Time for the RBA to cut the CLF

By Leith van Onselen

The ABC reported yesterday that the Federal Government has issued extra $14 billion in bonds to pay for the ballooning deficit, with more to come as the Budget deficit inexorably grows:

The Federal Government has boosted its issuance of Commonwealth bonds by almost 20 per cent to $86 billion this financial year…

Previously, the AOFM planned to issue $72 billion worth bonds this financial year.

The total of Commonwealth Government Securities (GGS) on issue at June 2016 is now forecast to be $426 billion, up from $412 billion projected in this year’s budget and the $390 billion set down in the 2014 budget.

RBC’s fixed income strategist Michael Turner said the AOFM could keep on track by issuing $1.7 billion worth of bonds every week.

“To put some context around those numbers, for June 2018 expected CGS on issue at that point in time has increased by $83 billion in 18 months,” Mr Turner said.

“This is the equivalent of an additional two years’ worth of net supply at current rates, on top of the issuance that was already forecast to occur.”

However, the flood of new issuance may test the market’s appetite for Australian Government debt.

Readers might recall that in late-2011, the Reserve Bank of Australia (RBA) announced the creation of the Committed Liquidity Facility (CLF), 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 ballooning-out to $426 billion by June 2016, and likely to keep on growing, the question for the RBA is: shouldn’t the CLF be unwound and the banks instead required to hold government bonds, as initially required under Basel III? Surely the RBA/APRA should amend the liquidity rules so that Australia’s ADIs must buy government bonds, so that the size of the CLF requirement decreases?

As noted by Deep T way back in 2013:

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… This simple comparison demonstrates that the cost to the banks of 15bps is a direct subsidy to all ADIs.

…my advice to the RBA and APRA on the CLF is simple.

    • Significantly increase the cost from 15bps pa to better reflect the  cost of the alternative of owning government bonds, and

    • Due the increase in government bond issuance and the likely sustainability of that issuance, ADIs should be required to hold a significant portion (maybe 50%) of those bonds as part of Basel III liquidity provisions in order to decrease the size of the CLF whilst the bonds are on issue.

Don’t expect any action, though, as it suits the RBA/APRA to keep subsidising the banking sector.

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Leith van Onselen
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  1. Hahahaha great call!!!! There is NOOOOOOO WAYYY the CLF will be cut, amended, fudged with or touched in any manner. The Big 4 (and the second tier) LOVE the CLF. Why?

    Because it encourages them, no actually it mandates them, to hold bank bonds on their balance sheet, knowing full well they can turn these bonds into cash with the RBA. Not only does it incentivise them to hold the bonds issued by other banks, it also encourages them to hold bonds issued by their own RMBS vehicles. Imagine that – write some home loans, package them into your securitisation vehicle, then buy them off your securitisation vehicle and take the yield but not the balance sheet risk. And have the guarantee from the central bank to buy them from you if they go south!

    You have no idea how much the spread earned on these bond portfolio’s earn the banks. Most of the ‘bond trading’ going on at Aussie banks is really just managing liquidity requirements for APS210.

    All the while baking in systemic risk, giving the banks virtual guarantees they will be bailed out.

  2. Don’t expect any action, though, as it suits the RBA/APRA to keep subsidising the banking sector housing bubble.

    Fixed that for ya

      • You’re welcome. Yes they are, hence my cheeky comment. 😀

        Considering our banks exposure to commercial property before last recession pales in comparison to our current residential bubble, it could get very interesting very quickly if arrears start stacking up.

  3. The interest on debt is forecast to become the fourth largest Budget expense within a couple of years.

    We’ve gone from zero to Nero.

      • You know better than that Mav!

        End of the Howard years saw Government cede to the frightful RuddGillard years net assets, virtually no debt. Didn’t take Kev and Jules to long to turn that around, did it. Typical Labor legacy – blow the dough and let someone else fix the mess.

      • FiftiesFibroShack

        So what’s your counterfactual 3d, if Rudd didn’t get elected the nation would currently have a surplus?

      • If Rudd and Henry weren’t a couple of total morons our foreign debt would be less; our sales of assets to foreigners would be less; and the budget deficit would be less.
        This is not to praise the other damned lot at all. They wouldn’t even call it as it should have been called. Tried to have a bob each way with the well we’d have just done it better BS.

        Nobody faced or faces the real truth of our situation.

      • Bugger, I’ve lost the plot & no idea where I’m replying…? But thank God Flawse is back. Most sensible comments every time. Flawse, hope its going good for you, though I suspect its a little rough at the moment?
        Don’t worry you’re up in Qld, down here in SA its totally shickered! But Jay & the boys/gals are still dancin’!

      • Hey Malcolm, what’s so bad about corporate welfare? The entire country & its citizens live off welfare, so who cares?

    • Absolutely… and the most galling thing is how many times we here ‘how well our banking system is regulated.. ‘….. utter garbage

      • Jim,

        You use the term garbage. I use the term trash. What we have here is a Trash For Cash scheme for the banks where they get to bring in a bunch of trash they have packaged up, dump it on the desk of the RBA and get cash in return to go and generate even more trash mortgages. Instead of prudential lending it actively encourages the banks to create more trash.

        Mortgage holders need to ask themselves, who gets bailed, them or the banks when it all goes pear shaped. The answer, the banks. But who makes all the profit, the banks. Who takes all the risk, the person taking the mortgage and Australian government/society at large.

        I propose that instead of calling it the CLF, we should call it the TFC (Trash For Cash).

  4. So the treasury should issue to the banks, whom they guarantee, such that in the event of a run on those guaranteed firms they can sell the bonds issued by their guarantor. Hmm, pretty sure the markets might sniff a rat in there somewhere.

    • its a monster rat… APS210 says:

      – the banks must buy the governments’ and semi governments’ bonds as Level 1 assets. Forces the yield down on the govt borrowing costs.
      – the government (which is funded by the state governments via collections and direct subsidies) must guarantee the banks.
      – together they result in a AAA rating for the government and a AA rating for the banks.

      talk about one big, fat lump of festering systemic risk!

      All mandated by the governments’ regulator and facilitated by its central bank.

      Good on ya boys, thats how to ‘price risk’!