mortgage
myeazyassignment
FBPChapter2Slides.pdf
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Chapter 2
Understanding the Industry and the Economic
Environment
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Introduction to the Financial Services Industry
The Australian Bureau of Statistics reports that financial services industry is among the three largest sectors in the economy with manufacturing and the property/business services.
It is estimated that the industry currently employs about 500,000 people and the ‘Finance and Insurance’ category makes up around 40% of market capitalisation on the Australian Securities Exchange.
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Introduction to the Financial Services Industry…
These institutions act as financial intermediaries and help the supply of, and the demand for, financial assets: – Retail and commercial banks – Investment banks – Finance companies – Life insurance companies – General insurance companies – Building societies – Credit unions – The stock exchange – Brokers – Superannuation funds
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Financial Intermediaries Financial intermediaries can be broken down into
two major sectors: – Retail – Wholesale.
The retail sector includes the following services: – Cash management and deposit services. – Keeping cash safe while also allowing withdrawals
when needed. – Issue of cheque books so that payments can be
made securely. – Provision of personal loans, commercial loans,
and mortgage loans.
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Financial Intermediaries…
– Credit cards and processing of credit card transactions and billing.
– Debit cards for use as a substitute for cheques.
– Financial transactions at branches or ATMs.
– Wire transfers of funds and electronic fund transfers between banks.
– Standing orders and direct debits, so payments for bills can be made automatically.
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– Overdraft facilities, which is temporary advancement of the bank’s own money to meet monthly spending commitments of a customer in their current account.
– Charge card advances of the bank’s own money for customers wishing to settle credit advances monthly.
– Bank cheques guaranteed by the bank itself and pre-paid by the customer.
– Private banking services extended exclusively to high net worth individuals.
– Financial planning services.
Financial Intermediaries…
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Wholesale Sector
The wholesale sector includes the following services: – Capital market bank – a bank that underwrites debt and
equity, assists company deals (advisory services, underwriting and advisory fees), and restructure debt into structured finance products.
– Asset management – the term usually given to describe companies which run collective investment funds.
– Hedge fund management – hedge funds often employ the services of ‘prime brokerage’ divisions at major investment banks to execute their trades.
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Wholesale Sector…
– Custody services – the safe-keeping and processing of the world’s securities trades and servicing the associated portfolios.
– Reinsurance – re-insurance is insurance sold to insurers themselves, to protect them from catastrophic losses.
– Intermediation or advisory services.
– Venture capital investing.
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A conglomerate is active in more than one sector for diversification, e.g., life insurance, general insurance, health insurance, asset management, retail banking, wholesale banking, investment banking.
Retail banks are the largest deposit-taking and financial institutions in Australia. The ‘big four’: – ANZ – Commonwealth Bank – NAB – Westpac Banking Corporation
Financial Intermediaries…
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In addition to banks, there are other financial institutions such as: – building societies – credit unions – merchant banks
Investment banks (also known as money market corporations) operate at the ‘wholesale end’ of the financial markets; the ‘middleman’ between companies issuing securities to raise funds and the investors who buy the paper.
Financial Intermediaries…
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Investment Banks
Investment banks deal in: – private and government securities – acceptance of bills – underwriting issues of debt and equity capital – devising innovative finance packages
They are not subject to the same regulation as ordinary banks nor do they accept deposits from the public like retail banks.
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ASIC, the Australian Securities and Investments Commission, is responsible for:
– The administration of the corporation legislation and the regulation of the financial services industry in Australia.
– Granting licences to financial services providers. • Licensees are also required to put in place compliance
arrangements, make certain disclosures and join an ASIC- approved dispute resolution scheme.
– Protecting consumers who have savings or deposit accounts and credit cards.
ASIC
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– Overseeing the market conduct and consumer protection issues on credit.
– Consumer credit lending and finance broking in Australia
Lending to small businesses and lending for investment purposes are under the regulation of ASIC. – It does not regulate loans between friends or family
members, or other non-commercial arrangements.
Its influence is limited to activities that take place in the context of ‘trade or commerce’.
ASIC…
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Australian Competition and Consumer Commission (ACCC) ensures vigorous competition in the marketplace, enforces the consumer protection and fair trading law: – Competition and Consumer Act 2010
Promotes competition and fair trade in the market place to benefit consumers, business and the community.
Regulates national infrastructure industries.
Is the only national agency dealing with competition matters.
ACCC
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Its primary responsibility is to ensure that individuals and businesses comply with the Commonwealth’s competition, fair trading and consumer protection laws.
The charging of interest, bank fees and credit card surcharges are regarded as ‘financial services’ and are therefore not within the jurisdiction of the ACCC. – The ACCC does not handle complaints about
misleading or deceptive conduct in relation to financial services as this falls under ASICs jurisdiction.
ACCC…
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Australian Prudential Regulation Authority (‘prudential’ means cautious or sensible) is the regulation authority of a range of financial institutions including banks, credit unions, insurance companies and superannuation funds.
Ensure sound practices and financial stability.
Oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry.
Established on 1 July 1998 to administer the APRA Act.
APRA
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A banking business cannot operate in Australia without authorisation from APRA.
An institution granted an authority to carry on banking business in Australia is referred to as an authorised deposit-taking institution or ADI.
A key principle in bank supervision is that capital is the cornerstone of a bank’s strength.
An applicant proposing to operate as a bank in Australia is required to have a minimum of $50 million in Tier 1 capital.
APRA…
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Banks are required to have a minimum of 4% of credit risk-weighted assets as ‘core’ or Tier 1 capital and a ratio of total capital. Tiers 1 and 2 are required to be of not less than 8% of credit risk-weighted assets.
Tier 1 capital consists of: – paid-up ordinary shares – non-repayable share premium account – general reserves – retained earnings – non-cumulative irredeemable preference shares – minority interests in subsidiaries
Tier 1 (or core) capital is required to always exceed Tier 2.
APRA…
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An ADI is required to at all times have definite enforcement rights over a mortgaged residential property (including a power of sale and a right to possession) in the event of default by the borrower.
Loans covered by security provided by third parties, where the relevant mortgage is unenforceable under the National Credit Code, are risk-weighted at 100% in the absence of any eligible collateral and guarantees.
APRA…
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Loans for other than housing are required to be secured against mortgages over existing residential property receive a risk-weight of less than 100%. – Loans, secured against speculative residential
construction or property development do not qualify for a risk-weight of less than 100%.
The determination of the appropriate risk-weight is also dependent upon mortgage insurance provided by an acceptable lenders mortgage insurer (LMI).
An ADI is required to revalue any property offered as security for such loans when it becomes aware of a material change in the market value.
APRA…
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Mortgage brokers operate within the financial services industry.
They need to understand the overall economy and be able to interpret economic indicators.
Close relationship between the loan market and overall economic conditions.
Government’s economic policies have a great impact on the loan market.
Presenting loan products involves making appropriate forecasts about the future and to comprehend economic situations around the globe.
Economic Environment
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Gross Domestic Product (GDP)
Key figure indicating the level of economic activities in an economy.
The market value of all final goods and services produced in an economy during a specific period.
The growth rate of GDP is used as a broad gauge of the overall economic health.
Strong GDP growth may induce the Reserve Bank to raise interest rates in order to combat inflation.
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Gross Domestic Product (GDP)…
GDP = C + I + G + (EX – IM), where: C: Private consumption I: Private investment G: Government expenditure EX: Exports of goods and services IM: Imports of goods and services
Since 1990, Australia’s real economy has grown by an average of around 3·3% a year.
Inflation
Rise in the general level of prices.
Deflation is a fall in the general price level.
The Consumer Price Index (CPI) is used as the main measure of inflation and movements in the cost of living in Australia. The CPI is an index number which is used to summarise the price of goods and services.
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Inflation
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Defined as a rise in the general level of prices. • Deflation is the opposite; a fall in the general level of
prices.
Average price of a pre-determined ‘basket of goods and services’ (approx 100,000) measured at the end of each quarter.
Affects individuals’ purchasing power.
Calculated on a quarterly basis, it is an index number which is used to summarise the price of goods and services.
Inflation…
There are five steps in calculating the CPI: 1. A selection of goods and services are selected to be
included in the index.
2. Accurate prices must be obtained for the relevant goods and services that are included in the index.
3. The aggregate price must be calculated, in other words the total cost of all the goods and services included in the index.
4. A base year must be chosen and the aggregate price found for that base year.
5. The aggregate price for the current period must be obtained.
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Inflation can be classified according to its value: – Up to 3% Moderate – 4 – 10% Gnawing – 11 – 20% Acute – 20 – 49% Galloping – Over 50% Hyperinflation
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Inflation…
Inflation Types Demand pull inflation – full employment, and demand
for goods and services exceeds supply of goods and services.
Cost push inflation – production costs rising and manufacturers pass-on increased costs to consumers in the form of higher prices.
Imported inflation – prices of goods and services rises in world markets.
Psychological inflation – expectations of inflation lead to decisions being taken adding to inflation.
Excess money supply inflation – increase in the money supply. Many economists feel that this is the sole cause of inflation.
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Refers to economy-wide fluctuations in production and economic activities.
Recession – Identified with low levels of profit expectation, low levels
of private and government investment, high level of unemployment and reduced output.
Recovery – Identified with increasing profit, increasing
investment, increasing consumer spending, decreasing unemployment and increasing national income.
Business Cycles
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Business Cycles…
Boom – Identified with high profits, faltering business optimism,
a slackening of investment, higher costs, high levels of employment and the commencement of unfavourable trends in international trade.
Contraction – Identified with declining profits, decreasing
investment, decrease in spending, decreasing wages and price levels and decreasing national income.
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Real estate is particularly susceptible to the ups-and- downs of the economy, simply because it is a substantial industry.
The purchase of a single-family dwelling, the sale of a condo, the lease of industrial or office space requires transactions of large amounts of money.
One of the key insights of business cycles is that many economic indicators move together.
A rise in interest rates can cause property and share investments to become less attractive and in certain circumstances to fall in value.
Business Cycles…
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*Not in Notes* Business Cycles…
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Fiscal Policy Concerned with the government’s use of its budget.
The budget can be in surplus, in other words the expenditure of the government is less than the revenue of the government.
Alternatively the budget can be in deficit, the expenditure can be greater than the revenue.
Government borrowings (deficit) effect availability of money in the economy: – Less bank lending – Less credit available
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Fiscal Policy…
The government’s budget needs to go through Parliament each year in May.
It is a plan of the government's expenditures and revenues for the coming year.
The expenditures are made to provide services for the community and fund the interest payments on the outstanding government debt.
The revenue mainly comes from income tax, company tax and other indirect taxes such as GST.
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There are three main economic effects of fiscal policy: – Psychological.
• Business expectations will be affected by announcements in the budget.
– Liquidity. • Changes to taxes can affect the money available for
investment. – Income.
• Changes to taxation levels or government spending will affect level of income for individuals and may reduce the level of private consumption.
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Fiscal Policy…
Monetary Policy Reserve Bank of Australia (RBA):
– Controlling inflation rate through the monetary policy.
The RBA gives banking and registry services to agencies of the Government, to other central banks, and other official institutions as well.
The RBA is fully-owned by the Australian Government and the profits are transferred back to the government.
Having an independent status, the bank is isolated from the political influences of the government.
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Monetary Policy…
The RBA carries out the following five essential roles in the economy:
1. Money Supply. ● Controls the level of currency in the economy.
2. Banker to the Federal and all State Governments. 3. Acts as Banker to the Banking System. 4. Lending policies.
● Changes to base lending rates (cash rate) affects flow of money in the economy.
5. Power to lend money to trading banks to maintain their liquidity.
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Monetary Policy…
A mortgage broker should observe the RBA’s monetary policy and possible affects on various loan products.
The current objective of the RBA is a policy of inflation targeting aimed at maintaining the annual inflation rate at between 2–3%, on average, over the cycle.
Financial institutions add their operational costs and risk premiums to this base rate and then determine the final interest rate of a loan.
The cash rate is the interest rate on overnight made between institutions in the money market.
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Interest Rates The interest rate is the price that adjusts so as to
balance lending and borrowing decisions.
On an economic level, two important concepts determines the market interest rate:
1. the demand for money, and 2. the supply of money
The market interest rate is the interaction between supply and demand of money in the economy.
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External Influences on Australian Economy
The external influences on Australian economy may occur in many ways such as the exchange rate, foreign direct investments and even the expectations in the global economy affect Australia: – Global Financial Crisis. – Sub Prime collapse.
A country’s exchange rate is determined by a number of things, but the most important determinant is the supply and demand of foreign exchange in the country.
Countries decide how their exchange rate will be determined: – Flexible (floating) exchange rate (Australia)
• Market forces determine exchange rate at any given time.
– Managed float (Myanmar) • Consistent central bank intervention to dampen
exchange rate movements.
– Fixed exchange rate (China) • Central bank continually intervenes to keep the
exchange rate at a fixed, pre-determined level. 101101
External Influences on Australian Economy…
