Finance and Accounting Capital Market - Reserve Bank of Australia - Case Study Example

Finance and Accounting Capital Mrket Contents Contents 2 Introduction 3 Monetary Policy 3 Liquidity Management 4 Role of RBA in Liquidity Management 4 Domestic Market Operations 5 International Market operations 7 Trading to use for monetary policy and liquidity management 8 Repo 9 Foreign Exchange Swaps 10 Reflection 12 References 13 Bibliography 14 Introduction The Reserve Bank of Australia is the central bank of Australia and it is responsible to function according to the Reserve Bank Act 1959. RBA has the duty to contribute to generate economic prosperity, stabilize the currency, empowers employment and welfare of the citizen of Australia. It sets a cash rate which is used to meet the agreed inflation target in medium-term, to maintain stable financial system, to issue the banknotes of the nation and to enable an effective payment system. It also provides certain banking services which required by the Australian govt. and other governmental agencies. RBA also provides specific banking services to various official institutions and overseas central banks. Apart from this, it also manages the gold and foreign exchange reserves of Australia. The Reserve Bank of Australia has two boards- The Reserve Bank Board which is responsible for controlling the financial stability and monetary policy and another is The Payment System Board which is responsible for the matters related to the payment systems according to the set out structure by Reserve Bank Act 199. RBA has the responsibility to set the rate of interest which is known as ‘cash rate’ and used in overnight unsecured loans (Reserve Bank of Australia, 2014). Monetary Policy Monetary policy can be defined as the actions of a central bank of nation to determine the size and growth rate of money supply in a country which also affects the rate of interest. Monetary policy can be maintained by increasing/decreasing the interest rate or changing the bank reserves. RBA is responsible for creating and implementing the monetary policy in Australia. It sets the rate of interest for money market instruments. Bank rates get changed according to the rate of interest of overnight unsecured loans and thus the behavior of lenders and borrowers are also affected in the financial market by the monetary policy. The main objective of monetary policy is to control the rate of inflation. The Governor and the Treasurer of RBA has decided to achieve 2-3% inflation rate over a financial period. Liquidity Management Liquidity means the ability of an organization to meet the urgent demands for funds. Liquidity management means making sure that the organization maintains liquid assets and sufficient to satisfy the demands of clients’ for savings withdrawal and loans and to pay the expenses of the organization. Liquidity management includes daily analysis and estimation about the timings and size of the cash inflows and cash outflows over the future period to minimize the risk of the savers on their deposits. In order to form a well managed liquidity management plan, organization must have a management information system (MIS) which is sufficient to generate the important information to make liquidity predictions and realistic growth rate. Apart from this, a savings organization should have a well structured liquidity policy which was written and developed by the experts with the active participation of the management. It should be revised and reviewed as and when it is necessary in a financial year. The monetary policy should flexible enough that it helps the managers to react quickly to a sudden situation (Biety, No Date). Role of RBA in Liquidity Management RBA plays the most important role to control the liquidity management in Australian economy. RBA does various trading everyday to maintain the targeted cash rate. RBA performs trading to control the liquidity management. RBA operates in both domestic and international market. Domestic Market Operations The Reserve Bank of Australia undertakes various transactions in domestic financial markets to guarantee that the operational focus on the monetary policy and the cash rate stays near to the target rate set by the Board of Reserve Bank. The cash rate is the rate of interest on unsecured overnight loans between institutions which are accepting deposits, for example, banks, credit unions and building societies. Transactions are additionally embraced to give liquidity to the installments framework and deal with the financial danger of the Banks balance sheet. The cash rate is decided by the demand and supply of exchange settlement (ES) funding. These are the funds which are held in accounting records at the RBA by various financial organizations, and are utilized by these record holders to meet settlement commitments. The board of Reserve Bank determines the targeted cash rate during t5he monetary policy meetings. The decision about the monetary policy taken by the Board is announced in media and also distributed through news services and also published on the website of RBA at 2:30pm on the day of meeting. The domestic operations of Bank are designed in such a way which helps to meet the target cash rate. From the above graph we can see the changes in cash rate during the years. The Reserve Bank of Australia can control the supply of ES funding through the open market operations. At the point when the Bank purchases securities, it pays for them by crediting the accounts of ES of its counter party (or the ES accounting record of the financial organization of which its counter party is a client), adding to the general supply of ES stores. Offers of securities have the inverse impact. The securities which the Bank is ready to buy in its domestic business operations are restricted to highly rated Australian dollar dominated securities. The Reserve Bank of Australia likewise operates various liquidity facilities that are mainly used to give funding to the financial organizations to deal with their and their customers payments activities. Funds got to from these offers are either reimbursed to the RBA on the same day, or are held overnight in the ES account of the recipients with the Bank. In the month of November 2013, the RBA has introduced a new liquidity facility which allows the ES account holders to access a specific amount of fund at the predetermined cash rate. These funds can be obtained through the open market repos with the RBA which means that Repos are contracted without a date of maturity. To the degree that record holders hold matching trusts against their open repo position, those ES balances gain the cash rate, in spite of the fact that a allowance is made for varieties in ES balances emerging from specific installments that settle in the evening. Basis point of 25 indicates as penalty which is applied on any setback in the ES record, imitating the plans for intraday repos (Reserve Bank of Australia, 2013). International Market operations The Reserve Bank of Australia undertakes various ranges of transactions in the international foreign exchange market and foreign obligation and currency markets. This action is overseen on a worldwide premise through the Reserve Banks work places in New York, London and Sydney. The RBA operates in the foreign exchange market all the time to help its customers and to support with domestic liquidity administration. Now and again, the Reserve Bank might additionally enter into the foreign exchange market to address confused economic situations or the misalignments of the worth of the Australian dollar. These operations are normally called as foreign exchange intervention. A significant part of the Reserve Banks operations in foreign holding markets reflect the release of its obligation regarding the administration of international reserves of Australia. The foreign currency assets that are held on the Reserve Bank’s balance sheet to encourage the policy operations are put practically altogether in superior quality sovereign debt, liabilities and gold of the International Monetary Fund. The process of risk management for the assets invested in money market and in debt is guided by an interior benchmark and includes every day movement in the underlying financial markets. The above table states that the authorization under which reserves are controlled needs investment in assets which have highest credit quality and the portfolio should have enough liquidity to meet the policy objectives. The major risks in the balance sheet can be minimized by maintaining a diversified currency portfolio. The process of investment is guided by an internal benchmark which show the best ability to combine the foreign currency assets and foreign currency which will maximize the return in the long run. Investments under the benchmark currencies are limited to cash investments, quasi-sovereign, super national debt instruments and sovereign instruments which are secured by quality debt under repos. The credit exposures are limited to Germany, France, Japan, China, Canada, Netherlands and USA. Apart from this, RBA also has invested in Asian debt markets through the EMEAP Asian Bond Fund (Reserve Bank of Australia, 2013). Trading to use for monetary policy and liquidity management The Reserve Bank of Australia determines the type of transaction which will be used to maintain the monetary policy and the liquidity management. The Bank uses open market repos, foreign exchange swaps Repo Repurchase agreement is the sale of securities with an agreement that the seller will buy back the securities later. The price during repurchase will be greater than the origin price of selling. The difference is the price rate is the interest which is known as repo rate. RBA provides facilities like Overnight, Intraday and open Repo. Intraday repos generally carry no rate of interest but depending on the settlement procedure, the price of repurchase may include some fees for settlement. Sometimes counterparties can also able to enter into a contract with RBA repos which have no date of maturity and these repos are open repos. Overnight repos are undertaken by the bank when it has to meet some urgent payments by the day and the bank is not able to manage funds from anywhere else. During the financial year 2012-2012 the overnight repo was undertaken only twice. Most of the transactions of the RBA in the domestic market are operated as repos. Under the contract of reverse repo, RBA wants to purchase both private debt securities and govt. debt securities. To protect against the decline in the value of the securities and the default of the counterparty, the bank needs the value of the security in order to exceed the cash lent by some margin. From the above table we can see the amount held under the repurchase agreement by RBA. In the past year, as the balance sheet of RBA was fluctuating with movements in govt. bonds thus the value of the securities held under the reverse repo has varied between the range of $17 billion to $37 billion. An amount of $100 billion of stocks under repos has been outstanding in the domestic market as the bank has si8gnifiacnt amount of share in the market. Most of the active users of repos generally are the securities firms who are seeking to finance the inventories of (CGS) Commonwealth Govt. Securities, semi govt. securities and fixed income trading desk of other banks (Reserve Bank of Australia, 2013, pp. 22-24). Foreign Exchange Swaps It is an agreement which is used to exchange currencies between two foreign participants. The contract includes swap principal and certain rate of interest which is made on a loan in one currency for the principal amount and payments of interest of equal value in another currency. The Reserve Bank of Australia is one of the most active participants in the foreign exchange market. The largest client of the bank is the govt. of Australia and in the year 2012-2013, the bank has sold $6.1 billion foreign currency to the govt. These deals were financed, as they regularly may be, by the Bank obtaining foreign currency in the spot market. Now and again of amazing stretch in the foreign exchange advertise, the Bank can choose to reserve these streams briefly from foreign currency reserves. These reserves are renewed at a later time when economic situations have standardized. The last time this happened was in late 2008. Foreign exchange swaps are embraced for a few reasons, however the larger part (by quality) reflects transactions attempted to aid with household liquidity management. They could be utilized within the same path as repos in securities to oversee framework liquidity. The Reserve Banks foreign exchange swap transactions have a critical part in dealing with the liquidity effect of expansive streams, for example, security developments, in light of the fact that the swap business sector is bigger and more fluid than the local repo market. In 2012/13, turnover in swaps attempted for liquidity management purposes totaled $58.7 billion. The RBA also takes part in the foreign exchange business sector to deal with its foreign currency reserves. The Reserve Bank utilizes foreign exchange swaps as a component of the policy operations. Risk related Credit facilities on these instruments is figured out how to a low level by executing foreign exchange transactions under universally perceived legitimate understandings just with counterparties that meet strict qualification criteria and have been sanction by a gathering of senior Bank authorities. These counterparties are highly rated and they also consider the factors other than the credit ratings. The Bank has tried to diminish risk which is associated with foreign exchange swaps further through margining under two-way credit help appends. This includes the Bank getting and sending security to blanket exposures on foreign exchange swaps produced by developments in exchange rates far from the contracted rate (Reserve Bank of Australia, 2013, pp. 26-66). In the year 2013 at 30th June, RBA has gone under a contract to buy $1.5 billion of foreign currency and has sold $5.7 billion of foreign currency. There was an unrealized net loss of $275 million on these foreign exchange swaps were included in the net profit. Net cash collateral on 30th June was nil. Reflection From the above study I have understood that, Reserve Bank of Australia controls the monetary policy and manages the level of liquidity in the economy. It operates both in the domestic and the international market to maintain the targeted cash rate. It used many trading options like Repos and foreign exchange swaps. Repos are generally used in the domestic market and it also enters into agreement with other foreign countries to the foreign currency swaps. RBA has also taken some measures to minimize the credit risk associated with the foreign exchange swaps by margining two way credit support annexes. The net profit of the bank has also increased in 2013 from 2012 to $4313 million. Thus it plays an important role in managing liquidity and forming the monetary policy. References Reserve Bank of Australia., 2014. About the RBA. [Online]. Available at: http://www.rba.gov.au/about-rba/index.html. [Accessed on May 22, 2014]. Reserve Bank of Australia., 2013. Domestic Market Operations. [Online]. Available at: http://www.rba.gov.au/mkt-operations/dom-mkt-oper.html. [Accessed on May 22, 2014]. Reserve Bank of Australia., 2013. International Market Operations. [Online]. Available at: http://www.rba.gov.au/mkt-operations/intl-mkt-oper.html. [Accessed on May 22, 2014]. Reserve Bank of Australia., 2013. R E S E RV E B A N K OF AUSTRALIA ANNUAL REPORT. [Pdf].Available at: http://www.rba.gov.au/publications/annual-reports/rba/2013/pdf/2013-report.pdf. [Accessed on May 22, 2014]. Biety, M., No Date. An Introduction to Liquidityand Asset-liability Management. [Pdf]. Available at: https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&ved=0CEQQFjAA&url=http%3A%2F%2Fwww.woccu.org%2Fdocuments%2FTool4&ei=qed9U47NCoqXuAT-44HoBQ&usg=AFQjCNEpmEyEouMEnhcFFjA4S3rw0veUnw&bvm=bv.67229260,d.c2E. [Accessed on May 22, 2014]. Bibliography Australian Financial Markets Association., 2013. repurchase Agreement (repo) trade Matching Best Practice Guidelines. [Pdf]. Available at: http://www.afma.com.au/afmawr/_assets/main/lib90032/repo%20agreement%20(repo)%20trade%20matching%20best%20practice%20guidelines.pdf. [Accessed on May 22, 2014]. Allen, F., et al., 2013. Financial Markets, Institutions and Liquidity. [Pdf]. Available at: http://www.rba.gov.au/publications/confs/2013/pdf/allen-carletti.pdf. [Accessed on May 22, 2014]. Read More