Commercial Banks: Funds and Activities

Chapter - Commercial Banks

• Major Sources of Bank Funds: Deposits are the most important source, more crucial for smaller banks. Large banks primarily rely on money markets for funds, while a post-GFC trend shows increasing importance of deposits. Government injection through buying securities also acts as a source.

• Major Uses of Bank Funds: Lending and investing. Smaller banks often have more substantial portfolios of investment securities for liquidity, in contrast to larger banks. Agricultural loans are a bigger part of portfolios for smaller rural banks.

• Treasury Securities Holdings: Banks hold Treasury securities for their high liquidity and convertibility to cash quickly. This balances profitability and solvency, though often a trade-off. Banks may choose excessive liquidity over high returns or vice versa.

• Off-Balance Sheet Activities: Revenue-generating activities that do not directly impact balance sheets. Examples include loan commitments and standby letters of credit. These activities significantly affect bank risk profiles and profitability, but aren't immediately shown on financial statements.

Contingent Assets and Liabilities

• Contingent Asset: A potential asset based on a future event, like a loan commitment, giving the customer an option to borrow.

• Contingent Liability: Obligation, like a letter of credit, that becomes a liability if a customer fails to meet an obligation with a supplier.

Small Banks vs Large Banks

• Investment Holdings: Small banks have a larger proportion of investments for liquidity than larger banks that primarily use money markets to acquire this.

• Loan Portfolio Composition: Large banks tend to have larger proportions of commercial loans sourced from national markets, whereas smaller banks tend to operate in local markets with more agricultural/real-estate lending.

• Standby Letters of Credit (LOCs): The bank acts as a third party to facilitate transactions between customers and beneficiaries. Banks essentially guarantee the performance of contractual obligations and can substitute creditworthiness for that of customers when transactions are complete.

Non-interest Income

• Importance of Non-interest Income: This supplementary income plays a significant role in banks, especially during economic uncertainty. It is less risky than interest margins and is often less impacted by economic fluctuations.

Profitability vs Safety Dilemma in Banking

• Conflicting Goals: Bank management constantly struggles to reconcile profitability with the goals of solvency and liquidity.

• Resolution Challenges: Balancing safety and liquidity can be difficult, particularly when there are many conflicting goals to consider.

Overview of Nonbank Financial Institutions in Australia

• Diverse Range: Primarily includes building societies, credit unions, and finance companies, which offer a wider range of financial products than banks.

• Role of Regulation: Building societies and credit unions, and more generally, nonbank financial institutions, fall under the supervision of APRA (Australian Prudential Regulation Authority) and operate under the same regulations as banks—this framework seeks to maintain safety and stability within the financial system.

• Differences from Banks: Finance companies don't deal in demand deposits, and their operations are primarily focused on lending activities rather than deposit-taking.

Credit Unions

• Common Bond of Association: Credit unions are known for shared characteristics of members, like similar residence, occupation, or association.

• Original Purpose: Initially created to serve as outlets for member savings and provide loans on favorable terms primarily for consumer lending.

• Contemporary Operations: To remain competitive, some credit unions have modified their common membership requirements.

Finance Companies

• Funding Sources: Primarily rely on borrowing from commercial banks, issuing commercial paper, and/or leveraging corporate relationships.

• Specialized Activities: Consumer finance companies focus on consumer loans, whereas captive finance companies fund their parent company transactions.

Explore the major sources and uses of funds for commercial banks, with a focus on the importance of deposits, lending, and investment. Understand Treasury securities holdings and off-balance sheet activities. Differences between large and small banks are highlighted.