As our banks head into 2015, they have a new cost investors might not be aware of – more than $400 million a year for what’s effectively an insurance premium charged by the Reserve Bank as part of a unique liquidity backstop for the banks and the financial system in the event of a repeat of funding freeze seen in the GFC in the last quarter of 2008.
Then the RBA stumped up well over $150 billion to provide emergency liquidity to the banking system, and other finance groups, after offshore funding was cut off in the wake of the markets freezing after Lehman Brothers collapsed.
Despite claims to the contrary from the banks and others that they survived the GFC, they would not have without that support from the central bank (helped by the regulator, APRA), as well as Federal Government guarantees of bank deposits and bank debt raisings (the latter for a limited period of time).
In the last speech from the Reserve Bank for 2015 this week, Assistant Governor (http://www.rba.gov.au/speeches/2014/sp-ag-161214.html) Guy Debelle (who oversees the country’s financial markets) revealed the cost of the standby funding in dollar terms. The size fee of 0.15% of the backstop funds for each bank, had been known for a year.
That premium will rise in coming years as the banks expand their business and the need for more highly liquid assets rises.
Mr Debelle said the banks are in the process of finalising and signing agreements with the RBA to participate in what’s called The Committed Liquidity Facility (CLF).
It’s complex and has been adopted because Australia just doesn’t have enough high quality liquid assets to backstop the banks and the financial system in the event of a repeat of late 2008. That’d despite all the political nonsense about Australia having too much Federal government debt – we don’t.
The regulators have agreed that the banks will have to be able to survive a 30 day period of being cut off from offshore funding and frozen local markets, with only the RBA as the lender of last resort.
Mr Debelle explained the need for the CLF and why the banks will have to pay the fee – and its cost for 2015.
"As has been known for some time, the Australian financial system does not have an especially large stock of High Quality Liquid Assets (HQLA).The only instruments that have been deemed to meet the Basel standard of liquidity are debt issued by the Commonwealth and state governments (CGS and semis) along with cash balances at the Reserve Bank,” Mr Debelle said.
"The banking system’s overall liquidity needs are greatly in excess of what could reasonably be held in those assets. To put some numbers on this, APRA has determined that for next year, the Australian banking system’s liquidity needs amount to $450 billion. The total stock of CGS and semis on issue currently amounts to around $600 billion.
"If the banks were to attempt to meet their liquidity needs solely by holding only CGS and semis, a number of problems would arise. Firstly, any attempt would likely be in vain, because there are a large number of other entities which are required to or want to hold CGS and semis too.
"Second, in the process of trying to do this, the liquidity of the market for these securities would be seriously compromised. This would be completely self-defeating as the overall aim is to have the banks hold more liquid assets.
"To address these circumstances, an important component of the liquidity regime in Australia is the committed liquidity facility (CLF) where, on the payment of a 15 basis point fee, banks will be able to obtain a commitment from the Reserve Bank to provide liquidity against a broad range of assets under repurchase agreement.
"APRA has recently determined that the total CLF requirements of the Australian banking system for 2015 amount to around $275 billion. This amount was determined by first assessing that the amount of CGS and semis that could reasonably be held by banks without unduly affecting market functioning was $175 billion.
"The Reserve Bank provided this assessment to APRA. The CLF amount is then simply the difference between this and the overall liquidity needs of the system.
"The banks that require a CLF from the Reserve Bank sign a deed of agreement with us and pay their fee before the end of this year. Then from the beginning of next year, the arrangement comes into effect.”
The cost of the 0.15% fee on the $275 billion of standby funds in the CLF will be $415 million a year. That’s the annual cost of the Reserve Bank (i.e.) taxpayers providing the banking system with liquidity support – effectively a form of insurance. Because its coming from taxpayers, there has to be a cost to reflect the banks accessing the country’s AAA credit rating.
The fee has to be paid by the start of next month, when new rules come into formal effect.
This is also the background to the recommendations from the Murray Inquiry into the Financial System that some our biggest banks (the Big Four actually), need to hold more capital to help keep their alive in any future GFC.
If the banks had enough capital (more than what they now have) and if there was much more Federal and State debt on issue, then the CLF wouldn’t be needed, and nor would the Murray Inquiry have recommended the high capital needs.
Judging by comments at the ANZ and NAB annual meetings, the banks are getting the message – there was none of the whining we saw a week ago at the Westpac AGM from chairman, Lindsay Maxsted.
