Domestic Market Operations and Liquidity Facilities

Introduction

The Reserve Bank of Australia is responsible for the formulation and implementation of monetary policy. The Monetary Policy Board’s (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 conducts open market operations to keep the operational target for monetary policy – the cash rate – consistent with the target rate set by the Monetary Policy Board. The cash rate is 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.

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.

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 Balances

Reserves held by banks at the RBA – otherwise known as Exchange Settlement (ES) balances – play a central role in monetary policy implementation. Banks use reserves to meet their payment obligations with each other and with the Reserve Bank, and may also hold reserves for precautionary or regulatory purposes. Banks can lend surplus reserves to other banks in money markets including the overnight cash market, where the cash rate is determined. The Reserve Bank remunerates reserves that banks leave in their ES account at an interest rate known as the ES rate.

The Reserve Bank supplies as many reserves as banks demand via full allotment repurchase agreement (repo) auctions at its open market operations (OMO). To obtain these reserves, banks ordinarily pay a floating rate that is a fixed spread above the prevailing cash rate target (OMO rate). In this way, the OMO rate will change in response to changes in the cash rate target. The OMO rate helps to control the cash rate at a price near the cash rate target, as banks will have an incentive to obtain reserves from OMO if the cash rate is above the OMO rate. Similarly, the ES rate provides a floor for the cash rate, because banks can leave reserves in their ES account rather than lend in the cash market below the ES rate. In this way, these operations help the Reserve Bank achieve its cash rate target and ensure other short-term interest rates are consistent with the target.

The Reserve Bank operates a demand-driven ‘ample reserves’ system to implement monetary policy. Under this system, the supply of reserves rises and falls in response to changes in demand, so that the supply of reserves consistently meets banks’ underlying demand.

At present, the supply of reserves is greater than banks’ demand, because the Reserve Bank’s bond purchases during COVID significantly increased the supply of reserves. As a result, demand to borrow reserves via OMO remains low. Over time, as the Reserve Bank’s bond holdings decrease, the supply of reserves will also decline until the supply of reserves approaches banks’ demand for reserves. At this time, banks will offset any further reductions in the supply of reserves by borrowing more from OMO.

Liquidity and Policy Target Rate

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 Monetary Policy 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 morning (or the next good business day), the Reserve Bank announces its dealing intentions for its OMO. Counterparties are able to offer to sell highly rated debt securities to the Reserve Bank under repurchase agreement (repo). Under a repo, the seller agrees to repurchase an equivalent 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 (the price differential) akin to the interest earned on a secured loan.

Very occasionally, the Reserve Bank might announce additional OMOs. For further information on additional OMOs, see Technical Notes: Open Market Operations (Section 1.1.2).

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 price differential and provide a means by which financial institutions can meet payments in advance of funds being received.
• Overnight repos have a price differential which accrues at a pricing rate set 25 basis points above the cash rate target.
• 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 pricing rate set equal to the rate on surplus ES balances. For further information, see SF Repos.

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]