Reserve Bank of Australia Annual Report – 2013 Financial Statements Note 15 – Financial Instruments and Risk
As the central bank of Australia, the RBA is responsible for implementing monetary policy and managing Australia's foreign reserve assets. Consequently, the RBA holds a range of financial assets, including Australian dollar securities, foreign government securities, repurchase agreements, deposits with the BIS and other central banks, interest rate futures contracts, foreign currency swaps, gold loans, cash and cash equivalents. The RBA also holds a shareholding in the BIS. As to financial liabilities, the RBA issues Australia's banknotes and offers deposit facilities to its customers, mainly the Australian Government, and eligible financial institutions. Accordingly, the main financial claims on the RBA are banknotes on issue and deposit liabilities. The RBA also provides banking services to its customers, and operates Australia's high-value payments and interbank settlement systems. These payments and settlements occur through accounts held on the RBA's balance sheet.
AASB 7 requires disclosure of information relating to financial instruments; their significance and performance; terms and conditions; fair values; risk exposures and risk management.
Financial Risk
The RBA is exposed to a range of financial risks reflecting its policy and operational responsibilities. These risks include market risk, credit risk and liquidity risk. The chapters in the Annual Report on ‘Operations in Financial Markets’ and ‘Risk Management’ provide additional information on the RBA's management of these financial risks.
Market risk
Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises foreign exchange risk, interest rate risk and other price risk.
Foreign exchange risk
Foreign exchange risk is the risk that the fair value or cash flows of foreign currency assets and liabilities will fluctuate because of movements in exchange rates. Foreign exchange risk arises from the RBA's foreign currency assets, which are held to support its operations in the foreign exchange market. The value of these assets, measured in Australian dollars, varies with movements in the value of the Australian dollar exchange rate against the currencies in which the assets are invested. An appreciation in the exchange rate results in valuation losses, while a depreciation leads to valuation gains. The overall level of foreign currency exposure is determined by policy considerations and the Bank does not seek to reduce foreign exchange risk. The RBA's net foreign currency exposure as at 30 June 2013 was $42.0 billion ($35.9 billion as at 30 June 2012). Within the overall exposure and to a limited extent, foreign currency risk can be mitigated by holding assets across a diversified portfolio of currencies. The RBA holds foreign reserves in four currencies – the US dollar, the euro, the Canadian dollar and the yen – because the markets for these currencies are typically liquid and suitable for investing foreign exchange reserves. The RBA has announced its intention to hold assets in renminbi but has not as yet purchased such assets.
The RBA also undertakes foreign currency swaps to assist its daily domestic liquidity management. These instruments carry no foreign exchange risk since the exchange rates at which both legs of the transaction are settled are agreed at the time the swap is undertaken.
Concentration of foreign exchange
During 2012/13 the Reserve Bank adjusted the proportions of its holdings in the currencies in which it invests, increasing the proportion of US dollars and reducing the proportion of euros. The RBA's net holdings of foreign exchange (excluding its holding of Special Drawing Rights) were distributed as follows as at 30 June:
| Per cent of foreign exchange | ||
|---|---|---|
| 2013 | 2012 | |
| US dollar | 55 | 45 |
| Euro | 35 | 45 |
| Canadian dollar | 5 | 5 |
| Japanese yen | 5 | 5 |
| Total foreign exchange | 100 | 100 |
Sensitivity to foreign exchange risk
The sensitivity of the RBA's profit and equity to a movement of +/−10 per cent in the value of the Australian dollar exchange rate as at 30 June is shown below. These figures are generally reflective of the RBA's exposure over the financial year.
| 2013 $M | 2012 $M | |
|---|---|---|
| Change in profit/equity due to a 10 per cent appreciation in the reserves-weighted value of the A$ |
−3,764 | −3,267 |
| Change in profit/equity due to a 10 per cent depreciation in the reserves-weighted value of the A$ |
4,601 | 3,993 |
Interest rate risk
Interest rate risk is the risk that the fair value or cash flows of financial instruments will fluctuate because of movements in market interest rates. The RBA's balance sheet is exposed to interest rate risk because most of its assets are financial assets, such as domestic and foreign securities, which have a fixed income stream. The price of such securities increases when market interest rates decline, while the price of a security will fall if market rates rise. Interest rate risk increases with the maturity of a security because the associated income stream is fixed for a longer period. Interest rate risk on foreign assets is controlled through limits on the duration, or interest rate sensitivity, of the portfolio. Interest rate risk on domestic assets is small as the bulk of the portfolio is held under short-term repurchase agreements. The RBA reduced the duration targets for some of its portfolios of foreign securities during 2012/13.
Sensitivity to interest rate risk
The figures below show the effect on the RBA's profit and equity of a movement of +/−1 percentage point in interest rates, given the level, composition and modified duration of the RBA's foreign currency and Australian dollar securities as at 30 June.
| 2013 $M | 2012 $M | |
|---|---|---|
| Change in profit/equity due to movements of +/−1 percentage point
across yield curves: |
||
| Foreign currency securities | −/+339 | −/+467 |
| Australian dollar securities | −/+140 | −/+171 |
A rise in interest rates would be associated with a valuation loss; a fall in interest rates would be associated with a valuation gain.
Other price risk
The RBA holds shares in the BIS. The RBA's membership of the BIS is mainly to maintain and develop strong relationships, which are to Australia's advantage, with other central banks. Shares in the BIS are owned exclusively by its member central banks and monetary authorities. For accounting purposes, the RBA treats the BIS shares as ‘available for sale’ and the fair value of these shares is estimated on the basis of the BIS' net asset value, less a discount of 30 per cent. Accordingly, these shares are revalued to reflect movements in the net asset value of the BIS and in the Australian dollar. The price risk faced on the BIS shares is incidental to the policy reasons for holding them and is immaterial compared with other market risks faced by the RBA. For this reason, this exposure is not included as part of the RBA's net foreign currency exposure outlined above.
Credit risk
Credit risk is the potential for financial loss arising from an issuer or counterparty defaulting on its obligations to: repay principal; make interest payments due on an asset; or settle a transaction. For the RBA, credit risk arises from exposure to: the issuers of securities that it holds; and counterparties which are yet to settle transactions. The RBA's credit exposure is low compared with that of most commercial financial institutions, as it manages such risks within a highly risk-averse framework. In particular, credit risk is managed by: holding securities issued by a limited number of highly rated governments, government-guaranteed agencies and supranational organisations; and holding high-quality collateral against buy repurchase agreements.
Cash invested under repurchase agreements in overseas markets is secured by collateral in the form of government securities or securities issued by US agencies; the RBA takes and maintains collateral to the value of 102 per cent of the cash invested. Cash invested under domestic buy repurchase agreements is secured by securities issued by Australian governments, banks and various corporate and asset-backed securities (see Note 1(b)). The RBA holds collateral to a value of between 101 and 123 per cent of the amount invested according to the risk profile of the collateral held. If the current value of collateral offered by a counterparty to a repurchase transaction falls by more than a predetermined amount, the counterparty is required to provide additional collateral to restore this margin; the thresholds are specified in the legal agreements which govern these transactions.
The RBA does not sell or re-pledge securities held as collateral under buy repurchase agreements.
The RBA's maximum exposure to credit risk in relation to each class of recognised financial assets, other than derivatives, is the carrying amount of those assets as indicated in the balance sheet.
The RBA's maximum credit risk exposure in relation to derivative financial instruments is:
- Foreign exchange swaps – As at 30 June 2013, the RBA was under contract to purchase $1.5 billion of foreign currency ($4.4 billion at 30 June 2012) and sell $5.7 billion of foreign currency ($9.5 billion at 30 June 2012). As of that date there was a net unrealised loss of $275 million on these swap positions included in net profit ($110 million unrealised gain at 30 June 2012). To manage credit risk associated with foreign exchange swaps, the Bank in 2012/13 began to give or receive collateral under credit support annexes (CSAs) to cover the potential cost of replacing in the market the Bank's exposure to a swap if a counterparty fails to deliver the second leg of such a transaction and the exchange rate has moved from the rate at which the swap was contracted. Net cash collateral received was nil at 30 June 2013.
- Interest rate futures – As at 30 June 2013, the amount of credit risk on interest rate futures contracts was approximately $0.6 million ($0.7 million at 30 June 2012). As at 30 June 2013, there was an unrealised loss brought to account on those contracts of $0.15 million ($0.03 million unrealised loss at 30 June 2012).
Concentration of credit risk
As noted, the RBA operates to minimise its credit risk exposure through comprehensive risk management policy guidelines. The table below indicates the concentration of credit risk in the RBA's investment portfolio.
The RBA held no past due or impaired assets at 30 June 2013 or 30 June 2012.
| Risk rating of security/issuer(a) |
Risk rating of counterparties(a) |
Per cent of investments | ||
|---|---|---|---|---|
| 2013 | 2012 | |||
| Australian dollar securities | ||||
| Holdings – Commonwealth Government Securities | AAA | na | 1.5 | 1.9 |
| Holdings – semi-government securities | AAA | na | 5.4 | 4.0 |
| AA | na | 1.2 | 4.0 | |
| Securities sold under repurchase agreements | AAA | A | – | 0.1 |
| Securities purchased under repurchase agreements | AAA | AA | 14.7 | 9.1 |
| AAA | A | 8.3 | 8.6 | |
| AAA | BBB | – | 0.1 | |
| AAA | Other(b) | 0.6 | 0.7 | |
| AA | AA | 6.6 | 7.1 | |
| AA | A | 3.1 | 2.6 | |
| AA | BBB | – | 0.1 | |
| AA | Other(b) | 0.2 | 0.2 | |
| A | AA | 0.8 | 0.5 | |
| A | A | 1.4 | 1.3 | |
| BBB | AA | 0.1 | – | |
| Foreign investments | ||||
| Holdings of securities | AAA | na | 16.3 | 17.2 |
| AA | na | 23.2 | 18.1 | |
| A | na | 0.5 | 0.5 | |
| Securities sold under repurchase agreements | AAA | A | 0.6 | – |
| AA | A | – | 1.8 | |
| AA | BBB | 1.7 | – | |
| Securities purchased under repurchase agreements | AAA | AA | 0.7 | 0.5 |
| AAA | A | 1.8 | 1.2 | |
| AA | AA | 0.9 | 1.8 | |
| AA | A | 5.1 | 11.9 | |
| AA | BBB | – | 0.2 | |
| Deposits | na | AAA | 0.6 | – |
| Cash collateral | na | AA | 0.2 | – |
| na | A | 0.1 | – | |
| Other | na | AA | – | 0.1 |
| na | A | – | 0.1 | |
| Gold loans | na | AAA | – | 0.1 |
| Other | 4.4 | 6.2 | ||
| 100.0 | 100.0 | |||
|
(a) Standard & Poor's or equivalent rating. (b) This category includes counterparties which are not rated. |
||||
Collateral pledged
At 30 June 2013, the carrying amount of securities sold and contracted for purchase under sell repurchase agreements was $2,371 million ($1,172 million at 30 June 2012). Terms and conditions of sell repurchase agreements are consistent with those for buy repurchase agreements disclosed above.
Cash collateral of $253 million was provided to cover credit risk on foreign exchange swaps under terms and conditions established by CSAs. As noted above, CSAs were introduced with swap counterparties during the course of 2012/13. The collateral exchanged under a CSA is designed to cover the cost of replacing the swap position in the market if a counterparty fails to deliver on the second leg of a swap. The RBA's CSAs specify that only Australian dollar cash is eligible as collateral. Under CSAs, either party to the agreement may be obliged to deliver collateral with interest paid or received on a monthly basis.
Liquidity risk
Liquidity risk is the risk that the RBA will not have the resources required at a particular time to meet its obligations to settle its financial liabilities. As the ultimate source of liquidity in Australian dollars, the RBA has the power and operational wherewithal to create liquidity in unlimited amounts in Australian dollars at any time. A small component of the RBA's liabilities is in foreign currencies, namely foreign sale repurchase agreements.
Liquidity risk is also associated with financial assets to the extent that the RBA may, in extraordinary circumstances, be forced to sell a financial asset at a price which is less than its fair value. The RBA manages this risk by holding a diversified portfolio of highly liquid domestic and foreign assets.
The maturity analysis table (below) is based on the RBA's contracted portfolio as reported in the RBA's balance sheet. All financial instruments are shown at their remaining term to maturity, which is equivalent to the repricing period. Other liabilities include amounts outstanding under sale repurchase agreements. Foreign currency swaps reflect the gross settlement amount of the RBA's outstanding foreign currency swap positions.
Maturity Analysis – as at 30 June 2013
| Balance sheet total $M |
Contracted maturity $M | No specified maturity $M |
Weighted average coupon rate % |
Weighted average effective rate % |
|||||
|---|---|---|---|---|---|---|---|---|---|
| On demand |
0 to 3 months |
3 to 12 months |
1 to 5 years |
Over 5 years |
|||||
| Assets | |||||||||
| Cash and cash equivalents | 137 | – | 115 | – | – | – | 22 | 2.75 | 2.75 |
| Australian dollar securities | |||||||||
| Securities sold under repurchase agreements | 77 | – | – | 38 | 17 | 22 | – | 5.92 | 2.72 |
| Securities purchased under repurchase agreements | 35,130 | – | 33,870 | 1,260 | – | – | – | 2.73 | 2.73 |
| Other securities | 7,968 | – | 3,496 | 1,998 | 966 | 1,508 | – | 4.12 | 3.04 |
| Accrued interest | 74 | – | 60 | 14 | – | – | – | na | na |
| 43,249 | |||||||||
| Foreign exchange | |||||||||
| Balances with central banks | 1,175 | 10 | 1,165 | – | – | – | – | 0.09 | 0.09 |
| Securities sold under repurchase agreements | 2,294 | – | 1,155 | 516 | 421 | 202 | – | 0.39 | 0.21 |
| Securities purchased under repurchase agreements | 7,777 | – | 7,777 | – | – | – | – | 0.09 | 0.09 |
| Other securities | 39,339 | – | 16,686 | 10,377 | 6,271 | 793 | 5,212 | 0.50 | 0.27 |
| Deposits with BIS | 3 | 2 | – | – | – | – | 1 | 0.02 | 0.02 |
| Collateral exchanged | 253 | – | 253 | – | – | – | – | 2.75 | 2.75 |
| Accrued interest | 89 | – | 61 | 28 | – | – | – | na | na |
| 50,930 | |||||||||
| Gold | |||||||||
| Gold loans | 42 | – | – | 42 | – | – | – | 0.40 | 0.40 |
| Gold holdings | 3,257 | – | – | – | – | – | 3,257 | na | na |
| 3,299 | |||||||||
| Property, plant & equipment | 491 | – | – | – | – | – | 491 | na | na |
| Loans and advances | 4 | – | – | – | – | 4 | – | 3.04 | 3.04 |
| Other assets | 417 | – | 21 | – | – | – | 396 | na | na |
| Total assets | 98,527 | 12 | 64,659 | 14,273 | 7,675 | 2,529 | 9,379 | 1.54 | 1.35 |
| Liabilities | |||||||||
| Deposits | 26,183 | 6,033 | 20,150 | – | – | – | – | 2.52 | 2.52 |
| Distribution payable to Australian Government | – | – | – | – | – | – | – | na | na |
| Other liabilities | 5,389 | – | 5,201 | – | – | – | 188 | 0.03 | 0.03 |
| Australian notes on issue | 56,943 | – | – | – | – | – | 56,943 | 0.13 | 0.13 |
| Total liabilities | 88,515 | 6,033 | 25,351 | – | – | – | 57,131 | 0.83 | 0.83 |
| Capital and reserves | 10,012 | ||||||||
| Total balance sheet | 98,527 | ||||||||
| Local Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (46) | – | (46) | – | – | – | – | na | na |
| Contractual inflow | 4,266 | – | 4,266 | – | – | – | – | na | na |
| 4,220 | – | 4,220 | – | – | – | – | |||
| Foreign Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (5,700) | – | (5,700) | – | – | – | – | na | na |
| Contractual inflow | 1,480 | – | 1,480 | – | – | – | – | na | na |
| (4,220) | – | (4,220) | – | – | – | – | |||
Maturity Analysis – as at 30 June 2012
| Balance sheet total $M |
Contracted maturity $M | No specified maturity $M |
Weighted average coupon rate % |
Weighted average effective rate % |
|||||
|---|---|---|---|---|---|---|---|---|---|
| On demand |
0 to 3 months |
3 to 12 months |
1 to 5 years |
Over 5 years |
|||||
| Assets | |||||||||
| Cash and cash equivalents | 164 | – | 135 | – | – | – | 29 | 3.25 | 3.25 |
| Australian dollar securities | |||||||||
| Securities sold under repurchase agreements | 17 | – | – | – | 17 | – | – | 5.50 | 2.47 |
| Securities purchased under repurchase agreements | 24,484 | – | 23,983 | 501 | – | – | – | 3.57 | 3.57 |
| Other securities | 8,028 | – | 2,269 | 2,225 | 2,007 | 1,527 | – | 5.09 | 3.39 |
| Accrued interest | 119 | – | 117 | 2 | – | – | – | na | na |
| 32,648 | |||||||||
| Foreign exchange | |||||||||
| Balances with central banks | 572 | 10 | 562 | – | – | – | – | 0.15 | 0.15 |
| Securities sold under repurchase agreements | 1,155 | – | 245 | – | 330 | 580 | – | 1.01 | 1.01 |
| Securities purchased under repurchase agreements | 12,129 | – | 12,129 | – | – | – | – | 0.14 | 0.14 |
| Other securities | 29,344 | – | 7,413 | 6,850 | 8,707 | 1,595 | 4,779 | 0.95 | 0.37 |
| Deposits with BIS | 5 | 3 | 1 | – | – | – | 1 | 0.01 | 0.01 |
| Accrued interest | 91 | – | 91 | – | – | – | – | na | na |
| 43,296 | |||||||||
| Gold | |||||||||
| Gold loans | 48 | – | – | 48 | – | – | – | 0.40 | 0.40 |
| Gold holdings | 3,979 | – | – | – | – | – | 3,979 | na | na |
| 4,027 | |||||||||
| Property, plant & equipment | 448 | – | – | – | – | – | 448 | na | na |
| Loans and advances | 5 | – | – | – | – | 5 | – | 3.40 | 3.40 |
| Other assets | 491 | – | 33 | – | – | – | 458 | na | na |
| Total assets | 81,079 | 13 | 46,978 | 9,626 | 11,061 | 3,707 | 9,694 | 1.97 | 1.59 |
| Liabilities | |||||||||
| Deposits | 18,000 | 3,500 | 14,500 | – | – | – | – | 3.45 | 3.45 |
| Distribution payable to Australian Government | 500 | – | 500 | – | – | – | – | na | na |
| Other liabilities | 2,615 | – | 2,447 | – | – | – | 168 | 0.19 | 0.19 |
| Australian notes on issue | 53,595 | – | – | – | – | – | 53,595 | 0.19 | 0.19 |
| Total liabilities | 74,710 | 3,500 | 17,447 | – | – | – | 53,763 | 0.98 | 0.98 |
| Capital and reserves | 6,369 | ||||||||
| Total balance sheet | 81,079 | ||||||||
| Local Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (83) | – | (83) | – | – | – | – | na | na |
| Contractual inflow | 5,191 | – | 5,191 | – | – | – | – | na | na |
| 5,108 | – | 5,108 | – | – | – | – | |||
| Foreign Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (9,539) | – | (9,539) | – | – | – | – | na | na |
| Contractual inflow | 4,431 | – | 4,431 | – | – | – | – | na | na |
| (5,108) | – | (5,108) | – | – | – | – | |||
Fair Value of Financial Instruments
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction, and is usually determined by the quoted market price. The RBA's Australian dollar securities, foreign government securities, interest rate futures, foreign currency swap contracts and its shareholding in the BIS are carried in the balance sheet (and shown in this note) at fair value. The RBA's repurchase agreements, the BIS deposits, cash and cash equivalents, notes on issue and deposit liabilities are carried in the balance sheet (and shown in this note) at face value, which is equivalent to their amortised cost using the effective interest method; this approximates fair value.
AASB 7 requires that the fair value of financial assets and liabilities be disclosed according to their accounting classification under AASB 139.
| 2013 $M | 2012 $M | |
|---|---|---|
| Assets accounted for under AASB 139 | ||
| At fair value through Profit or Loss | 47,960 | 38,283 |
| Loans and receivables | 46,421 | 37,912 |
| Available for sale | 367 | 325 |
| Assets accounted for under other standards | 3,779 | 4,559 |
| Total assets as at 30 June | 98,527 | 81,079 |
| Liabilities accounted for under AASB 139 | ||
| At fair value through Profit or Loss | 287 | 15 |
| Not at fair value through Profit or Loss | 88,038 | 74,020 |
| Liabilities accounted for under other standards | 190 | 175 |
| Total liabilities as at 30 June | 88,515 | 74,210 |
AASB 7 also requires that financial assets and liabilities measured at fair value be disclosed according to their position in the fair value hierarchy. This hierarchy has three levels for financial instruments valued at fair value: Level 1 is based on quoted prices in active markets for identical assets; Level 2 is based on quoted prices or other observable market data not included in Level 1; while Level 3 valuations are based on inputs other than observable market data.
| Level 1 $M | Level 2 $M | Level 3 $M | Total $M | |
|---|---|---|---|---|
| As at 30 June 2013 | ||||
| Assets at fair value through Profit or Loss | ||||
| Domestic government securities | 4,083 | 3,958 | – | 8,041 |
| Foreign government securities | 38,809 | 1,098 | – | 39,907 |
| Foreign currency swap gains | – | 12 | – | 12 |
| Available for sale | ||||
| Shares in international and other institutions | – | – | 367 | 367 |
| 42,892 | 5,068 | 367 | 48,327 | |
| Liabilities at fair value through Profit or Loss | ||||
| Foreign currency swap losses | 15 | 272 | – | 287 |
| 15 | 272 | – | 287 | |
Level 3 assets are comprised of shares in the BIS. In accordance with the accounting policy, the gain on BIS shares of $42 million has been included in Other Comprehensive Income.
| Level 1 $M | Level 2 $M | Level 3 $M | Total $M | |
|---|---|---|---|---|
| As at 30 June 2012 | ||||
| Assets at fair value through Profit or Loss | ||||
| Domestic government securities | 5,364 | 2,720 | – | 8,084 |
| Foreign government securities | 28,389 | 1,684 | – | 30,073 |
| Foreign currency swap gains | 8 | 118 | – | 126 |
| Available for sale | ||||
| Shares in international and other institutions | – | – | 325 | 325 |
| 33,761 | 4,522 | 325 | 38,608 | |
| Liabilities at fair value through Profit or Loss | ||||
| Foreign currency swap losses | – | 15 | – | 15 |
| – | 15 | – | 15 | |