====== Authorised Deposit-taking Institutions ======
===== The 30-Second Summary =====
  *   **The Bottom Line:** **An Authorised Deposit-taking Institution (ADI) is a government-regulated financial fortress, like a bank or credit union, whose primary role is to protect public deposits and provide the stable financial plumbing for the entire economy.**
  *   **Key Takeaways:**
  * **What it is:** A fancy name for a bank, credit union, or building society that has an official government license to take your money (deposits) and lend it out.
  * **Why it matters:** ADIs are the bedrock of a modern economy. For a value investor, their collective health is a barometer for [[systemic_risk]], and their individual regulatory status creates a powerful [[economic_moat]].
  * **How to use it:** When analysing a financial company, confirming its ADI status is step one. This tells you it operates under strict rules, which you can then analyse using metrics like the [[capital_adequacy_ratio]].
===== What is an Authorised Deposit-taking Institution? A Plain English Definition =====
Imagine your local town's economy. You have shops, factories, and homes. For it all to work, you need a central, trusted, and incredibly secure place to hold money and facilitate payments. This place isn't just any old business; it's a special institution given a unique privilege and a heavy responsibility by the town council. This is the essence of an Authorised Deposit-taking Institution, or ADI.
In the simplest terms, an ADI is what most of us just call "the bank." It could be a giant global bank like HSBC, a member-owned credit union, or a local building society. The key isn't the name on the door, but the words in its title:
  *   **Authorised:** This is the most important word. It means the government's financial regulator (like the Prudential Regulation Authority (PRA) in the UK, the Federal Reserve and FDIC in the US, or the Australian Prudential Regulation Authority (APRA) in Australia) has given this institution its stamp of approval. It has been vetted, meets strict financial requirements, and is under constant supervision. You can't just decide to open a bank in your garage—you need to earn this authorisation.
  *   **Deposit-taking:** This is its core function. ADIs are legally permitted to accept money from the public (individuals and businesses) and promise to give it back on demand or at a specified time. This act of taking deposits is a sacred trust.
  *   **Institution:** This signifies a permanent, stable, and foundational entity, not a fleeting enterprise.
The "deal" an ADI makes with society is simple: in exchange for the incredible privilege of taking public deposits and the powerful ability to create money through lending, it must submit to rigorous regulation. These rules govern everything from how much capital it must hold as a buffer against losses, to how it manages risk, to the information it must disclose to the public. This entire framework is designed to ensure one thing above all else: stability.
> //"Banking is a very good business if you don't do anything dumb." — Warren Buffett//
Buffett's folksy wisdom cuts to the heart of the matter. The business model of an ADI is straightforward: take in deposits at a low cost (paying little to no interest on checking accounts, for example) and lend that money out at a higher interest rate (mortgages, business loans). The difference is their profit. The regulations are there to stop them from doing "anything dumb" with your money, which in turn protects the entire system.
===== Why It Matters to a Value Investor =====
A value investor, following the teachings of [[benjamin_graham]], seeks durable businesses at sensible prices, with a primary focus on capital preservation. From this perspective, understanding ADIs is not just academic; it's fundamental to risk management and identifying genuine value.
1.  **The Ultimate Regulatory Moat:**
    Warren Buffett popularised the idea of an [[economic_moat]]—a sustainable competitive advantage that protects a company from rivals. ADIs have one of the widest and deepest moats in the business world: the regulatory moat. The immense cost, complexity, and time required to obtain a banking license creates a formidable barrier to entry. This structural advantage means established ADIs face limited new competition, allowing them to earn steady, predictable profits over the long term, a quality highly prized by value investors.
2.  **A Barometer for Systemic Risk:**
    Value investors are not just micro-analysts of single companies; they are macro-aware. The health of a nation's ADIs is a direct reflection of the health of its economy. When these institutions are strong, well-capitalised, and lending prudently, the economy hums along. When they start taking excessive risks, as we saw in the lead-up to the 2008 Global Financial Crisis, they become carriers of a systemic contagion that can infect every other sector. A prudent investor, therefore, keeps an eye on the banking system's stability as a key indicator of broad market risk.
3.  **The Embodiment of "Margin of Safety":**
    The core principle of value investing is the [[margin_of_safety]]—buying an asset for significantly less than its intrinsic value to protect against error or bad luck. ADIs are built on this very concept. Regulatory capital requirements (like the Common Equity Tier 1 ratio) are, in effect, a mandated margin of safety for the institution itself. Furthermore, government deposit insurance schemes (like the FDIC in the US, which insures deposits up to $250,000) provide an explicit margin of safety for depositors. This stability at the base of the financial system is what allows the rest of the market to function.
4.  **A "Too-Hard Pile" That Can Hide Opportunity:**
    Because of their complexity and opaque financial statements, many investors (including Warren Buffett at times) place banks in their [[circle_of_competence|'too-hard' pile]]. However, for the diligent investor willing to learn the specific rules and metrics that govern ADIs, this complexity can be an advantage. The market often misprices well-run, conservative banks simply because they are lumped in with their more reckless peers. By understanding what makes a //good// ADI, an investor can find value where others are afraid to look.
===== How to Apply It in Practice =====
Understanding the concept of an ADI is one thing; using it to make better investment decisions is another. You don't need a PhD in finance, but you do need a practical checklist to separate the fortresses from the houses of cards.
=== The Method: A Four-Step Checklist for Evaluating an ADI ===
When you look at a bank or credit union as a potential investment, apply this value-focused lens:
  - **Step 1: Verify the License and Regulator**
    This is the foundational check. Before you do anything else, confirm the institution is indeed a regulated ADI. A quick visit to the website of the country's main financial regulator will usually provide a list of authorised institutions. Knowing who regulates them tells you what set of rules they are playing by. This is non-negotiable.
  - **Step 2: Assess Capital Strength (The Shock Absorber)**
    This is the single most important metric. A bank's capital is its buffer to absorb unexpected losses without going bankrupt. The key figure to look for is the **Common Equity Tier 1 (CET1) Ratio**.
    *   **What it is:** It measures the bank's highest-quality capital (mostly common stock and retained earnings) as a percentage of its risk-weighted assets.
    *   **How to interpret it:** A higher CET1 ratio is always better. It means the bank can withstand a bigger economic storm. Regulators set a minimum, but a conservative, well-run bank will operate far above it. A CET1 ratio above 11-12% is generally considered strong. One hovering just above the regulatory minimum (often around 7-9%) is a red flag. This is the bank's [[margin_of_safety]].
  - **Step 3: Scrutinise the Loan Book (The Engine Room)**
    A bank makes money from its loans. But bad loans are the poison that can kill it.
    *   **Net Interest Margin (NIM):** This is the difference between the interest it earns on loans and the interest it pays on deposits. A stable or gently rising NIM is a sign of pricing power and good management. A rapidly shrinking NIM can signal intense competition or poor risk management.
    *   **Non-Performing Loans (NPLs):** These are loans where the borrower has stopped making payments (typically for 90 days or more). You want this number to be as low as possible. A low and stable NPL ratio (e.g., below 1%) indicates prudent lending. A rising NPL ratio is the first sign of trouble ahead.
  - **Step 4: Understand the Funding Base (The Foundation)**
    Where does the bank get its money? Not all funding is created equal.
    *   **Sticky Retail Deposits:** Money from millions of individual checking and savings accounts is considered the highest quality funding. It's stable, low-cost, and unlikely to flee in a crisis.
    *   **Wholesale Funding:** Money borrowed from other financial institutions or capital markets is more expensive and far more skittish. A bank that relies heavily on this "hot money" is at much greater risk of a "bank run" during a panic. A value investor heavily prefers a bank funded by its loyal customers.
===== A Practical Example =====
Let's compare two hypothetical ADIs to see these principles in action: "Steady Savers Bank" and "Go-Go Growth Lending."
^ Feature ^ **Steady Savers Bank** ^ **Go-Go Growth Lending** ^
| **Regulator** | Prudential Regulation Authority (PRA) | Prudential Regulation Authority (PRA) |
| **CET1 Ratio** | 14.5% (Very Strong) | 9.5% (Barely above minimums) |
| **Net Interest Margin (NIM)** | 2.5% (Stable) | 4.5% (High, but volatile) |
| **Non-Performing Loans (NPLs)** | 0.4% of total loans (Excellent) | 5.0% of total loans (Alarming) |
| **Primary Funding Source** | Retail customer deposits (85%) | Wholesale market borrowing (60%) |
| **Investor Focus** | Long-term, prudent growth. Focus on high-quality mortgages and small business loans. | Short-term profit maximisation. Focus on high-risk unsecured consumer and speculative property loans. |
**Analysis from a Value Investor's Perspective:**
  *   **Go-Go Growth Lending** might look appealing on the surface with its high Net Interest Margin. It seems to be making a lot of money! However, a deeper look reveals it's a house of cards. It achieves that high NIM by making very risky loans, as evidenced by its alarmingly high NPL ratio. Its thin capital buffer (low CET1) means even a mild recession could wipe out its equity. Its reliance on flighty wholesale funding makes it vulnerable to a credit crunch. This is a classic speculative trap.
  *   **Steady Savers Bank** is the epitome of a value investment. It's "boring" in the best way possible. Its fortress-like CET1 ratio means it can sleep soundly through economic storms. Its low NPLs prove its lending culture is disciplined and focused on capital preservation. It is funded by loyal customers, not fickle markets. While its growth may be slower, its durability and resilience give it a much higher [[intrinsic_value]]. This is the kind of institution that survives and thrives over decades.
===== Advantages and Limitations =====
==== Strengths ====
  * **Built-in Moat:** The regulatory hurdles to becoming an ADI are immense, protecting established players from upstart competition and ensuring a stable industry structure.
  * **Predictable Business Model:** The core business of taking deposits and making loans is as old as commerce itself. For well-managed ADIs, this leads to relatively stable and understandable earnings streams.
  * **Systemic Importance:** Because of their central role, regulators and governments have a vested interest in the survival of ADIs, often leading to support during a widespread crisis. This is the controversial concept of [[too_big_to_fail]].
==== Weaknesses & Common Pitfalls ====
  * **Opacity and Complexity:** Bank financial statements are notoriously difficult for a non-specialist to decipher. It's often said that banks are a "black box," making it hard to truly know the quality of the assets within. This is a major challenge to one's [[circle_of_competence]].
  * **High [[Financial Leverage|Leverage]]:** ADIs are inherently leveraged businesses; they use a small base of equity to control a huge pool of assets (loans). While this magnifies profits in good times, it can magnify losses disastrously in bad times. A small increase in bad loans can have a massive impact on shareholder equity.
  * **Vulnerability to Economic Cycles:** The fortunes of ADIs are directly tied to the health of the broader economy. During a recession, unemployment rises, businesses fail, and loan defaults inevitably increase, hurting bank profits and capital. They are price-takers of macroeconomic risk.
===== Related Concepts =====
  * [[economic_moat]]
  * [[margin_of_safety]]
  * [[systemic_risk]]
  * [[capital_adequacy_ratio]]
  * [[circle_of_competence]]
  * [[too_big_to_fail]]
  * [[financial_leverage]]