Question

Step 1:

Asset	Commonwealth Bank		ANZ Bank		NAB Bank		Average
	Amount (m)	%	Amount (m)	%	Amount (m)	%	Amount (m)	%
Cash	42,814	4.47%	68,048	7.58%	42,152	5.18%	51,004.67	5.73%
Interbank loans	8,678	0.91%	5,504	0.61%	35,030	4.30%	16,404.00	1.84%
Trade securities	31,127	3.25%	43,605	4.86%	45,637	5.60%	40,123.00	4.51%
Investment securities	79,019	8.24%	69,384	7.73%	42,029	5.16%	63,477.33	7.13%
Loans	647,503	67.53%	574,331	64.00%	468,277	57.49%	563,370.33	63.28%
Other assets	148,711	15.61%	136,454	15.21%	181,391	22.27%	155,852.00	17.51%
Total assets	958,852	100%	897,326	100%	814,516	100%	890,231.33	100%

Step2:

Cash;

The purpose and importance of the type of asset

The purpose of cash is that it's a liquidity supplier and is a solvency indicator of a bank .In the case if there are needs or withdrawals , the bank can use cash reserves to support .

The monetary size of the asset compared to the total assets of banks and reasons for the average size of the type of asset;

The monetary size of the asset on average is around 5.73%, which could potentially mean it's a small business, since the bank would expand as a surplus cash in other loans or advances to earn interest income.Furthermore, a large amount of unused cash is not desirable , which is could poteinally be used for an emergency sitution. ANZ had the highest cash percentage (7.58%) compared to NAB and Commonwealth Bank.

The risks that the bank run due to holding the type of asset;

The bank would run a liquidity risk if cash holds arent sufficient .There are no risks in holding of cash.This is a hedge against sudden requirements for capital. However if there is a large holding of cash , then the interest income of the bank would decrease.

Methods/instruments that banks use to hedge the risks pertaining to this type of asset;

This is used by financial derivatives.Since the cash held is not subject to any interest risk or currency fluctuation. This is a risk free asset and do not need hedging.

The income generated from the type of asset compared to the income generated from other type of assets;

The cash held in the balance sheet do not generate any income for the bank and is a part of the reserve, meaning it's not a way of income unless its invested; with a requirement of quick payments.

Interbank loans:

a)       The purpose and importance of the type of asset

Interbank loans are short-term loans protracted by banks to one another. The purpose is to meet the legislative obligations of holding adequate liquid assets like cash. The importance of interbank loans is for the lender bank to receive interest on its additional cash along with the other bank to be able to meet the legislative obligation without difficulty at a low interest rate without much trouble.

b)      The monetary size of the asset compared to the total assets of banks and reasons for the average size of the type of asset

The size of this asset must be lower since it is meant for encountering compliance norms for short-terms. The average size of this asset is because it is not the core of banking business standard considering that the interest rate in this is correspondingly much less compared to what bank obtains from lending capitals to business and merchandise customers.   

c) The risks that the bank run due to holding the type of asset

Even though the risk that the bank run due to holding this asset is normally lower than other loans except for times when economic is in distress which involves the risk of liquidation of the banks to which a bank has lent out capital. There needs to be consideration that this loan is generally neither guaranteed to be insured therefore if one bank fails, it can lead to distress or even the downfall of other banks participating in lending to the failed bank.

d) Methods/instruments that banks use to hedge the risks pertaining to this type of asset

There are methods/instruments that the bank can use to hedge the risks pertaining to this asset which are obligatory collateral provision to secure the loan hence preventing unsecured interbank loans, insurance against the loan and maintaining the ratio of interbank loans low.

e) The income generated from the type of asset compared to the income generated

from other type of assets

The income generated from interbank loans is generally much less compared to other loans.The purpose for this is the lower interest rate that banks impose on interbank loans along with the lower magnitude of interbank loan in comparison to other assets.

Trade securities:

a)    The purpose and importance of the type of asset

Banks purchase securities for merchandise to expand their assets and attain extra profitability. Trade securities symbolises instruments that are bought with the intention of selling them in a short term generally within a year. Businesses categorise any investments in debt or equity securities to be held till maturity, trading or available to be sold. However, since banks constantly stock large liability concerning their retail customers, they usually carry a small percentage of their assets in such trade securities.

b)      The monetary size of the asset compared to the total assets of banks and reasons for the average size of the type of asset

It can be seen in the table that all the banks produce low percentage of their total assets invested in trade securities. Considering that banks have a main responsibility towards their customers in terms of time and demanding deposits. Banks are also in business of making loans. Therefore, a range of trade securities is constructed only with the remaining funds following that all other reserve and loan demands have been met. Hence, banks do not and cannot hold a substantial proportion of their assets capitalized in trade securities.

c)       The risks that the bank run due to holding the type of asset

The risks related with retaining trade securities are alike for banks in the same way as they are for any other investor. Trade securities are identified at fair value in the balance sheet and any supressed gain or loss is disclosed in the income statement. Assuming that the value of these securities go down extremely, banks might face some asset liability difference and their ability to convert into cash securities may be compromised. Nevertheless, the risks are not extreme as the amount of these securities in the asset range is low.

d) Methods/instruments that banks use to hedge the risks pertaining to this type of asset

There is an average risk acceptance from banks for their securities portfolio since they cannot risk their capability to meet their liabilities. Hence, banks normally invest in trade securities that are highly liquid and ranked high. So, banks do not invest a great amount in equity securities and trade security portfolio mainly contains highly rated fixed income securities.

e) The income generated from the type of asset compared to the income generated from other type of assets

The income generated from trade securities can come in the figure of interest obtained from fixed income securities or from dividends of equity securities. This type of revenue is supposed to be an addition to the bank’s main source of revenue that is from the interest being obtained on the loans made.

Investment securities:

The purpose and importance of the type of asset

Investment securities are held for investment as a result to be debt or equity however the purpose of holding must be for investment purpose. The reason of holding such assets is so when they are marketed the banks will obtain the capital. Maintaining fixed income securities as investment securities, banks will be advantaged by getting regular cash flows from that instrument. Banks retaining marketable securities as investment securities are benefitted by means of obtaining a better liquidity position.

b) The monetary size of the asset compared to the total assets of banks and reasons for the average size of the type of asset

Looking at the table, it can be seen that investment securities form 8.24%, 7.73% and 5.16% of the total assets for Commonwealth bank, ANZ bank, NAB bank correspondingly. This provides an average of 7.13% out of the total assets for investment securities. It is shown that loans form the most important assets for banks with an average of 63.28%, since the major purpose of the bank is to loan money which causes less funds with the bank to finance in other types of assets. Banks finance less in investment securities as it might have better opportunities. The anticipated capital gratitude or the cash flows from investment securities may not be entirely interesting which would have led to banks financing relatively lesser in investment securities.

c) The risks that the bank run due to holding the type of asset

It cannot be predicted of the aftermath of investment decisions through investment decision maker as the actual market circumstances and economic situation might not essentially be the same as what is expected to be. Having uncertainty with investment decision can have a negative influence with the whole portfolio causing overall loss or reduced profit as a risk. There are risks associated with holding investment securities such as intermediate cash flows for instance dividend can be decreased or stopped by the corporation, the political and economic condition of the state can vary, the foreign money gain or loss valuation in the investment decision making can be drastically changed from the actual circumstance.

d) Methods/instruments that banks use to hedge the risks pertaining to this type of asset

The most common approach involved in in hedging risks consist of buying or selling imitative instruments. For instance, if the bank has capitalized in equity securities and is anticipating a decrease of stock rate, then a put option can be bought to give it a right but not a requirement to be sold. Another way for the bank to not be very impacted when interest rates or stock prices varies from up or down is by having a well-diversified investment portfolio.

Loans;

The following aspects should be addressed in your discussion and explanation of each of the type of assets:

The purpose and importance of the type of asset;

Purpose of taking a loan is providing finance. From banks point of view by giving loans they are satisfying financial requirements of the society. Banks provide loans since banks engaged in finance business which receives money from public in the form of deposits by paying less interest rate and in turn uses the amount for Issuing loans for higher Interest rates usually more than the deposit rate.Loans are important since they form major part of banking business

The monetary size of the asset compared to the total assets of banks and reasons for the average size of the type of asset

Loans comprise more than half of the assets. The reason is because loans are a very essential part of the bank, and an imporant source of income for the banks. If banks have more loans , since loans are treated as bak turnover and the average size shows in alll the banks the amounts.

The risks that the bank run due to holding the type of asset;

Due to holding large volume of loans, risk of default is also quite an important factor for a bank to consider because if loans are not paid for long period of time they become non performing assets which has adverse effect on bank's financial performance.There is risk that borrower may default the loan amount and loan become a non performing therefore, banks have to access the credibility of borrower before issuing loans and thereafter steps shall be taken for recovery of amount regularly from the borrower.

Methods/instruments that banks use to hedge the risks pertaining to this type of asset;

Interest rate swaps and other hedging strategies have long provided a way for parties to help manage the potential impact on their loan portfolios of changes occurring in the interest rate environment. A standard interest rate swap is a contract between two parties to exchange a stream of cash flows according to pre-set terms. In essence, the transaction involves trading costs associated with two different types of loans—typically swapping the terms of a floating rate loan for those of a fixed rate loan or vice versa.Borrowers may have specific objectives when choosing to participate in an interest rate swap or related hedging strategy. For example, the goal may be to reduce interest expense on a particular loan by swapping a higher fixed rate for a lower floating rate. Alternatively, a borrower may wish to hedge existing interest rate risk related to the potential that rates will move higher in the future. This is accomplished by swapping the terms of an existing variable rate loan for those of a fixed rate loan that will lock in the interest rate on a loan for the loan duration.

An important distinction of an interest rate swap compared to other types of financial transactions is that principal is never exchanged. The swap represents an agreement to exchange interest cash flows over time. Interest rate swaps are completely customizable with flexible terms. The contract is legally separate from the hedged item, and no upfront premium is required to execute a swap.

The income generated from the type of asset compared to the income generated from other type of assets;

Banks earn interest by providing various loans. When they are financing assets on the basis of equated monthly instalment or EMI, they are charging some interest on each instalment because entire payment is made over a period of time and not immediately.

Since Income generated from loans is Interest Income which is Major part of Total Bank Income

QUESTION:

Step 3: Use the information contained in the table (step 1) and your answers provided in step 2 to write up a conclusion about whether the average monetary/percentage sizes of the different assets are optimum or whether banks can increase/decrease the sizes of the different assets to increase their profits without unacceptable increasing risks to the banks.

Answer 1

Cash

Common wealth Bank-size is only 4.47% much lower than average rate shoushould incrincrease cash size to avoid liquidity crisis.

NAB Bank-Size is close to average no need to alter.

ANZ Bank-Much higher than average.They should utilise idle cash in some profitable activities.

Interbank Loan

Commonwealth Bank-Lower than Average rate so it is good as it is required to fulfill only regulatory norms

ANZ Bank-Same as above

NAB Bank-Much higher than average so it should be reduce as these type of assets generate very low income.

Trade securities

All banks are maintaining a very low trade securities hence no need to change.

Investment Securities-

Commonwealth Bank-Only this bank is maintaining a very high investment securities it can adversely affect bank due to fall in investment value.Hence should be reduced to certain extent.

Rest two banks rate are close to average hence no need to alter.

LOAN

It forms an important part of total assets it is the major source of income for the business.Without this bank will have to reduce its income hence as it is mormore than 60% for commonwealth and ANZ Bank they should try to reduce it a little or else firm revenue will get adversely affected due non recovery of auch loan and their interest.