APRA yesterday released its new criteria guidelines for access to the RBA’s Committed Liquidity Facility (CLF), which is designed as the fall back for banks should the global financial system ever seize again. Other nations are forcing banks to hold a prescribed portion of liquid assest in the form of government bonds. The shortage of available bonds in Australia has led to the cretion of the CLF.
From Banking Day:
APRA has previously said that each bank’s annual funding strategy must “clearly state the amount of the CLF required in the forecast period. “The bank regulator has now made clear that “the size of the CLF for each ADI [authorised deposit-taking institution] will be limited to a specified percentage of that ADI’s Australian dollar net cash outflow target as agreed by APRA, plus an allowance for an appropriately sized buffer. “The CLF will “be available to address Australian dollar liquidity needs only,” APRA said.
Further criteria for deciding “the appropriate size of the CLF” will include: “they have taken all reasonable steps towards meeting their liquidity requirements through their own balance sheet management, before relying on the CLF…relevant qualitative and quantitative liquidity requirements, including having in place a statement of the board’s tolerance for liquidity risk…an appropriately robust liquidity transfer pricing mechanism…and appropriate remuneration arrangements”
Glenn Stevens, governor of the Reserve Bank of Australia, has previously explained that the CLF “is a facility, for which the institutions concerned will pay a fee, which would provide cash against quality collateral pledged by institutions that the bank and APRA judge to be solvent.”
The whole thing continues to be very opaque but at least now there are criteria for judging that solvency, even if we’ll never know how reliable they are nor how precisely they’ve been applied, nor whether liquidity was actually insolvency.
Moreover, as Deep T. has argued:
At this point I should point out that whilst I would argue that the whole concept of the CLF is flawed and that available bank liquidity is a direct consequence of a strongly capitalised balance sheet of each ADI with significant extra capital requirements for systemically important banks. I also consider the CLF to be a massive taxpayer subsidy to all Australian ADIs which if not properly sized for the cost and risk will lead to moral hazard risks. Nevertheless, we have the CLF and its not going away but maybe pressure can be applied to change some of the rules around the CLF.
The first issue with the CLF arises from its original premise, ie there are not enough government bonds to provide the banks liquidity requirements. Whilst this may also be an indicator of the oversized nature of the total ADI balance sheets, since the CLF was announced almost $200Bn of federal government bonds issuance has been built up, 90% of which have been purchased by offshore investors. Additionally it would appear that Australia will have deficits for a number of years to come, increasing this issuance.
Has APRA changed the rules so that the ADIs must buy government bonds so that the size of the CLF requirement decreases? No they haven’t and this suits all ADIs but especially Mega Bank. The cost of the CLF is very low ie 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 probably now in the order of 150bps if you could pull together a direct comparison including costs. The significant comparison is with the cost of the undrawn CLF and not the cost of a drawn facility. On this point our RBA Governor would seem to be misleading.
This simple comparison demonstrates that the cost to the banks of 15bps is a direct subsidy to all ADIs. However, it’s a subsidy which is of much greater value to Mega Bank because Mega Bank is so thinly capitalised on residential mortgages than other ADIs, that the subsidy has a much greater effect on increasing Mega Bank’s return on capital and that’s a significant part of the measures that the senior managers of Mega Bank are paying themselves bonuses under.
