An important post from Macrobusiness (MB) by the excellent Leith van Onselen which opens the can of worms which is the RBA’s Committed Liquidity Facility (a.k.a. Bank Safety Net or Unofficial Government Guarantee). Its all about the RBA’s version of QE!
He says:
Figures from the International Monetary Fund (IMF) show that Australian government debt has risen faster than most other developed nations, increasing from 16.7% of GDP to an expected 41.7% this year – a jump of 25 percentage points. From The Australian:
The IMF report comes as Scott Morrison prepares to unveil next month’s budget, which will recycle improved company tax flows into personal income tax cuts while taking on more debt to finance infrastructure development. The Treasurer argues that the government is no longer borrowing to finance daily running costs but just to cover infrastructure and defence investments.
The mid-year budget update in December showed gross debt peaking at $591 billion in 2019-20, having hit $500bn in 2016-17. Gross debt stood at $319bn when the Coalition took office in 2013.
The IMF predicts this year will be the peak for Australian gross debt at 41.7 per cent of GDP, before a decline to 32.2 per cent over the next five years…
Although the IMF projects that Australia’s federal and state budgets will be back in surplus by 2020, it says there will be a continuing need to raise funds to roll over debts as they mature.
We think the projected return to surplus by 2020 is wishful thinking, given:
Commodity prices will likely fall, draining company profits, national income, and company tax revenue;
The housing downturn will dampen consumer spending, jobs and growth, draining company and personal income tax revenue; and
We are likely to see tax cuts offered from both sides in the upcoming federal election campaign.
Regardless, there is another important question that is rarely asked outside of MB: why is the Reserve Bank of Australia (RBA) persisting with the Committed Liquidity Facility (CLF) when there is now so much government debt on issue?
The CLF was established in late-2011 in order to meet the Basel III liquidity reforms. Below is the RBA’s explanation of the CLF [my emphasis]:
The facility, which is required because of the limited amount of government debt in Australia, is designed to ensure that participating authorised deposit-taking institutions (ADIs) have enough access to liquidity to respond to an acute stress scenario, as specified under the liquidity standard…
The CLF will enable participating ADIs to access a pre-specified amount of liquidity by entering into repurchase agreements of eligible securities outside the Reserve Bank’s normal market operations. To secure the Reserve Bank’s commitment, ADIs will be required to pay ongoing fees. The Reserve Bank’s commitment is contingent on the ADI having positive net worth in the opinion of the Bank, having consulted with APRA.
The facility will be at the discretion of the Reserve Bank. To be eligible for the facility, an ADI must first have received approval from APRA to meet part of its liquidity requirements through this facility. The facility can only be used to meet that part of the liquidity requirement agreed with APRA. APRA may also ask ADIs to confirm as much as 12 months in advance the extent to which they will be relying on a commitment from the Bank to meet their LCR requirement.
The Fee
In return for providing commitments under the CLF, the Bank will charge a fee of 15 basis points per annum, based on the size of the commitment. The fee will apply to both drawn and undrawn commitments and must be paid monthly in advance. The fee may be varied by the Bank at its sole discretion, provided it gives three months notice of any change…
Interest Rate
For the CLF, the Bank will purchase securities under repo at an interest rate set 25 basis points above the Board’s target for the cash rate, in line with the current arrangements for the overnight repo facility.
In light of the federal budget deficit projected to balloon out to nearly $600 billion, the question for the RBA is: shouldn’t the CLF be unwound and the banks instead be required to hold government bonds, as initially required under Basel III?
Bonds on issue are roughly triple that of when the CLF was first announced, so surely the RBA should amend the liquidity rules so that Australia’s ADIs are forced to purchase government bonds, so that the size of the CLF requirement decreases?
The most likely reason is because the RBA wants to keep open the option of bailing-out the banks. As noted by Deep T:
When there is capital flight due to official interest rate decreases, the RBA could and would step in and fund the banks’ funding shortfall from a loss of international investors using the Committed Liquidity Facility at rates below the banks’ international funding rates. The CLF used in these circumstances would be a form of quantitive easing and would have a dampening effect on mortgage rates by subsidising bank borrowing rates but could never be a lasting solution and only have limited effect in the long term. So yes, high cost international funding by the banks can easily be replaced by cheap RBA funding through a form of QE or money printing subsidising bank profits and banker bonuses.
The fact of the matter is the CLF represents another subsidy to the banks. The cost of the CLF is very low – i.e. 15bps pa – compared to the alternative. The CLF allows ADIs to originate mortgage assets and create RMBS rather than buying government bonds. The net spread on mortgage assets or RMBS compared to government bonds is much greater than 15bps pa, thus representing a significant direct subsidy to the banks.
MB reader, Jim, nicely dissected the lunacy of the CLF in a comment in 2016:
You’ve missed the real beauty of the CLF, and APS210
So the banks are forced to hold ‘as much as possible’ qualifying Tier 1 securities to meet their APS210 requirements. But… even with the large commonwealth government deficit, there still isn’t enough CGS to go round (CGS and TCorp bonds only qualify for Tier 1 securities under APS210).
Which is why the RBA invented the CLF. The CLF allows, no, it requires the banks to:
– hold their own securitised bonds on their balance sheet to qualify as ‘liquid assets’
– buy each other’s bonds to qualify as ‘liquid assets’
So, ANZ, CBA, NAB and WBC each have around $50bn of their own off balance sheet mortgages sitting back on their balance sheet to protect them against a ‘liquidity event’. Then they each have around $10bn each of each other’s bonds, so NAB holds around $50bn of WBC/ANZ/CBA bonds etc.
And if / when the liquidity shit hits the fan (e.g. foreigners stop buying the bank’s bonds), the banks can swap them into the RBA for a 15bps fee.
So the RBA will be forced to sit on about half a trillion dollars of Aussie bank paper ($100bn each plus a little more for CBA and WBC, plus Suncorp, Bendigo etc). Just think what THAT would do to your graph of yellow lines – more than double it in an instance.
So the CLF is not about government debt, its about bank debt, and how the RBA has bent over forward for the banks. Having worked in treasury at a Big 4, the CLF is the biggest joke under the sun – a guaranteed way to print money for the banks. This is why the fixed income desks at banks are always the best paying – those guys are paid to buy and hold bank bonds under APS210 requirements.
Do an investigation on how much REAL systemic debt is sitting in the banking system – the RBA has made itself lender of last resort to over $500bn worth of debt.
The bottom line is that with the stock of outstanding Commonwealth debt now so large (and still growing), the rationale for maintaining the CLF has evaporated. But don’t expect any action from the RBA, which wants to maintain the capability of bailing-out the banks via its own form of quantitative easing.
He says:
