissot, B. and Gadanecz, B., 2018. Measures of financial inclusion-a central bank
perspective. IFC Bulletins chapters, 47.
Westpac.com.au., 2018. [online] Available at:
https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/
ASX_FY17_Financial_Results_Bookmarked.pdf [Accessed 31 Aug. 2018].

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