Domestic Market Operations and Liquidity Facilities

Introduction

The Reserve Bank of Australia is responsible for the formulation and implementation of monetary policy. The Board's monetary policy decisions are announced in a media release which is distributed through market data services and published on the Reserve Bank's website at 2.30 pm (AEST/AEDT) on the day of each Board meeting. The Reserve Bank undertakes transactions in domestic financial markets to implement the policy decisions of the Reserve Bank Board and facilitate the smooth functioning of the payments system.

As part of its responsibility for monetary policy, the Reserve Bank Board sets a target for the ‘cash rate’ – the interest rate on unsecured overnight loans between banks. Any change to the cash rate target takes effect from the day after the Board's monetary policy decision is announced.

Prior to March 2020, the cash rate target was the Reserve Bank Board's sole operational target for monetary policy. The Reserve Bank's domestic open market operations were designed to ensure that the actual cash rate remained consistent with the target rate and that the financial system had appropriate liquidity.

During 2020, the Reserve Bank introduced a comprehensive package of additional policy measures to address COVID-19-related pressures on the Australian economy. These measures resulted in some important changes to domestic market operations including:

• A significant increase in liquidity in the banking system has moved the cash rate to the low end of the corridor.
• Purchases of government bonds in the secondary market, for a time, to:
  • achieve a target for the yield on an Australian Government bond further out the yield curve than the cash rate (initially the AGS closest to three years to maturity);
  • lower government bond yields further out along the yield curve than the target bond and so lower the whole structure of interest rates; and
  • address market dislocations.
• A term funding facility for the banking system, through which for a specified period authorised deposit taking institutions (ADIs) could access new low-cost three-year funding. See Term Funding Facility.

The term funding facility closed to new drawdowns on 30 June 2021. The yield target was discontinued on 2 November 2021. On 1 February 2022 it was announced that purchases under the bond purchase program would cease after 10 February 2022. On 3 May 2022 the Reserve Bank announced that it would not reinvest the proceeds of its government bond holdings as they mature.

In addition to open market operations, the Reserve Bank operates standing facilities where Eligible Counterparties can approach the Reserve Bank for collateralised liquidity provision, subject to various conditions. These are principally used to provide financial institutions with funding to manage their (and their customers') payments activity. They may also be used by the Reserve Bank to provide funding to certain banks under a Committed Liquidity Facility. For further information, see Committed Liquidity Facility.

In rare circumstances, the Reserve Bank may provide exceptional liquidity assistance (ELA) to Eligible Counterparties for a short period of time. Provision of ELA and associated terms are at the absolute discretion of the Reserve Bank.

The Cash Rate and Exchange Settlement Funds

On a day-to-day basis, the cash rate is determined by the supply and demand for exchange settlement (ES) funds (also known as the cash market). These funds are held in accounts at the Reserve Bank by banks (as well as a small number of other financial institutions) and are used by account holders to meet their payment obligations with each other and with the Reserve Bank.

Under arrangements introduced in November 2013, some ADIs maintain a quantity of ES funds in their account as a buffer against intraday payments and payments they may need to settle after the time that the interbank cash market has officially closed. The size of these buffers is agreed in advance with the Reserve Bank. To facilitate these liquidity buffers, ESA holders have the option to directly source ESA balances through transactions (open-ended repurchase agreements or ‘open repos’) between ESA holders and the Reserve Bank.

In the several years up until early 2020, the supply of ‘surplus’ ES funds beyond these agreed buffer amounts had typically been between $2 billion and $3 billion (Graph 1). However, the policy measures announced by the Reserve Bank since March 2020 have led to considerable change in the cash market. The Reserve Bank's transactions with financial institutions alter the supply of ES funds and so the Reserve Bank's bond purchases and the term funding facility program have significantly increased balances held in ES accounts. As expected, this has caused the cash rate to drift below the cash rate target, but remain above the rate paid on ES balances – the lower bound of the policy interest rate corridor.

Other transactions between the Reserve Bank and financial institutions also alter the supply of ES balances. For example, when ADIs purchase banknotes from the Reserve Bank, settlement is in ES balances. Similarly, transactions between the Reserve Bank's customers and financial institutions (and their customers) change the supply of ES balances. As the Australian Government is a customer of the Reserve Bank, these gross flows can be very large. Expenditure and payments by the Government adds ES balances to the account of the recipient (or their financial institution), while receipts have the opposite effect.

The Reserve Bank is the Administrator of the cash rate. It is calculated as the weighted average of the interest rate at which overnight unsecured funds are transacted in the domestic interbank market and has a robust waterfall of fallbacks to enable it to continue to be published, including in the absence of market transactions. In addition to being the Reserve Bank Board's operational target for monetary policy, the cash rate is also an important financial benchmark in the Australian financial markets. The cash rate is the (near) risk-free benchmark rate (RFR) for the Australian dollar. It is used as the reference rate for Australian dollar overnight indexed swaps (OIS) and the ASX's 30-day interbank cash rate futures contract. The Cash Rate is also known by the acronym AONIA in financial markets. For further information, see Cash Rate Methodology – Overview.

Open Market Operations

The Reserve Bank conducts regular open market liquidity operations, providing liquidity to eligible financial institutions. Each Wednesday (or the next good business day) morning, the Reserve Bank announces its dealing intentions for its open market liquidity operations. The Reserve Bank may, if required and at its absolute discretion, announce additional operations on other business days. Following the Reserve Bank’s announcement, financial institutions are invited to propose transactions. Counterparties are able to offer to sell highly rated debt securities to the Reserve Bank either under repurchase agreement (repo) or outright sale. Under a repo, the seller agrees to repurchase the security at a future time and at a pre-agreed price. The transaction is similar to a secured loan, with the difference between the purchase and repurchase prices akin to the interest earned on a secured loan.

Late each afternoon, the Reserve Bank may announce an additional round of open market liquidity operations, if required. Notably, the Reserve Bank assesses the need for these additional rounds on a system-wide basis rather than on the position of individual institutions. The large increase in the size of ES balances since March 2020 has resulted in fewer operations being undertaken in the afternoon. Very occasionally, the Reserve Bank might announce further additional rounds of open market liquidity operations later in the evening. These are conducted prior to the close of the SWIFT End Session. For further information on additional rounds, see Technical Notes: Open Market Operations (Section 1.1.2).

Liquidity management through market operations can also involve management of the effect of large maturities of Australian Government Securities (AGS) on system liquidity. The Reserve Bank may act to manage the volume of funds that are paid out of the Australian Government's account at the Reserve Bank into ES accounts (for the credit of the security holder) on the maturity date. In addition to potentially using repos and foreign exchange swaps to withdraw liquidity on the maturity date, the Reserve Bank can make purchases of the relevant near-to-maturity AGS ahead of the maturity date. Given the large increase in ES balances since March 2020, these purchases, which are undertaken to manage near-term liquidity flows and have no implications for the Reserve Bank's monetary policy stance, have been undertaken less frequently.

The Reserve Bank's open market operations may also include government bond purchases, of Australian Government Securities (AGS) and semi-government securities (semis) with terms to maturity generally greater than 18 months. Prior to March 2020, the Reserve Bank typically undertook purchases of government securities on a quarterly basis to replenish the holdings of securities used for liquidity management purposes. Between March 2020 and February 2022, the Reserve Bank purchased government securities in support of the policy aims announced: the yield target on an Australian Government bond (discontinued on 2 November 2021); the bond purchase program (ceased on 10 February 2022); and to address market dislocations. For further information see Government Bond Purchases.

Data on all of the Reserve Bank's outright holdings of securities are published in Statistical Table A3.1 on the Reserve Bank website.

Standing Facilities

Separate to its open market operations, the Reserve Bank can also use repurchase agreements to provide liquidity to Eligible Counterparties in exchange for collateral via its standing facilities.

The standing facilities are commonly used to provide payments system participants with liquidity as required to support orderly settlement of payments. Intraday, overnight and open repos (repos without a maturity date) are used for this purpose, and are available on pre specified terms to Eligible Counterparties that settle payments across their own ES account (except where the member is restricted by special terms and conditions relating to its ES account):

• Intraday repos have no interest charge and provide a means by which financial institutions can meet payments in advance of funds being received.
• Overnight repos have an interest charge set 25 basis points above the cash rate target. These ‘overnight’ repos are rarely used as the higher rate of interest attached to them creates the incentive to source funds in the interbank market.
• Through open repos (that is, repos contracted without a maturity date) ESA holders can access a certain amount of funds from the Reserve Bank at a price set equal to the rate on surplus ES balances. To the extent that ESA holders retain matching funds against their open repo position, and meet any minimum ES balance requirement for after-hours payments, those ES balances earn the rate on surplus ES balances. An allowance is made for variations in ES balances arising from after-hours payments initiated through the direct entry (DE) system or New Payments Platform (NPP). Any remaining shortfall or surplus ES balances attract interest at the appropriate rate, either 25 basis points above the cash rate target in the case of a shortfall or, since November 2020, 10 basis points below the cash rate target in the case of surplus ES balances. These deposit and lending rates form the lower and upper bounds of the policy interest rate corridor. Banks have no incentive to borrow or lend ES balances outside this corridor.

The standing facilities are also the means by which the Reserve Bank provides liquidity to a bank that draws on the Reserve Bank's commitment to it under a Committed Liquidity Facility (CLF). Intraday, term and open repos could each be used for this purpose and they are available on pre-specified terms to banks to which the Reserve Bank has agreed to provide a CLF.

Exceptional Liquidity Assistance

In rare circumstances, when an Eligible Counterparty is experiencing acute liquidity difficulties, but is solvent, the Reserve Bank may provide ELA if it is considered to be in the public interest. This would generally be done through a term repo for a short period of time. The Reserve Bank will consider requests for ELA from Eligible Counterparties, including those that do not settle repos across their own Exchange Settlement Account. The provision of liquidity and associated terms, including acceptable collateral, is at the absolute discretion of the Reserve Bank (see Liquidity Facilities Technical Notes).

In support of a request for ELA from the Reserve Bank, entities would be expected to:

• inform their regulator immediately of any liquidity concerns and their intention to request ELA, prior to approaching the Reserve Bank;
• have already made reasonable efforts to access private sector sources of liquidity; and
• present evidence of their solvency, including an attestation of positive net worth.^[1]

Footnote

More background on the Bank's arrangements for ELA can be found in RBA Board Minutes (September 2021) [1]