Australian banks and financial uncertainties
Australian banking industry is the least affected financial sector by Global Financial Crisis (GFC). It is strong, profitable and sophisticated. The financial sector in Australia is the largest contributor to the national economy. It contributed 11 per cent or $135 billion of real gross value to the national output in 2010 (Australian Bureau of Statistics, 2011).
Of the 21 banks being operational as of October 2010, the big four – CBA, NAB, ANZ and Westpac – are generally named the ‘four pillars’ of Australian economy. They are not largest in terms of market lending but also in terms of holding assets.
Australian banking sector made efforts to leverage country’s strengths on property, natural resources, public-private partnership and similar other activities. The foreign banks operating in Australia have developed reputation on innovation, advanced capital and risk management system.
Of late, most research on capital structure have focused on public, nonfinancial corporations with access to U.S. or international capital markets. This is the right place to start. These companies have the broadest menu of financing choices and can adjust their capital structures at relatively low cost (Myers, Stewart C, 2001)
Recent studies say that on average, while the American non-financial companies have indebtedness level around 47% of their capital structure, for financial institutions, this percentage is near 90%, and this figure reaches 95% for investment banks. Baghat, S., & Bolton, B. (2011)
High financial leveraging level in banks results from the fact that debts in banks are subsidized by deposit insurances or other implicit redemption guarantees, in contrast with non-financial companies. (Juca, M.N., De Sousa, A.F. and Fishlow, A., (2012) However, a research by European Central Bank says it did not find a significant effect of deposit insurance on the capital structure of banks. (Reint, G and Heider, F. 2009)
Financing for banks mostly come from retail banking – the customer deposits whereas the companies have to burrow from banks or issue more shares or debt instruments to raise money. The interest rates prevailing in the market and the company’s current rate of dividend payments and other costs related capital raising significantly influence the way financing determinants are set. This is not always the case for banks, who significantly rely on retail depositors. The sign and significance of the effect of most variables on bank capital structure are identical to the estimates found for non-financial firms.
The banks have to survive on buffer – they get deposits from the public and lend the same money to others. Above that, the banks cannot lend all the money they get in deposit because of the liquidity policies. Companies don’t have such glitches. Company can invest whatever amount they raise – either through loans or issuance of shares or bonds.
Additionally, the banks have legal requirements to invest in government bods, which is not applicable for the other companies, albeit the superannuation companies. The investments in bonds and requirements for keeping capital liquidity put strain on financing requirements and capital structure of the banks.
Until the latest financial crisis, the banks heavily relied on the wholesale funds. The capital structure of banks was based on the principles set out by Basel agreements. As they have government guarantees, the referred operations encouraged the assumption for a higher risk level of assets, and thus generated the consequent need for increasing the level of own capital of the banks. (Jucá, M Nascimento, Sousa1, Almir Ferreira de, Fishlow, Albert, 2012)
Following the crisis, the discussions have started about the influences of standard determinants on the capital structures of banks and financial institutions. They cite works by Octavia and Brown (2008), and Gropp and Heider (2010) which indicated that in case of banks that have a pad of own capital above the minimum value established by the Basel agreements, explanation variables, such as size, profitability, growth opportunity, guarantees, payment of dividends and assets risk, as well as control variables, such as actual GDP growth and market return, are equally relevant in the definition of capital structure of banks.
The heavy reliance on wholesale funding had disastrous impact on banks. The degree of impact on the Australian banks were less compared to many European Banks but the consequences taught Australian banks on determining the source of funding. An increasing body of empirical studies suggests that banks that relied more heavily on deposit funding fared better in the global financial crisis than those more dependent on other sources (Rixtel, Adrian van and Gasperini, Gabriele, 2013)
It was lesson for Australian banks that they must not rely too much to the wholesale funding rather look after other alternative sources. Retail deposits are the other reliable sources to which banks focused after the crisis.
The GFC has opened doors of financial uncertainties. The experiences taught the finance industry that we must not rely completely on any instruments we development to maintain the health of the industry. The banks in Australia have refocused from wholesale funds to retail funding following the GFC but this very source may not be reliable for long. It would be advisable for banks to see all forms of alternatives to retain a stronger industry.
There can never be any absolute instruments giving positive results for all the time. The changes in trends and circumstances would change the dynamics of how financial system works.
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References
Albul, B., Jaffee, Dwight M., Tchistyi, A. (2010), Contingent Convertible Bonds and CapitalStructure Decisions, Federal Reserve Bank of Atlanta, 25 April 2010, viewed 15 May 2014, <http://www.frbatlanta.org/documents/news/conferences/10fmc_tchistyi.pdf>
Australian Bureau of Statistics cat no. 5206.0 – Australian National Accounts: National Income, Expenditure and Product, Dec 2010 (released 02 Mar 2011), Table 6, Gross Value Added by Industry, chain volume measured.
Baghat, S., & Bolton, B. (2011). Bank Executive Compensation And Capital Requirements Reform. Social Science Research Network (SSRN). Retrieved from <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1781318>.
Jucá, M Nascimento, Sousa1, Almir Ferreira de, Fishlow, Albert, (2012), Capital Structure Determinant’s of North American Banks and the Compensation Executive Program-An Empiric Study on the Actual Systemic Crisis, International Journal of Business and Management Vol. 7, No. 17; 2012, Canadian Center of Science and Education, viewed at <http://ccsenet.org/journal/index.php/ijbm/article/viewFile/18902/13347>
Juan, M. N., De Sousa, A. F., and Fishlow, A., (2012). Capital Structure Determinant’s of North American Banks and the Compensation Executive Program-An Empiric Study on the Actual Systemic Crisis. International Journal of Business and Management, 7(17), pp. 13-26.
Murphy, Dr David, n.d.,An Introduction to Convertible Securities and their Valuation, Value Consultants Limited, viewed 16 May 2014, <http://www.angloplatinum.com/investors/news/documents/Intro_to_Convertible_Securities_Part_1.pdf>
Myers, Stewart C, Capital Structure, Journal of Economic Perspectives, Vol 15, No 2, American Economic Association, Spring 2001, p82
Reint, G and Heider, F (2009), Determinants of bank capital structure, working paper series, No 1096, September 2009, European Central Bank, viewed at https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1096.pdf
Rixtel, Adrian van and Gasperini, Gabriele (2013), Financial crises and bank funding: recent experience in the euro area, BIS Working Papers No 406, Bank for International Settlements, March 2013, viewed 9 May 2014 <http://www.bis.org/publ/work406.pdf>
Sirbu, Mihai, Pikovsky I., and Sherve, Steven E., (2004), Perpetual Convertible Bonds, SIAM Journal on Control and Optimization, Vol 43, No 1, pp58-85. Society for Industrial and Applied Mathematics, Philadelphia, PA, viewed 14 May 2014, <http://www.math.cmu.edu/users/shreve/PerpetualConvertibleBonds.pdf>