Without fuss, the Reserve Bank of Australia has reduced the amount of money on deposit with offshore commercial banks in the past year, ending years of using them to hold part of Australia’s $37 billion official foreign reserves.

Traditionally, under a long held benchmark, the bank held up to 10% of the country’s foreign exchange reserves in unsecured deposits with commercial banks rated AA-minus or better. Now the bank has eliminated that part of the benchmark it uses to manage the foreign exchange reserves, according to the latest annual report from the central bank, which was released a week ago.

As a result, the use of commercial banks declined to “a minimum” in the 2010-11 financial year, the bank says.

Australia had $37.7 billion of foreign exchange reserves in the year to June, down from $43.09 billion in the year to June 2010. The bank said the move followed a review completed in 2010 of lessons learned from the GFC in 2008.

The RBA’s move is a rare public acknowledgement from one of the world’s leading central banks that using commercial banks has become riskier since the GFC: that is riskier to a highly risk averse central bank. The RBA is saying the risks now outweigh the rewards from using commercial bank deposits.

So it has reduced its use of commercial banks in regions such as Japan, the US and Europe to hold deposits. The move wasn’t linked to the problems in Europe, although those current pressures will have confirmed the rightness of the RBA’s move.

So the bank has quietly run down some $4 billion in cash and switched into secured investments via so-called secured repurchase agreements with other groups that are considered to be a less risky form of investment. And those investments are held with banks with large, high quality capital bases.

The move is buried deep in the bank’s 2010-11 annual report, which also reveals that the bank has also cut the amount and duration of reserves that can be held in Japanese yen and decided to invest in Canadian dollars. The Canadian dollar joins the yen, the US dollar and the euro in the quartet of currencies used for our foreign exchange reserves.

The moves follow a study the RBA made of the lessons learnt from the 2008 financial crisis.

“The benchmark allocation to commercial bank deposits was removed and the Reserve Bank’s use of such deposits was reduced to a minimum,” the bank said in the section of the annual report on Reserves Management. “This decision reflected a reassessment of unsecured credit exposures in the portfolio.

“This review took into account the contribution of such exposures to portfolio return, the availability of alternative secured-cash investments and the potential difficulties for central banks posed by exposures to commercial banks at times of market stress.”

In other words the RBA weighed up the trade off between returns from holding unsecured cash with commercial banks against the combination of other secured cash investments and whether the RBA could get this cash when volatility surges. (And the possible blow to confidence if it became known that a key central bank was withdrawing cash from a bank under pressure).

It is not a judgment on the creditworthiness of commercial banks, it’s the RBA deciding that the lower returns from other forms of investment and greater certainty in getting that cash in times of market stress were worth more than the higher returns from using commercial banks deposits. But it is an acknowledgement by the bank that using these deposits has become riskier since the GFC.

In the annual report, the RBA explained the way it manages the reserves and how it changed the the structure of the benchmark by which the RBA manages the foreign part of Australia’s official reserve assets.

Peter Fray

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