The AFR posted an interesting article yesterday on the blow-out in Federal Government debt, which is projected to pass $500 billion late this year:
The AOFM dutifully maintains disclosures showing that as of December 19, 2016, bonds on issue totalled $462.3 billion…
The forecasts in MYEFO helpfully show that by June 30 of this year the projected value of Australian bonds on issue is $496 billion or 28.3 per cent of gross domestic product. The following year, 2017-18, that figure rises to $539 billion or 29.7 per cent of GDP…
The article goes on to explain how Treasurer Scott Morrison will have to raise the $500 billion debt limit ceiling.
The bigger issue in my view is why the Reserve Bank of Australia (RBA) won’t wind-back the Committed Liquidity Facility (CLF), which 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 ballooning-out beyond $500 billion, and with the deficit 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? Bonds on issue will soon triple from when the CLF was first announced, so surely the RBA/APRA 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 today:
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 an outrageous 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 last year:
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.
Bottom line: with the stock of outstanding Commonwealth debt now so large (and 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.
