Is a term deposit the best option for surplus capital works funds, and can the owners corporation choose a bank?

The short answer is term deposits.

To explain why, we start with the Strata Management Act 2015, where the investment of strata funds is dealt with very vaguely in Section 75(1)

1. An owners corporation may invest any money in its administrative fund or capital works fund in any manner permitted by law for the investment of trust funds or in any investment prescribed by the regulations.

Could "Any manner permitted by the law" be any vaguer? And the strata regulations say nothing.

So we then refer to the Act governing strata agents and the management of trust accounts generally, Section 82(1c) of the Property and Stock Agents Act 2002.

"Trust money to be paid into trust account...until so paid or disbursed is to be paid into and retained in a trust account (whether general or separate) at an authorised deposit-taking institution in New South Wales and approved by the Secretary for the purposes of this Part."

Key bit is "authorised deposit-taking institution in New South Wales". And within that its 'deposit taking' entities, which rules out shares and managed funds and cryto, etc. This also rules out investments overseas, even with a bank.

You don't have to arrange the term deposit with the same bank as the strata agent. The list of ADIs held by APRA is essentially a list of banks and credit unions. Banks and credit unions offer only term deposits as investment options. You can either instruct the agent or arrange the term deposit yourself.