The liquidity coverage ratio, part of the Basel III liquidity standard, comes into effect at the beginning of next year. Earlier today Reserve Bank assistant governor Guy Debelle discussed its implementation and impact during a speech at the Australasian Finance and Banking Conference.
The liquidity coverage ratio requires banks to hold sufficient ‘high quality liquid assets’ to withstand a 30-day period of stress. The amount of assets held is determined by the composition and maturity structure of each banks’ balance sheet. The higher their short-term liabilities, the more HQLA they need to hold.
An interesting feature of the Australian financial system is that we only have a small supply of HQLA. The only financial instruments that meet the Basel standard of liquidity and debt issued by the Commonwealth and state governments, as well as cash balances at the RBA.
Australia’s financial system is generally tailored around mortgage assets, which historically have a low risk weighting, but are hardly considered a liquid asset class. Our corporate bond market is also underdeveloped by international standards and generally, Australian businesses prefer equity or bank debt (Why Australia isn’t banking on corporate bonds, March 26).
Debelle notes that the banking system’s overall liquidity needs are greatly in excess of what could reasonably be held in Commonwealth and state government bonds.
For example, APRA estimated that for next year, the Australian banking system has liquidity needs worth $450 billion. By comparison, the total stock of Commonwealth and state government bonds on issue is worth around $600bn.
Realistically, the banks can’t hold three quarters of the government bond stock. Doing so would severely compromise the liquidity of those assets -- to the point where they’d no longer be considered HQLAs.
That’s where the RBA’s committed liquidity facility comes in. For a 15-basis point fee, “banks will be able to obtain a commitment from the Reserve Bank to provide liquidity against a broad range of assets under repurchase agreement”.
According to APRA, the “the total CLF requirements of the Australian banking system for 2015 amount to around $275bn”. This was determined by subtracting the amount of government bonds that banks could reasonably hold (around $175bn) from the total liquidity needs of the banking system ($450bn).
Debelle notes that the impact of the LCR on market pricing is relatively small. That’s good news, and indicates that the market should continue to operate effectively after its implementation.
One clear impact, however, has been observed in the funding mix for Australian banks. According to Debelle, “historically, Australian banks have tended to raise a significant share of their short-term funding in foreign markets”. Under the new liquidity regime, the cost of short-term foreign currency funding has increased and is now less attractive.
As a result, the funding mix has shifted considerably since the global financial crisis. Deposits as a share of total funding have increased, reflecting a mix of strong competition for deposits and the perceived safety of bank deposits for investors. More recently, deposits appear to have shifted to a new equilibrium of almost 60 per cent of total bank funding.
Generally speaking, deposits are considered a safer source of funding than short-term debt but “deposits which are deemed to be subject to high run-off rates and those which are callable within 30 days will be more expensive for banks”. It’s no surprise that banks are offering higher interest rates on deposit products that are considered more stable.
The introduction of the LCR and the RBA’s CLF will mark a fundamental change for the Australian banking system. Much of the adjustment has already been made -- particularly with regard to funding mix -- so its implementation on January 1 will go largely unnoticed.
But this shift -- combined with the potential reforms recommended by the Murray inquiry -- point at a broader shift towards a less risky financial system that hopefully will be better positioned to cope and survive during a financial crisis