微信客服：xiaoxionga100
微信客服：ITCS521
FINM3404-无代写
时间：2024-03-17
FINM3404
Banking and Lending Decisions
Lecture 1
Coordinator & Lecturer: Dr Hasibul Chowdhury
Email: h.chowdhury@business.uq.edu.au
Tutors:
Jon Aster
Email: j.hearn1@uq.edu.au
Sabina Yesmine
Email: s.yesmine@uq.edu.au
Rasheda Huda
Email: r.huda@uq.edu.au
Ann Le
Email: ann.le96@uq.net.au
Wenbin Hu (Tutor and Facilitator)
Email: wenbin.hu@uq.net.au
Minh Le
Email: b.le@uq.edu.au
Course Staff
2
Tutors’ contact and consultation times are posted on Blackboard.
Communication
• Please regularly check Blackboard announcements.
• Any question during the lecture, please use following Zoom ID, log in to the meeting and write
your question in the chat box. Wenbin/Hasibul will respond to your questions:
• Zoom meeting ID is 717 931 8451
• Outside of lecture hours, if you have any question on lecture contents, please email Hasibul or
attend his consult session.
• If you have any question on tutorials, please email your tutor or attend their consult sessions.
Saunders, Cornett, and Erhemjamts (2021) Financial Institutions
Management: A Risk Management Approach, (10th Edition) McGraw
Hill.
Required Resources
4
▪ 2-hour lectures.
▪ 2-hour tutorials (Starting from Teaching Week 2).
▪ Lecture slides and Tutorial questions will be posted in Blackboard on Friday
before the lecture week.
▪ Lectures and tutorials will be recorded.
▪ Tutorial solutions and recording will be available in Blackboard on Friday
after we finish all tutorials for the week.
Course Structure
5
▪ Financial institutions and credit risk analysis
▪ The monetary authorities, RBA, interest rates
▪ Risks of financial institutions
▪ Bank liquidity risk
▪ Asset-liability management I
▪ Asset-liability management II
▪ Securitization & financial crisis
▪ Capital adequacy requirement
▪ Bank performance analysis and deposit insurance design
▪ Loan portfolio and concentration risk
▪ Investment banking
Brief Course Contents
6
Assessments
7
Assessment task Weighting Descriptions
Online Quiz: In-Semester Exam During
Class
(28 March 2024, 8:00 AM - 9:10 AM)
Reading: 10 minutes
Duration: 60 minutes
25% The exam will be based on the materials covered in
Topics 1- 4 (including tutorials).
This is a time-constrained online quiz which will consist of 20 multiple-
choice questions (mix of theory and calculations). Students are
required to log in to the course Blackboard site to complete the quiz.
Late submission is subject to a late penalty.
Individual Assignment (Case Study)
(09 May 2024, 14:00)
25% Carefully read ‘China Huarong: Was it a risky business?’ (see URL on
Blackboard under “Assessment” and please make sure you also read
other materials that will strengthen your assignment). Please use this
case as a background to carefully develop your answers to the two
questions mentioned in the document titled "Assignment Instruction".
Late submission is subject to a late penalty.
Final Exam
(Examination Period)
Reading: 10 minutes
Duration: 120 minutes
50% The exam will be based on ALL materials covered in the course (from
Topics 1- 11).
This assessment task is to be completed in-person. The exam
includes short answers and problem-solving questions. The duration of
the exam will be a total of 120 minutes plus 10 minutes of reading
time.
Late submission is subject to a late penalty.
▪ Practice and don’t just skim through the reading materials.
▪ Seek help as early as possible. Don’t fall behind.
▪ Attend the consults regularly.
▪ Try to understand the concepts.
▪ Set your strategy early.
Some Tips for Success in FINM3404
8
Topic 1
Financial Institutions and Credit Risk Analysis
Textbook reference: Chapter 1 & 10 (Saunders et al., 2021)
Other references:
Holland, Q. C. P., Liu, B., Roca, E., & Salisu, A. A. (2020). Mortgage asymmetric pricing, cash rate and
international funding cost: Australian evidence. International Review of Economics & Finance, 65, 46-68.
Trönnberg, C. C., & Hemlin, S. (2014). Lending decision making in banks: A critical incident study of loan
officers. European Management Journal, 32(2), 362-372.
▪ Evaluate the specialness and the changing dynamics of
financial intermediaries
▪ Evaluate the rationale for bank regulation
▪ Outline the types of loans
▪ Analyse the pricing of commercial loans
LEARNING OBJECTIVES
10
Part A
Introduction to Financial Intermediation & Banking
1. Why are financial institutions (FIs) special?
https://www.youtube.com/watch?v=M2xAWtIE7vA
a) FIs function as brokers.
b) FIs function as asset transformers.
c) FIs reduce the degree of information costs or imperfections.
d) FIs provide liquidity and lower price risk.
e) FIs reduce transaction cost services.
f) FIs provide maturity intermediation.
1. Why are financial institutions (FIs) special?
13
a) Broker Function
i. Full service securities firm
▪ FI act as an agent for the saver by providing information and
transaction services.
▪ Carry out investment research and make investment
recommendation for their retail or household clients.
▪ Conducting the purchase and sale of securities for a commission
and fee.
1. Why are financial institutions (FIs) special? (Continued…)
14
a) Broker Function (continued…)
ii. Discount brokers
▪ Carry out the purchase or sale of securities at better prices
and with greater efficiency than household savers could
achieve by trading on their own.
▪ Efficiency results in reduced cost of trading or achieve
economies of scale.
1. Why are financial institutions (FIs) special? (Continued…)
15
b) Asset Transformer Function
The asset transformation function is accomplished by:
▪ Issuing their own securities, such as deposits and insurance
policies that are more attractive to household savers.
▪ Using the proceeds to purchase the primary securities of
corporations. FIs take on the costs associated with the
purchase of securities.
1. Why are financial institutions (FIs) special? (Continued…)
16
c) Information cost reduction
▪ By putting excess funds into financial institutions, individual
investors give to the FIs the responsibility of deciding who
should receive the money and of ensuring that the money is
utilized properly by the borrower.
▪ In this sense, depositors have delegated the FI to act as a
monitor on their behalf. Further, the FI can collect information
more efficiently than individual investors.
1. Why are financial institutions (FIs) special? (Continued…)
17
c) Information cost reduction (Continued…)
▪ The FI can utilize this information to create new products, such as
commercial loans, that continually update the information pool.
▪ This more frequent monitoring process sends important
informational signals to other participants in the market, a process
that reduces information imperfection and asymmetry between the
ultimate providers and users of funds in the economy.
1. Why are financial institutions (FIs) special? (Continued…)
18
d) Liquidity risk reduction
▪ Liquidity risk occurs when savers are not able to sell their
securities on demand.
▪ Commercial banks, for example, offer deposits that can be
withdrawn at any time.
▪ Yet, the banks make long-term loans or invest in illiquid assets
because they are able to diversify their portfolios and better
monitor the performance of firms that have borrowed or issued
securities.
1. Why are financial institutions (FIs) special? (Continued…)
19
e) Transaction cost reduction
▪ By pooling the assets of many small investors, FIs can gain
economies of scale in transaction costs.
▪ This benefit occurs whether the FI is lending to a corporate or
retail customer, or purchasing assets in the money and capital
markets.
▪ In either case, operating activities that are designed to deal in
large volumes typically are more efficient than those activities
designed for small volumes.
1. Why are financial institutions (FIs) special? (Continued…)
20
f) Maturity intermediation
▪ FI can offer the relatively short-term liabilities desired by households and
also satisfy the demand for long-term loans such as home mortgages.
▪ By investing in a portfolio of long- and short-term assets that have variable
and fixed rates components, the FI can reduce maturity risk exposure by:
utilizing liabilities that have similar variable and fixed rates
characteristics, or
by using futures, options, swaps, and other derivative products.
1. Why are financial institutions (FIs) special? (Continued…)
21
Which of the following are reasons for the specialness of financial
intermediaries?
A. higher average information costs
B. lower price risk and superior liquidity attributes for financial claims
to household savers
C. higher average transaction costs
D. higher information asymmetry
E. All of the listed options are correct
MCQ 1
apps.elearning.uq.edu.au/poll/63254
Which of the following statements is false?
A. A financial intermediary specialises in the production of information
B. A financial intermediary reduces its risk exposure by pooling its assets
C. A financial intermediary benefits society with a mechanism for payments
D. A financial intermediary acts as a lender of last resort
E. A financial intermediary provides brokerage services
MCQ 2
apps.elearning.uq.edu.au/poll/63254
2. Rationale for bank regulation
2. Rationale for bank regulation
25
a) Reduce systemic risk
▪ Systemic risk occurs when bank failures are potentially
contagious, so that the losses in one bank cascade into other
banks, or to other economies throughout the world.
▪ The spread of failure is called ‘contagion’.
▪ Contagion risk is increased by the large volume of business
transacted between the major banks.
2. Rationale for bank regulation (Continued…)
26
b) Protect against moral hazard
▪ Moral hazard occurs when there is a danger that agents will alter
their behavior to profit from an established risk-protection
mechanism.
▪ Bank regulation is intended to reduce the risk of moral hazard
and to limit failure losses which eventually impose a burden on all
taxpayers generally.
2. Rationale for bank regulation (Continued…)
27
c) Protect consumers and pursue social goals
▪ Regulators have the necessary skills and expertise to
assess the riskiness of financial institutions. Information
provided on the health of financial institutions helps to
protect depositors.
▪ The social goals being pursued include efficiency in its
many forms, and an effective banking system that facilitates
economic growth and impartially allocates credit in the
community.
Part B
Introduction to Credit Analysis
3. Types of loans
3. Types of loans
30
a) Business loans
▪ Banks and other FIs can provide business loans for periods as short as a few days, to
a few weeks, or for as long as 10 years or more.
▪ Borrowing firms use short-term business loans (with maturity of one year or less) to
fund their working capital and other short-term funding requirements.
▪ Borrowing firms use long-term business loans to finance credit requirements that
extend to more than a year. For example, purchase of real assets and new business
start-up costs.
▪ A type of large business loan is a syndicated loan, which is provided by a group of FIs
as opposed to a single lender.
▪ A secured business loan is backed by a first claim on collaterals of the borrower if
default occurs.
3. Types of loans
31
a) Business loans (continued…)
▪ Unsecured business loans have only general claims to the assets of the borrower if
default occurs.
▪ A spot loan is made by the FI and the borrower uses the entire amount immediately.
▪ In a line of credit/loan commitment, the FI makes an amount of credit available for the
borrower (for example, $15 million) and the borrower has the option to use any amount
up to $15 million at any time over the commitment period.
b) Housing loans
▪ These loans are simple principal and interest loans made to individuals and families for
the purchase of home.
▪ These mortgage products require that interest and principal be paid back over a long
loan period such as 25 years.
3. Types of loans
32
b) Housing loans (continued…)
▪ Home loans are the largest part (91.8%) of Australian household debt. Out of total loans
given in Australia, housing loan is 59.35%, borrowing for commercial purpose is
36.61%, and other purpose loan is 4.04% (RBA, 2017).
Figure: Residential mortgages as a share of total bank
loans. (Source: IMF 2017 and Holland et al., 2020)
▪ The value of Australian residential market
during October 2016 was AUD 6.7 trillion,
which is almost four times larger than the
equity market value of AUD 1.66 trillion
recorded in that period (Holland et al.,
2020).
3. Types of loans
33
b) Housing loans (continued…)
“The Australian banks are very exposed to the housing
market. Around 60 per cent of their lending is for housing
(Graph 3). And housing is also common collateral for
loans to small and medium businesses. A decline in
housing prices impacts the value of that collateral but of
itself does not necessarily lead to losses. If there were an
economic shock that resulted in borrowers being unable to
service their debt, however, and at the same time housing
prices fell sharply, the debt would be unable to be
recovered in full by the sale of the property, resulting in a
loss to the banks. If the losses were large enough the
banks might exacerbate the decline by reducing their
lending.”
https://www.rba.gov.au/speeches/2021/sp-ag-2021-09-
22.html
3. Types of loans (Continued…)
34
c) Consumer or individual loans
▪ FIs provide consumer loan financing through credit cards such as Visa,
MasterCard and proprietary credit cards issued by Qantas, Woolworths and other
large organizations dealing with consumers.
▪ The loan provided by credit cards is of revolving type, indicating that the borrower
maintains a line of credit on which they draw as well as repay up to some
maximum amount over the life of the credit contract.
▪ However, non-revolving type personal loans include car loans and fixed-term
consumer loans such as 24-month loans.
▪ Banks face higher default rates on consumer loans (specially, credit card loans)
than business loans. Such high rates of default emphasize the importance of client
risk evaluation before credit decisions.
The term 'spot loan' refers to a loan:
A. that is granted on the spot
B. that needs to be repaid on the spot
C. granted at the spot rate
D. for which the full loan amount is withdrawn by the borrower on the spot
E. none of the listed options are correct
MCQ 3
apps.elearning.uq.edu.au/poll/63254
Which of the following statements is true?
A. A line of credit facility is a credit facility with a maximum size and a
minimum period of time over which the borrower can withdraw funds.
B. A line of credit facility is a credit facility with a minimum size and a
minimum period of time over which the borrower can withdraw funds.
C. A line of credit facility is a credit facility with a maximum size and a
maximum period of time over which the borrower can withdraw funds.
D. A line of credit facility is a credit facility with a minimum size and a
maximum period of time over which the borrower can withdraw funds.
E. None of the listed options are correct
MCQ 4
apps.elearning.uq.edu.au/poll/63254
4. Role of asymmetric information in lending
4. Role of asymmetric information in lending
38
Asymmetric information: The borrowers have more information about
themselves than is available to the bank.
a. Adverse selection: Adverse selection occurs before the loan is made.
High risk borrowers try to get loans from banks because they are willing
to pay less than they would have to pay if their true condition were
known to the bank.
b. Moral hazard: This is the risk that the borrower, who now has the loan,
might use the funds to engage in high risk activities in expectation of
earning higher return. This is more likely to occur when the lender is
unable to monitor the borrower’s activities.
INDUSTRY OUTLOOK
39
40
▪ Loan officers mainly apply “deliberation” technique and less “intuition”
while making lending decisions.
▪ Two approaches to evaluate loan applications - transactional lending
and relationship lending.
▪ An example statement of deliberation technique – “We focused on
the cash flow in this case, as we always do...’’
▪ An example statement of using intuition in lending decision - ‘‘Well, I
thought that I could trust these two persons together...Forecasts
expressed in numbers are good support...but at the same time they
only forecasts. So, it was not actually based on quantitative
information much.” Another example – “The owners left, made a first
impression. But at the first meeting with information and facts the gut
feeling was not so positive.”
INDUSTRY OUTLOOK
5. Credit risk models
5. Credit risk models
42
a) Qualitative models
▪ Borrower-specific factors
These are idiosyncratic to the borrowers:
❖ Is the borrower creditworthy?
[Evaluate reputation, leverage, volatility of earnings, collateral].
The six Cs of credit: Character, Capacity, Cash, Collateral, Conditions
and Control.
❖ Can the lender perfect its claim against the borrower’s earnings and
any assets that may be pledged as collateral?
❖ Can the loan agreement be properly structured and documented?
5. Credit risk models (continued…)
43
a) Qualitative models (continued…)
▪ Market-specific factors
These have an impact on all borrowers at the time of the credit decision.
i. The Business Cycle: The position in the economy in the business
cycle phase is important to an FI in assessing the probability of default.
Example, during recession, firms in the consumer durable good sector
that produce autos, refrigerators, or houses do badly compared with
those in non-durable goods sector producing clothing and food.
5. Credit risk models (continued…)
44
a) Qualitative models (continued…)
▪ Market-specific factors
ii. The Level of Interest Rates: At times of high interest rate the FIs not only
find funds to finance their lending decisions scarcer and more expensive but
also recognize that high interest rate are correlated with higher credit risk in
general.
The FI manager then weighs these factors subjectively to come to an overall
credit decision. Because of their reliance on subjective judgment of the FI
manager, qualitative models are often called expert systems.
5. Credit risk models (continued…)
45
b) Quantitative models
▪ Customer profitability analysis (CPA)
✓ It begins with the assumption that the lender should take the whole
customer relationship - all revenues and expenses associated with a
customer - into account when pricing a loan.
✓ Revenues paid by a borrower includes loan interest, commitment fees,
fee for cash management services and data processing charges.
✓ Expenses incurred on behalf of the customer includes wages & salaries
of the lender’s employees, credit investigation cost, interest accrued on
deposit account reconciliation and processing costs and funds’ acquisition
costs.
5. Credit risk models (continued…)
46
b) Quantitative models
▪ Customer profitability analysis (CPA)
NLF
ExpRev
NBTR
−
=
NBTR = Net before-tax rate of return to the lender from the whole customer
relationship
Rev = Revenues from loans and other services provided to this customer
Exp = Expenses from providing loans and other services to this customer
NLF = Net loanable funds used in excess of this customer’s deposits and calculated
as the amount of credit used by the customer minus customer’s average collected
deposits (adjusted for required legal reserve).
5. Credit risk models (continued…)
47
b) Quantitative models
▪ Customer profitability analysis (CPA)
A bank is considering granting a 1.5 m line of credit for six months to Black
Gold Inc, an energy company. Assuming Black Gold uses the full line and
keeps a deposit equal to 20% of the credit line with the bank, the following
revenues and expenses should result from dealing with the customer.
Required: Complete the Annualized Customer Profitability Analysis by
calculating rate of return. Interpret your answer.
Class practice 1
5. Credit risk models (continued…)
48
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1
Sources of revenue expected to be supplied by a customer
Interest income from loan (12%, six months) ?
Loan commitment fees (1%) ?
Fees for managing customer's deposits $45,000
Funds transfer charges $5,000
Fees for trust services and recordkeeping $61,000
Total revenues ?
5. Credit risk models (continued…)
49
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1
Costs expected to be incurred in serving this customer
Deposit interest owed to the customer (10%) ?
Cost of funds raised to lend this customer $80,000
Activity costs for this customer's accounts $25,000
Cost of funds transfers to this customer $1,000
Cost of processing the loan $3,000
Recordkeeping costs $1,000
Total expenses ?
5. Credit risk models (continued…)
50
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1
Net amount of banker’s reserves expected to be drawn upon by this
customer this year
Average amount of credit committed to customer $1,500,000
Average customer deposit balances (net of required reserves) $270,000
Net amount of loanable funds ?
5. Credit risk models (continued…)
51
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1 - Solution
NBTR =
Total revenues −Total expenses
Net amount of loanable funds
=
$216,000−$125,000
$1,230,000
= 7.4%
Decision rule:
Bank should accept the loan because NBTR is positive. It indicates that if granted, the proposed loan
will generate more revenues than expenses required to service this loan.
5. Credit risk models (continued…)
52
b) Quantitative models
▪ Linear discriminant models
▪ Linear discriminant models categorise borrowers into high or low default
risk based on borrower characteristics.
▪ In this section, we will use Altman’s discriminant function as the credit
classification model:
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
where,
X1 = Working capital / Total assets ratio
(Working capital = Current assets – Current liabilities)
X2 = Retained earnings / Total assets ratio
5. Credit risk models (continued…)
53
b) Quantitative models
▪ Linear discriminant models (continued…)
X3 = Earnings before interest and taxes / Total assets ratio
X4 = Market value of equity / Book value of long-term debt ratio
X5 = Sales / Total assets ratio
Decision rule:
Z-score < 1.81 = High default risk category
Z-score > 2.99 = Low default risk category
Z-score between 1.81 to 2.99 = Zone of ignorance (borrower may or may not default)
5. Credit risk models (continued…)
54
b) Quantitative models
▪ Linear discriminant models
Suppose that the financial ratios of a potential borrower are given below:
X1 = 0.2
X2 = 0
X3 = - 0.2
X4 = 0.1
X5 = 2.0
Calculate Z-score for this firm and explain whether the bank should give loan to this firm.
Class practice 2
5. Credit risk models (continued…)
55
b) Quantitative models
▪ Linear discriminant models
▪ The ratio X2 is zero and X3 is negative, indicating that this firm could
potentially have net loss in this period.
▪ X4 shows that the borrower is highly leveraged.
▪ On the contrary, X1 and X5 indicate that the firm is reasonably liquid.
▪ However, we calculate the Z-score below:
Class practice 2
Z = (1.2 × 0.2) + (1.4 × 0) + (3.3 × (-0.2)) + (0.6 × 0.1) + (1.0 × 2.0)
= 1.64
5. Credit risk models (continued…)
56
b) Quantitative models
▪ Linear discriminant models
Decision:
As the Z-score for this firm is less than 1.81, the firm is in high default risk
region. So, the bank should not make a loan to this borrower until it
improves its earnings.
Class practice 2
Thank you
END OF TOPIC 1
Banking and Lending Decisions
Lecture 1
Coordinator & Lecturer: Dr Hasibul Chowdhury
Email: h.chowdhury@business.uq.edu.au
Tutors:
Jon Aster
Email: j.hearn1@uq.edu.au
Sabina Yesmine
Email: s.yesmine@uq.edu.au
Rasheda Huda
Email: r.huda@uq.edu.au
Ann Le
Email: ann.le96@uq.net.au
Wenbin Hu (Tutor and Facilitator)
Email: wenbin.hu@uq.net.au
Minh Le
Email: b.le@uq.edu.au
Course Staff
2
Tutors’ contact and consultation times are posted on Blackboard.
Communication
• Please regularly check Blackboard announcements.
• Any question during the lecture, please use following Zoom ID, log in to the meeting and write
your question in the chat box. Wenbin/Hasibul will respond to your questions:
• Zoom meeting ID is 717 931 8451
• Outside of lecture hours, if you have any question on lecture contents, please email Hasibul or
attend his consult session.
• If you have any question on tutorials, please email your tutor or attend their consult sessions.
Saunders, Cornett, and Erhemjamts (2021) Financial Institutions
Management: A Risk Management Approach, (10th Edition) McGraw
Hill.
Required Resources
4
▪ 2-hour lectures.
▪ 2-hour tutorials (Starting from Teaching Week 2).
▪ Lecture slides and Tutorial questions will be posted in Blackboard on Friday
before the lecture week.
▪ Lectures and tutorials will be recorded.
▪ Tutorial solutions and recording will be available in Blackboard on Friday
after we finish all tutorials for the week.
Course Structure
5
▪ Financial institutions and credit risk analysis
▪ The monetary authorities, RBA, interest rates
▪ Risks of financial institutions
▪ Bank liquidity risk
▪ Asset-liability management I
▪ Asset-liability management II
▪ Securitization & financial crisis
▪ Capital adequacy requirement
▪ Bank performance analysis and deposit insurance design
▪ Loan portfolio and concentration risk
▪ Investment banking
Brief Course Contents
6
Assessments
7
Assessment task Weighting Descriptions
Online Quiz: In-Semester Exam During
Class
(28 March 2024, 8:00 AM - 9:10 AM)
Reading: 10 minutes
Duration: 60 minutes
25% The exam will be based on the materials covered in
Topics 1- 4 (including tutorials).
This is a time-constrained online quiz which will consist of 20 multiple-
choice questions (mix of theory and calculations). Students are
required to log in to the course Blackboard site to complete the quiz.
Late submission is subject to a late penalty.
Individual Assignment (Case Study)
(09 May 2024, 14:00)
25% Carefully read ‘China Huarong: Was it a risky business?’ (see URL on
Blackboard under “Assessment” and please make sure you also read
other materials that will strengthen your assignment). Please use this
case as a background to carefully develop your answers to the two
questions mentioned in the document titled "Assignment Instruction".
Late submission is subject to a late penalty.
Final Exam
(Examination Period)
Reading: 10 minutes
Duration: 120 minutes
50% The exam will be based on ALL materials covered in the course (from
Topics 1- 11).
This assessment task is to be completed in-person. The exam
includes short answers and problem-solving questions. The duration of
the exam will be a total of 120 minutes plus 10 minutes of reading
time.
Late submission is subject to a late penalty.
▪ Practice and don’t just skim through the reading materials.
▪ Seek help as early as possible. Don’t fall behind.
▪ Attend the consults regularly.
▪ Try to understand the concepts.
▪ Set your strategy early.
Some Tips for Success in FINM3404
8
Topic 1
Financial Institutions and Credit Risk Analysis
Textbook reference: Chapter 1 & 10 (Saunders et al., 2021)
Other references:
Holland, Q. C. P., Liu, B., Roca, E., & Salisu, A. A. (2020). Mortgage asymmetric pricing, cash rate and
international funding cost: Australian evidence. International Review of Economics & Finance, 65, 46-68.
Trönnberg, C. C., & Hemlin, S. (2014). Lending decision making in banks: A critical incident study of loan
officers. European Management Journal, 32(2), 362-372.
▪ Evaluate the specialness and the changing dynamics of
financial intermediaries
▪ Evaluate the rationale for bank regulation
▪ Outline the types of loans
▪ Analyse the pricing of commercial loans
LEARNING OBJECTIVES
10
Part A
Introduction to Financial Intermediation & Banking
1. Why are financial institutions (FIs) special?
https://www.youtube.com/watch?v=M2xAWtIE7vA
a) FIs function as brokers.
b) FIs function as asset transformers.
c) FIs reduce the degree of information costs or imperfections.
d) FIs provide liquidity and lower price risk.
e) FIs reduce transaction cost services.
f) FIs provide maturity intermediation.
1. Why are financial institutions (FIs) special?
13
a) Broker Function
i. Full service securities firm
▪ FI act as an agent for the saver by providing information and
transaction services.
▪ Carry out investment research and make investment
recommendation for their retail or household clients.
▪ Conducting the purchase and sale of securities for a commission
and fee.
1. Why are financial institutions (FIs) special? (Continued…)
14
a) Broker Function (continued…)
ii. Discount brokers
▪ Carry out the purchase or sale of securities at better prices
and with greater efficiency than household savers could
achieve by trading on their own.
▪ Efficiency results in reduced cost of trading or achieve
economies of scale.
1. Why are financial institutions (FIs) special? (Continued…)
15
b) Asset Transformer Function
The asset transformation function is accomplished by:
▪ Issuing their own securities, such as deposits and insurance
policies that are more attractive to household savers.
▪ Using the proceeds to purchase the primary securities of
corporations. FIs take on the costs associated with the
purchase of securities.
1. Why are financial institutions (FIs) special? (Continued…)
16
c) Information cost reduction
▪ By putting excess funds into financial institutions, individual
investors give to the FIs the responsibility of deciding who
should receive the money and of ensuring that the money is
utilized properly by the borrower.
▪ In this sense, depositors have delegated the FI to act as a
monitor on their behalf. Further, the FI can collect information
more efficiently than individual investors.
1. Why are financial institutions (FIs) special? (Continued…)
17
c) Information cost reduction (Continued…)
▪ The FI can utilize this information to create new products, such as
commercial loans, that continually update the information pool.
▪ This more frequent monitoring process sends important
informational signals to other participants in the market, a process
that reduces information imperfection and asymmetry between the
ultimate providers and users of funds in the economy.
1. Why are financial institutions (FIs) special? (Continued…)
18
d) Liquidity risk reduction
▪ Liquidity risk occurs when savers are not able to sell their
securities on demand.
▪ Commercial banks, for example, offer deposits that can be
withdrawn at any time.
▪ Yet, the banks make long-term loans or invest in illiquid assets
because they are able to diversify their portfolios and better
monitor the performance of firms that have borrowed or issued
securities.
1. Why are financial institutions (FIs) special? (Continued…)
19
e) Transaction cost reduction
▪ By pooling the assets of many small investors, FIs can gain
economies of scale in transaction costs.
▪ This benefit occurs whether the FI is lending to a corporate or
retail customer, or purchasing assets in the money and capital
markets.
▪ In either case, operating activities that are designed to deal in
large volumes typically are more efficient than those activities
designed for small volumes.
1. Why are financial institutions (FIs) special? (Continued…)
20
f) Maturity intermediation
▪ FI can offer the relatively short-term liabilities desired by households and
also satisfy the demand for long-term loans such as home mortgages.
▪ By investing in a portfolio of long- and short-term assets that have variable
and fixed rates components, the FI can reduce maturity risk exposure by:
utilizing liabilities that have similar variable and fixed rates
characteristics, or
by using futures, options, swaps, and other derivative products.
1. Why are financial institutions (FIs) special? (Continued…)
21
Which of the following are reasons for the specialness of financial
intermediaries?
A. higher average information costs
B. lower price risk and superior liquidity attributes for financial claims
to household savers
C. higher average transaction costs
D. higher information asymmetry
E. All of the listed options are correct
MCQ 1
apps.elearning.uq.edu.au/poll/63254
Which of the following statements is false?
A. A financial intermediary specialises in the production of information
B. A financial intermediary reduces its risk exposure by pooling its assets
C. A financial intermediary benefits society with a mechanism for payments
D. A financial intermediary acts as a lender of last resort
E. A financial intermediary provides brokerage services
MCQ 2
apps.elearning.uq.edu.au/poll/63254
2. Rationale for bank regulation
2. Rationale for bank regulation
25
a) Reduce systemic risk
▪ Systemic risk occurs when bank failures are potentially
contagious, so that the losses in one bank cascade into other
banks, or to other economies throughout the world.
▪ The spread of failure is called ‘contagion’.
▪ Contagion risk is increased by the large volume of business
transacted between the major banks.
2. Rationale for bank regulation (Continued…)
26
b) Protect against moral hazard
▪ Moral hazard occurs when there is a danger that agents will alter
their behavior to profit from an established risk-protection
mechanism.
▪ Bank regulation is intended to reduce the risk of moral hazard
and to limit failure losses which eventually impose a burden on all
taxpayers generally.
2. Rationale for bank regulation (Continued…)
27
c) Protect consumers and pursue social goals
▪ Regulators have the necessary skills and expertise to
assess the riskiness of financial institutions. Information
provided on the health of financial institutions helps to
protect depositors.
▪ The social goals being pursued include efficiency in its
many forms, and an effective banking system that facilitates
economic growth and impartially allocates credit in the
community.
Part B
Introduction to Credit Analysis
3. Types of loans
3. Types of loans
30
a) Business loans
▪ Banks and other FIs can provide business loans for periods as short as a few days, to
a few weeks, or for as long as 10 years or more.
▪ Borrowing firms use short-term business loans (with maturity of one year or less) to
fund their working capital and other short-term funding requirements.
▪ Borrowing firms use long-term business loans to finance credit requirements that
extend to more than a year. For example, purchase of real assets and new business
start-up costs.
▪ A type of large business loan is a syndicated loan, which is provided by a group of FIs
as opposed to a single lender.
▪ A secured business loan is backed by a first claim on collaterals of the borrower if
default occurs.
3. Types of loans
31
a) Business loans (continued…)
▪ Unsecured business loans have only general claims to the assets of the borrower if
default occurs.
▪ A spot loan is made by the FI and the borrower uses the entire amount immediately.
▪ In a line of credit/loan commitment, the FI makes an amount of credit available for the
borrower (for example, $15 million) and the borrower has the option to use any amount
up to $15 million at any time over the commitment period.
b) Housing loans
▪ These loans are simple principal and interest loans made to individuals and families for
the purchase of home.
▪ These mortgage products require that interest and principal be paid back over a long
loan period such as 25 years.
3. Types of loans
32
b) Housing loans (continued…)
▪ Home loans are the largest part (91.8%) of Australian household debt. Out of total loans
given in Australia, housing loan is 59.35%, borrowing for commercial purpose is
36.61%, and other purpose loan is 4.04% (RBA, 2017).
Figure: Residential mortgages as a share of total bank
loans. (Source: IMF 2017 and Holland et al., 2020)
▪ The value of Australian residential market
during October 2016 was AUD 6.7 trillion,
which is almost four times larger than the
equity market value of AUD 1.66 trillion
recorded in that period (Holland et al.,
2020).
3. Types of loans
33
b) Housing loans (continued…)
“The Australian banks are very exposed to the housing
market. Around 60 per cent of their lending is for housing
(Graph 3). And housing is also common collateral for
loans to small and medium businesses. A decline in
housing prices impacts the value of that collateral but of
itself does not necessarily lead to losses. If there were an
economic shock that resulted in borrowers being unable to
service their debt, however, and at the same time housing
prices fell sharply, the debt would be unable to be
recovered in full by the sale of the property, resulting in a
loss to the banks. If the losses were large enough the
banks might exacerbate the decline by reducing their
lending.”
https://www.rba.gov.au/speeches/2021/sp-ag-2021-09-
22.html
3. Types of loans (Continued…)
34
c) Consumer or individual loans
▪ FIs provide consumer loan financing through credit cards such as Visa,
MasterCard and proprietary credit cards issued by Qantas, Woolworths and other
large organizations dealing with consumers.
▪ The loan provided by credit cards is of revolving type, indicating that the borrower
maintains a line of credit on which they draw as well as repay up to some
maximum amount over the life of the credit contract.
▪ However, non-revolving type personal loans include car loans and fixed-term
consumer loans such as 24-month loans.
▪ Banks face higher default rates on consumer loans (specially, credit card loans)
than business loans. Such high rates of default emphasize the importance of client
risk evaluation before credit decisions.
The term 'spot loan' refers to a loan:
A. that is granted on the spot
B. that needs to be repaid on the spot
C. granted at the spot rate
D. for which the full loan amount is withdrawn by the borrower on the spot
E. none of the listed options are correct
MCQ 3
apps.elearning.uq.edu.au/poll/63254
Which of the following statements is true?
A. A line of credit facility is a credit facility with a maximum size and a
minimum period of time over which the borrower can withdraw funds.
B. A line of credit facility is a credit facility with a minimum size and a
minimum period of time over which the borrower can withdraw funds.
C. A line of credit facility is a credit facility with a maximum size and a
maximum period of time over which the borrower can withdraw funds.
D. A line of credit facility is a credit facility with a minimum size and a
maximum period of time over which the borrower can withdraw funds.
E. None of the listed options are correct
MCQ 4
apps.elearning.uq.edu.au/poll/63254
4. Role of asymmetric information in lending
4. Role of asymmetric information in lending
38
Asymmetric information: The borrowers have more information about
themselves than is available to the bank.
a. Adverse selection: Adverse selection occurs before the loan is made.
High risk borrowers try to get loans from banks because they are willing
to pay less than they would have to pay if their true condition were
known to the bank.
b. Moral hazard: This is the risk that the borrower, who now has the loan,
might use the funds to engage in high risk activities in expectation of
earning higher return. This is more likely to occur when the lender is
unable to monitor the borrower’s activities.
INDUSTRY OUTLOOK
39
40
▪ Loan officers mainly apply “deliberation” technique and less “intuition”
while making lending decisions.
▪ Two approaches to evaluate loan applications - transactional lending
and relationship lending.
▪ An example statement of deliberation technique – “We focused on
the cash flow in this case, as we always do...’’
▪ An example statement of using intuition in lending decision - ‘‘Well, I
thought that I could trust these two persons together...Forecasts
expressed in numbers are good support...but at the same time they
only forecasts. So, it was not actually based on quantitative
information much.” Another example – “The owners left, made a first
impression. But at the first meeting with information and facts the gut
feeling was not so positive.”
INDUSTRY OUTLOOK
5. Credit risk models
5. Credit risk models
42
a) Qualitative models
▪ Borrower-specific factors
These are idiosyncratic to the borrowers:
❖ Is the borrower creditworthy?
[Evaluate reputation, leverage, volatility of earnings, collateral].
The six Cs of credit: Character, Capacity, Cash, Collateral, Conditions
and Control.
❖ Can the lender perfect its claim against the borrower’s earnings and
any assets that may be pledged as collateral?
❖ Can the loan agreement be properly structured and documented?
5. Credit risk models (continued…)
43
a) Qualitative models (continued…)
▪ Market-specific factors
These have an impact on all borrowers at the time of the credit decision.
i. The Business Cycle: The position in the economy in the business
cycle phase is important to an FI in assessing the probability of default.
Example, during recession, firms in the consumer durable good sector
that produce autos, refrigerators, or houses do badly compared with
those in non-durable goods sector producing clothing and food.
5. Credit risk models (continued…)
44
a) Qualitative models (continued…)
▪ Market-specific factors
ii. The Level of Interest Rates: At times of high interest rate the FIs not only
find funds to finance their lending decisions scarcer and more expensive but
also recognize that high interest rate are correlated with higher credit risk in
general.
The FI manager then weighs these factors subjectively to come to an overall
credit decision. Because of their reliance on subjective judgment of the FI
manager, qualitative models are often called expert systems.
5. Credit risk models (continued…)
45
b) Quantitative models
▪ Customer profitability analysis (CPA)
✓ It begins with the assumption that the lender should take the whole
customer relationship - all revenues and expenses associated with a
customer - into account when pricing a loan.
✓ Revenues paid by a borrower includes loan interest, commitment fees,
fee for cash management services and data processing charges.
✓ Expenses incurred on behalf of the customer includes wages & salaries
of the lender’s employees, credit investigation cost, interest accrued on
deposit account reconciliation and processing costs and funds’ acquisition
costs.
5. Credit risk models (continued…)
46
b) Quantitative models
▪ Customer profitability analysis (CPA)
NLF
ExpRev
NBTR
−
=
NBTR = Net before-tax rate of return to the lender from the whole customer
relationship
Rev = Revenues from loans and other services provided to this customer
Exp = Expenses from providing loans and other services to this customer
NLF = Net loanable funds used in excess of this customer’s deposits and calculated
as the amount of credit used by the customer minus customer’s average collected
deposits (adjusted for required legal reserve).
5. Credit risk models (continued…)
47
b) Quantitative models
▪ Customer profitability analysis (CPA)
A bank is considering granting a 1.5 m line of credit for six months to Black
Gold Inc, an energy company. Assuming Black Gold uses the full line and
keeps a deposit equal to 20% of the credit line with the bank, the following
revenues and expenses should result from dealing with the customer.
Required: Complete the Annualized Customer Profitability Analysis by
calculating rate of return. Interpret your answer.
Class practice 1
5. Credit risk models (continued…)
48
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1
Sources of revenue expected to be supplied by a customer
Interest income from loan (12%, six months) ?
Loan commitment fees (1%) ?
Fees for managing customer's deposits $45,000
Funds transfer charges $5,000
Fees for trust services and recordkeeping $61,000
Total revenues ?
5. Credit risk models (continued…)
49
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1
Costs expected to be incurred in serving this customer
Deposit interest owed to the customer (10%) ?
Cost of funds raised to lend this customer $80,000
Activity costs for this customer's accounts $25,000
Cost of funds transfers to this customer $1,000
Cost of processing the loan $3,000
Recordkeeping costs $1,000
Total expenses ?
5. Credit risk models (continued…)
50
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1
Net amount of banker’s reserves expected to be drawn upon by this
customer this year
Average amount of credit committed to customer $1,500,000
Average customer deposit balances (net of required reserves) $270,000
Net amount of loanable funds ?
5. Credit risk models (continued…)
51
b) Quantitative models
▪ Customer profitability analysis (CPA)
Class practice 1 - Solution
NBTR =
Total revenues −Total expenses
Net amount of loanable funds
=
$216,000−$125,000
$1,230,000
= 7.4%
Decision rule:
Bank should accept the loan because NBTR is positive. It indicates that if granted, the proposed loan
will generate more revenues than expenses required to service this loan.
5. Credit risk models (continued…)
52
b) Quantitative models
▪ Linear discriminant models
▪ Linear discriminant models categorise borrowers into high or low default
risk based on borrower characteristics.
▪ In this section, we will use Altman’s discriminant function as the credit
classification model:
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
where,
X1 = Working capital / Total assets ratio
(Working capital = Current assets – Current liabilities)
X2 = Retained earnings / Total assets ratio
5. Credit risk models (continued…)
53
b) Quantitative models
▪ Linear discriminant models (continued…)
X3 = Earnings before interest and taxes / Total assets ratio
X4 = Market value of equity / Book value of long-term debt ratio
X5 = Sales / Total assets ratio
Decision rule:
Z-score < 1.81 = High default risk category
Z-score > 2.99 = Low default risk category
Z-score between 1.81 to 2.99 = Zone of ignorance (borrower may or may not default)
5. Credit risk models (continued…)
54
b) Quantitative models
▪ Linear discriminant models
Suppose that the financial ratios of a potential borrower are given below:
X1 = 0.2
X2 = 0
X3 = - 0.2
X4 = 0.1
X5 = 2.0
Calculate Z-score for this firm and explain whether the bank should give loan to this firm.
Class practice 2
5. Credit risk models (continued…)
55
b) Quantitative models
▪ Linear discriminant models
▪ The ratio X2 is zero and X3 is negative, indicating that this firm could
potentially have net loss in this period.
▪ X4 shows that the borrower is highly leveraged.
▪ On the contrary, X1 and X5 indicate that the firm is reasonably liquid.
▪ However, we calculate the Z-score below:
Class practice 2
Z = (1.2 × 0.2) + (1.4 × 0) + (3.3 × (-0.2)) + (0.6 × 0.1) + (1.0 × 2.0)
= 1.64
5. Credit risk models (continued…)
56
b) Quantitative models
▪ Linear discriminant models
Decision:
As the Z-score for this firm is less than 1.81, the firm is in high default risk
region. So, the bank should not make a loan to this borrower until it
improves its earnings.
Class practice 2
Thank you
END OF TOPIC 1
