Picking up the RBA risk tab

The RBA and APRA have just announced that due to Australia's low levels of government debt, taxpayers will lend directly to Australian banks to allow them to satisfy the new liquidity rules under BASEL III that are, a little ironically, meant to reduce the risk of banks going to taxpayers to bail them out.

To quote the RBA, "Under this approach, [banks] will be able to establish a committed secured liquidity facility with the RBA, sufficient in size to cover any shortfall between the [bank's] holdings of high-quality liquid assets and the Liquidity Coverage Ratio requirement."

In almost all other countries around the world, banks will have to manage their liquid assets independently of taxpayers by investing in super-safe securities (ie, government debt). In other countries, the idea is that if there is a run on a bank, or the bank's creditors refuse to lend to it due to perceptions of risk, it will be able to 'self-fund' itself without drawing on the public purse (ie, taxpayer bailouts).

In Australia, things will be different. In Australia, banks will be able to go directly to the taxpayer-owned bank, the RBA, and borrow from it if they get into liquidity trouble. To be clear, this is a new RBA lending facility that has not existed before (the RBA significantly extended the range of lending facilities it supplies to banks during the GFC). That is, it is a new form of taxpayer support for the banking system.

This also means that as explicit creditors, Australian taxpayers will have greater direct risks to their banking system than their peers overseas.

What is curious is why policymakers did not opt for a much simpler and safer solution, such as using AAA-rated residential mortgage-backed securities (ie, assets that are rated safer than many government credits) to satisfy the liquid assets definition.

This would have had the additional benefit of injecting significant liquidity into the RMBS market, reducing spreads, and thereby dramatically improving the ability of smaller lenders to raise cost-effective funding. Instead, we have been left with a much more nebulous and less transparent solution whereby the regulators will get directly into the lending business, and have to adjudicate whether it is safe or hazardous to finance individual institutions.

Christopher Joye is managing director of research group Rismark International which produces the RP Data-Rismark Hedonic House Price Indices. Rismark also operates a series of funds that invest in residential mortgages. His blog can be found here.