With the financial sector development contributing to economic growth for more than 100 years, banks are still a major financial institution in the market. Commercial banks, investment banks, and central reserve banks make up the largest group of financial intermediaries within the entire financial system. Starting from the Italian monetary exchange in the Middle Ages, the foundation of modern banks has long been developed along with the emergence of capitalism. Other financial institutions include insurance companies, managed and superannuation funds, credit unions, and hedge funds, all of which have facilitated the financial capital flow and market liquidity from different functional perspectives.
Welcome to Topic 3: Banks and Other Financial Institutions. In this topic, you will learn about:
- The banking system, including commercial, investment and central banks
- Other key financial institutions, including insurance and funds management companies
- International capital markets.
These relate to the Subject Learning Outcomes:
- Understand the role of the finance and accounting functions in an organisation.
- Develop analytical skills drawing from key finance theories, concepts, and techniques.
Welcome to your pre-seminar learning tasks for this week. Please ensure you complete these prior to attending your scheduled seminar with your lecturer.
Click on each of the following headings to read more about what is required for each of your pre-seminar learning tasks.
Read Chapter 3 of the prescribed text - Melicher, RW & Norton, EA 2017, Introduction to finance: Markets, investments, and financial management, 16th edn., John Wiley & Sons, Inc.
Read the following journal articles:
- Tobin, J 1982, ‘The commercial banking firm: a simple model’, Scandinavia Journal of Economics, 84(4):495-530
- Diamond, DW & Dybvig, PH 1983, ‘Bank runs, deposit insurance, and liquidity’, Journal of Political Economy, 91(3):401-419.
Identify the key takeouts from the articles and add these to your reflective journal. You can access the reflective journal by clicking on ‘Journal’ in the navigation bar for this subject.
If you are unsure of any concepts, reach out to your lecturer.
Read the following web articles:
- Confides Solutions n.d., Differences between bank and financial institutions, blog post.
- MyAussieBank n.d., Different types of home loans in Australia, blog post.
- MyAussieBank n.d., Other financial institutions, blog post.
- MyAussieBank n.d., How do banks make their money, blog post.
This topic has discussion forum activities, which will enhance your knowledge and give you the opportunity to interact with your peers. You can access the activities by clicking on the following links. You can also navigate to the forum by clicking on 'FIN100 Subject Forum' in the navigation bar for this subject.
Read and watch the following content.
The banking system
The Australian banking system plays a major role in the country’s financial system. Apart from traditional banking services, banks also provide the following.
- Business banking
- Trading in financial markets
- Stockbroking
- Insurance
- Funds management.
Did you know? There are 53 Australian banks, 14 of which are owned by the government.
Commercial banks
Commercial banks are “depository institutions that accept deposits, issue check-writing accounts and make loans to businesses and individuals” (Melicher & Norton 2017, p. 48). While they all provide similar services, they charge different interest levels and commissions for those services. To attract savings funds from households, commercial banks would, for example, pay them a 2 % interest per annum. The savings funds are used when businesses or other individuals borrow capital from the banks at an interest rate of 2.5 %. The interest gap here of 0.5 % is the profit base for commercial banks.
Bank loans
Both personal and business loans can be designed and packaged according to preferred commercial purposes from clients’ perspectives. For example, home loans (mortgage) are applied to property investments, while vehicle owners pay automotive loans in periodic instalments.
Usually, traditional commercial banks will set up their client service branches in different urban and rural locations. However, with the advancement of technologies, the banking function is increasingly shifting to online and mobile platforms. The following table provides you with examples of commercial banks from around the world.
Examples of commercial banks around the world
| Australia | United Kingdom | United States of America |
|---|---|---|
| Commonwealth Bank ANZ Westpac NAB |
HSBC Standard Chartered |
Bank of America JPMorgan Chase Wells Fargo |
Investment banks
Unlike commercial banks, the financial services provided by investment banks are more suitable for wholesale or corporate clients. Melicher & Norton (2017) define investment banks as service institutions that sell or market new securities issued by businesses to individual and institutional investors. Investment bank offices are typically headquartered in the central business district of a regional or global financial centre such as New York City, London, or Hong Kong.
The most significant role of investment banks is to facilitate the debt and equity issuing and selling for reputational corporations. An Initial Public Offering (IPO) is an example of investment banks assisting companies to issue their ordinary shares in the share exchange for the first time. Investment banks also provide advice and consulting services for mergers and acquisitions or market trading strategies to their corporate clients. The following table provides examples of investment banks from around the world.
Examples of investment banks around the world
| Australia | United Kingdom | United States of America |
|---|---|---|
| Macquarie Group | Barclay Capital | Goldman Sachs Morgan Stanley Citibank |
Central banks
A central bank is the official institution of a country that is responsible for regulating and operating the domestic currency, monetary policy, and other corporate financial institutions (Melicher & Norton 2017). This financial authority has represented part of the macroeconomic functions of governments. To issue and manage the volume of the domestic currency, a central bank needs to fulfil an accurate valuation of its currency compared to other foreign currencies. Usually, this valuation is based on the bilateral trading relations and capital flows between countries. Monetary policies, including notes issuing and interest decisions, are other essential regulatory functions of central banks.
For example, the Reserve Bank of Australia (RBA) holds a quarterly meeting to discuss and debate the current base interest rate level. Consequently, they decide to either decrease, maintain or increase the rate due to the economic status.
More importantly, central banks are regularly named ‘Bank of Banks’ to elaborate their management status of other commercial banks and financial institutions. Commercial banks deposit a certain level of reserve capital into the related accounts of a central bank, and the central bank periodically increases or decreases the number of reserves to manage the commercial credits. The following table provides you with some examples of central banks from around the world.
Examples of central banks around the world
| Australia | United Kingdom | United States |
|---|---|---|
| Reserve Bank of Australia | Bank of England | Federal Reserve |
In summary, commercial banks and investment banks are corporations for profit-seeking purposes. On the business level, their structure is similar to other companies. On the other hand, central banks are government authorities or agencies that exercise their regulatory competencies over other financial institutions.
Other financial institutions
In addition to banks, there are other forms of financial institutions. Some of these include:
- Insurance companies
- Fund managers.
Let us take a look at these in further detail.
Insurance companies
Insurance companies facilitate risk protection and management for retail and wholesale clients. The business areas of insurance companies may cover numerous fields, including any of the following:
- Life
- Health
- Property
- Automobile
- Infrastructure.
The successful operation of commercial insurance lies in accurate statistical principles and modellings (Melicher & Norton 2017). Through quantitative financial management, the business's profit margin can be maintained in an effective range. Due to their long-term structure of assets and liabilities, insurance companies may accumulate huge investable capital, which makes their investment strategy longer term compared to other financial institutions with a higher demand for short-term liquidity. Insurance companies can participate as cross-holding shareholders as influential institutional investors, meaning a public company holding shares of other public companies. Insurance companies can also work with the government to deliver time-consuming infrastructure projects.
Fund managers
Fund managers are another group of significant institutional investors in the modern financial world. Especially after World War II, they became more important to individual investors who were willing to invest their funds with emerging Industries.
Funds are a managed portfolio of collective financial assets in the market. These assets include but are not limited to the following:
- Common shares
- Bonds
- Money market securities
- Securities of real estate and infrastructures
- Financial derivatives.
In addition, to fund managers, there are different categories in which funds fall into. Let us take a look at some of these categories.
Mutual fund
The most tradable fund category is known as a mutual fund. A mutual fund is an American term, whereas it is known as a managed fund in Australia. In terms of mutual funds, they are usually open-ended-based. Open-ended based means there are no limits for the issuing unit of the fund, as long as new investors would like to invest in it (Melicher & Norton 2017). The large size of capital enables fund managers to support several assets classes with discounted management fees. The liquidity is a concern for fund managers because investors could require the redemption of their investments at any open market time.
Hedge fund
An emerging term of funds is the hedge fund. Hedge funds aim to achieve the absolute return from different assets holding, including the application of short sell and speculation with financial derivatives. In general, hedge funds are more profitable and popular during a period of high market fluctuation. Compared to mutual fund managers, hedge funds are less transparent to regulators and the investing public. The legal requirements applied to hedge funds are also generally less complex and strict.
International capital markets
The global capital markets are closely associated and correlated with each other now more than any other period in financial history. In the Eurobond market, both corporations and governments issue bonds denominated in domestic currencies and sell them to other foreign investors. An Australian corporation might, for example, issue bonds priced in Australian dollars, which would be the amount invested by investors from other countries such as the United States, Germany, Japan, China, and India, just to name a few. The Eurobond market facilitates capital financing from more open and broader financial resources globally.
The following quotation illustrates a descriptive example of international capital markets as the stock exchange:
According to the World Federation of Exchanges, the largest stock market in the world, as measured by the total market value of securities listed on that market, is the NYSE Euronext, with listed securities worth more than $11.8 trillion in the United States and $2.9 trillion in Europe. Next largest is the London Stock Exchange, with securities valued at £1.7 trillion, which is equivalent to $2.8 trillion given the exchange rate between pounds and United States dollars at the end of 2009.Gitman & Zutter 2012, p. 38
Foreign bond market
Another excellent example of the global capital market is the foreign bond market. The foreign bond market is an international capital market for long-term debt securities with more than one year of maturity. Unlike the Eurobond market, a foreign bond is a bond issued by a foreign corporation or government priced at the domestic currencies. For example, a bond issued by an Australian company denominated in Japanese Yen and sold in Japan is a foreign bond.
International share market
The international share market facilitates corporations to sell their shares to global investors. This market enables corporations to raise large amounts of capital more than they could in solely the domestic market. The great examples of the global share markets are those modern stock exchanges located in the leading financial centres such as New York, London, Hong Kong, Tokyo, and Singapore.
Key takeouts
Congratulations, we made it to the end of the third topic! Some key takeouts from Topic 3:
- Commercial banks are the most important financial institutions or intermediaries in the economy because they bridge the capital flows from the surplus side to the shortage side.
- Unlike commercial banks, the financial services offered by investment banks are more for wholesale or corporate clients.
- The central bank is the official institution of a country that regulates and operates the domestic currency, monetary policy and other corporate financial institutions.
- Insurance companies facilitate risk protection and management for retail and wholesale clients. The business areas of the insurance may cover numerous fields including:
- life
- health
- property
- automobile
- infrastructures.
- A funds managed portfolio is a collection of financial assets in the market.
Welcome to your seminar for this topic. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking 'Join' to enter the class.
Click here to access your seminar.
The following learning tasks will be completed during the seminar with your lecturer. Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
In-seminar learning tasks
The in-seminar learning tasks identified below will be completed during the scheduled seminar. Your lecturer will guide you through these tasks. Click on each of the following headings to read more about the requirements for each of your in-seminar learning tasks.
Watch the video, Global banking outlook 2018 from EY Global (2018), which discussed the global banking outlook in 2018 and beyond.
Working in a breakout room team assigned by your lecturer during the scheduled seminar, discuss the following four (4) questions with your teammates. Your lecturer will request that you present the findings back to the class.
- What is the general outlook for the global banking system in 2018?
- What are the individual outlooks for each part of the banking system?
- How does the outlook as discussed in the video connect to the history of the global banking system?
- Would you like to work in the banking system in the future? Why or why not?
- Working in the same breakout room as previously, visit the Organisation for Economic Co-operation and Development (OECD) website and select a country of your choice.
- Next, go into the data section, click the left menu ‘Finance’, then enter the page for short-term interests.
- Change the bottom button to show the short-term interest rates data from the 1990-2021 period. Discuss the short-term interest rates trend with your team members and elaborate on the economic reasons behind this trend. Please apply the central bank’s operation actions as references.
Welcome to your post-seminar learning tasks for this week. Please ensure you complete these after attending your scheduled seminar with your lecturer. Your lecturer will advise you if any of these are to be completed during your consultation session. Click on each of the following headings to read more about the requirements for each of your post-seminar learning tasks.
Knowledge check
Complete the following three (3) tasks. The following questions have been taken from p. 67 of Melicher, RW & Norton, EA 2017, Introduction to finance: Markets, investments, and financial management, 16th edn., John Wiley & Sons Inc.
Click the arrows to navigate between the tasks.
- Work in a breakout room as assigned by your lecturer during the consultation session. Select one (1) definition from ‘Key Terms’ at the end of Chapter 3 of the prescribed textbook.
- Discuss the definition of the key term you have selected and prepare a 5-minute presentation using a visual tool of your choice (for example, PowerPoint or Canva).
- Your group will present the financial term to other candidates during the scheduled consultation time.
Knowledge check
Complete the following three (3) tasks. The following questions have been taken from page 68 of Melicher, RW & Norton, EA 2017, Introduction to finance: Markets, investments, and financial management, 16th edn., John Wiley & Sons Inc.
Click the arrows to navigate between the tasks.
Please ensure you complete Assessment 2, Quiz 2 by the nominated time and date. You can access this quiz by clicking on “Assessment 2” in the navigation bar for this subject, then selecting “Quiz 2 – Week 3”.
As part of Assessment 1, identity 10 terms of current monetary instruments (physical and virtual) used in the market and research their definitions.
Each week you will have a consultation session, which will be facilitated by your lecturer. You can join in and work with your peers on activities relating to this subject. These session times and activities will be communicated to you by your lecturer each week. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking 'Join' to enter the class.
Click here to access your consultation session.
Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
- Elton, EJ, Gruber, MJ, & Busse, JA 1998, ‘Do investors care about sentiment?’, The Journal of Business, 71(4):477-500.
- Kang, J, Luo, J, & Na, HS 2018, ‘Are institutional investors with multiple blockholdings effective monitors?’, Journal of Financial Economics, 128(3):576-602.
- Intelligent Investor n.d., Value investing
- Investment Magazine n.d., Investments
References
- Confides Solutions n.d., Differences between bank and financial institutions, blog post, http://www.confiduss.com/en/info/blog/article/bank-financial-institution-comparison/
- Diamond, DW & Dybvig, P 1983, ‘Bank runs, deposit insurance, and liquidity’, Journal of Political Economy, 91(3):401-419.
- Engemann, KM 2013, Banking panics of 1931-33, Federal Reserve History, https://www.federalreservehistory.org/essays/banking-panics-1931-33
- EY Global 2018, Global banking outlook 2018, streaming video, YouTube, https://www.youtube.com/watch?v=ZPDb9eTStSE
- Gitman, LJ & Zutter, CJ 2012, Principle of managerial finance, 13th edn., Prentice Hall.
- Melicher, RW & Norton, EA 2017, Introduction to finance: Markets, investments, and financial management, 16th edn., John Wiley & Sons, Inc.
- MyAussieBank n.d., Different types of home loans in Australia, blog post, https://myaussiebanks.com.au/different-types-home-loans-australia/
- MyAussieBank n.d., How do banks make their money, blog post, https://myaussiebanks.com.au/how-banks-make-money/
- MyAussieBank n.d., Other financial institutions, blog post, https://myaussiebanks.com.au/other-financial-institutions/
- Tobin, J 1982, ‘The commercial banking firm: a simple model’, Scandinavia Journal of Economics, 84(4):495-530.
