Around 40 of Australia’s biggest financial deposit taking groups will get lender of last resort facilities from the Reserve Bank, just as banks did years ago, and just as they did in the December quarter of 2008 when the GFC was shutting down world and local markets.

The outline of new liquidity rules governing Australian banks were released this morning after the central bankers’ group in Basel, reached final agreement. In Australia it’s a huge hole to be filled, around $125 to $130 billion (or around 10% of GDP).

Australia clearly doesn’t have enough bonds on issue now to handle this and won’t from 2012-13 onwards when the Federal budget is due to move into surplus and the financing needs will start easing.

Because we don’t have a sophisticated corporate debt market, the new liquidity arrangements will probably hasten its development, there is a lot of money waiting to be made.

One way to get more private bonds is to push harder in restarting the home mortgage securitisation market. Now banks and a lot more big investors will have an incentive to turn their home loans into securitised bonds, (and buy them) which if AAA-rated, will qualify for the new rules.

The rules, as outlined in a statement from the Reserve Bank and Australian Prudential Regulation Authority (APRA) detail the key parts of the new rules which are designed to require banks to hold as much liquidity as prudentially possible.

In fact the new system echoes not only the Lender of Last Resort facility, but another old regulatory measure, the Liquids and Government Securities convention, which was used to manage liquidity levels in the banks and through them the economy.

The new system won’t go that far, the new liquidity reserve facility to be set up at the RBA will be a backstop, and the way that reserve is structured will echo the LGS convention and won’t be a day to day regulatory tool.

In short the 40 or so authorised deposit taking institutions will have told as many government bonds as they can for capital liquidity management purposes and because there are not  (and won’t be enough) Government bonds to cover the $120 billion needed to meet the new liquidity convention, a new facility will be set up at the Reserve Bank and will in effect be a lender of last resort facility.

It will be targeted at the shortfall between each bank’s holdings of bonds and what they need to hold to meet the new liquidity requirements. If bank X has $10 billion of existing bonds and needs $17.5 billion under the new liquidity rules, its facility at the RBA will cover that $7.5 billion difference, which will rise and fall with the bank’s liabilities.

It is designed to be the ultimate backstop, not something banks can rush off and access when times get a bit tight or one suffers a profit problem.

This new facility will formalise what happened in the last quarter of 2008 when the RBA did repurchase agreements with the banks covering $45 billion of AAA-rated home mortgages and took other measures (such as printing an extra $10 billion inc ash to cover a silent run on banks).

In some ways we paying another, unforeseen cost of our obsession with eliminating debt at the Federal government level and the sloth and downright incompetence of those in our financial markets.

Low debt though is important for credit rating although successive governments have ignored the strong demand that would come for longer dated bonds from insurance companies and superannuation funds which need 20 and 30 year securities to match their liabilities.

Brokers and investment banks have been obsessed with making easy money from cherry picking the huge superannuation magic pudding, rather than doing some hard work to develop a deep and growing bonds market.

Because we lack enough bonds, the RBA and APRA have been forced to go back to the past to build a new future, which is a bit ironic if you consider all the stuff sprouted about the supremacy of deregulation for years.

The statement this morning explains why this new/old system is needed.

“Fiscal prudence by a succession of governments means that the supply of government securities in Australia is relatively limited.

“A second level of eligible liquid assets that includes certain non-bank corporate debt is also in short supply in Australia. A small number of other jurisdictions are in a similar position.

“To address this situation, the Basel Committee’s framework incorporates scope for alternative treatments for the holding of liquid assets. One alternative treatment is to allow banking institutions to establish contractual committed liquidity facilities provided by their central bank, subject to an appropriate fee, with such facilities counting towards the LCR requirement.

“The Reserve Bank of Australia (RBA) and the Australian Prudential Regulation Authority (APRA) have agreed on an approach that will meet the global liquidity standard. Under this approach, an authorised deposit-taking institution (ADI) will be able to establish a committed secured liquidity facility with the RBA, sufficient in size to cover any shortfall between the ADI’s holdings of high-quality liquid assets and the LCR requirement.

“Qualifying collateral for the facility will comprise all assets eligible for repurchase transactions with the RBA under normal market operations. In return for the committed facility, the RBA will charge a market-based commitment fee.

“The commitment fee is intended to leave participating ADIs with broadly the same set of incentives to prudently manage their liquidity as their counterparts in jurisdictions where there is an ample supply of high-quality liquid assets in their domestic currency. Detailed work on determining an appropriate fee based on this principle is currently underway. A single fee will apply to all institutions accessing the facility.”

In other words, the fee will be designed and set at such a level to force the banks in the scheme to manage themselves as prudently as possible by maintaining liquidity at high levels.

The greatest area of collateral for this available to the banks will be AAA-rated home mortgages, but unlike 2008 when the banks were able to repo their own mortgages to the RBA, this new facility will require them to use mortgages of other banks as collateral (eg, the NAB can use any securitised CBA mortgages it holds).

The final design of the facility and its cost will be negotiated over the next two years.

Peter Fray

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