Philip Lowe, RBA Deputy Governor gave a speech entitled “The Transformation in Maturity Transformation“. He provided a useful summary of the current picture of bank funding. Banks capital has been increasing, as part of this global trend to higher and better quality capital, with an increase in common equity lifting the aggregate capital ratio from around 10½ per cent prior to the crisis to around 12½ per cent at end 2014. The recent capital announcements by some of the large banks will see this ratio rise further.
In terms of liquidity management he discussed two main initiatives.
The first is the introduction of a Liquidity Coverage Ratio (LCR) which, from the start of this year, has required banks to hold enough high-quality liquid assets to meet a stress scenario that lasts for 30 days. The challenge for the Australian banking system has been that the supply of such assets is limited due to the stock of government bonds on issue being small relative to the overall size of the financial system. To overcome this challenge, the RBA has provided banks with a Committed Liquidity Facility (CLF) under which it will make available sufficient liquidity (against eligible collateral) to address the shortfall in required holdings of high-quality liquid assets. The pricing of the CLF is aimed at replicating the cost of holding a sufficient volume of these assets, were they to be available in the marketplace. APRA administers the decisions as to which banks access the program, and the maximum amount available to each bank.
The second initiative is the Net Stable Funding Ratio (NSFR), which has a longer-term focus. It will establish a minimum amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a one-year horizon. The new requirement here will not come into effect until January 2018.
This increased focus on liquidity is clearly evident in the balance sheets of the Australian banks. On the assets side, holdings of liquid assets have increased substantially, after they declined for many years. Australian dollar denominated liquid assets are now equivalent to about 7 per cent of banks’ total assets, up from around 1 per cent in early 2008. If the CLF is added in, the current figure is around 15 per cent.
There have also been significant changes on the liabilities side of the balance sheet. The most noticeable has been a shift away from short-term wholesale debt towards deposits. In early 2008, deposits accounted for around 40 per cent of the Australian banks’ total funding. Today, that figure is just a little below 60 per cent. In part, this switch has been driven by the judgement that the risk of a run by depositors is less than the risk of a run by investors in short-term wholesale debt. To the extent that this judgement is correct, this switch has increased the effective maturity of banks’ liabilities in a stress event, even if it has not increased the contractual maturity.
There has also been some lengthening in the average contractual maturity of the various types of liabilities. The share of deposits at the major banks with a maturity of less than three months has declined since 2007, although this share has increased a little more recently as competition for term deposits has waned. Similarly, there has been a noticeable increase in the maturity of banks’ other debt liabilities since 2007. Of particular note, the share of other debt liabilities with maturities of less than three months has declined substantially.
He made that point that taken as a whole, these measures have made the system more resilient. But they have increased the cost of financial intermediation somewhat. They have also increased the likelihood that such intermediation will take place outside the banking sector. After all, to some extent this is what was intended. So we need to keep a close eye on how the overall system responds and make sure that in addressing the very real risks associated with maturity transformation, that we don’t create a new set of risks. This is likely to be an ongoing challenge for us all.
It is also important to point out that while the various measures have made the system more resilient, they do not guarantee stability. Because of the very nature of the business that banks undertake, they can still find themselves in a liquidity crisis. Here the role of the central bank acting as a lender of last resort is critically important.
