MEDIA RELEASE No: 98-05 Date: 24 April 1998 Embargo: For Immediate Release

BANKS' LIQUIDITY MANAGEMENT

The Reserve Bank has today issued new prudential guidelines dealing with liquidity management by banks, which will replace the Prime Assets Requirement.

The Prime Assets Requirement (PAR) is a prudential requirement that banks hold at all times a minimum level of assets of undoubted quality, in the form of Commonwealth Government securities, notes and coin and balances with the Bank. The requirement was introduced to ensure that banks had an emergency line of defence in times of liquidity pressures, but it was recognised that this was only one aspect of an adequate system for managing liquidity. The minimum PAR ratio was initially set at 12 per cent of banks' liabilities (excluding shareholders' funds) but has been reduced, in stages, in response to concerns about the availability of Commonwealth Government securities. The last change in arrangements was in June 1997, when the PAR ratio was reduced from 6 to 3 per cent and the definition broadened to include State Government securities.

At the time of the last reduction, the Bank indicated that it was refocussing its supervision of liquidity to put greater emphasis on banks' internal management practices. The Bank has subsequently reviewed its guidelines on liquidity, taking into account approaches used by banks, both in Australia and overseas; it has also looked at work by the Basle Committee on Banking Supervision. Following consultation with banks, the revised guidelines – Prudential Statement D1, Liquidity Management (April 1998) – have been finalised.

Under the new framework, the Bank will agree with each bank a liquidity policy which sets out how that bank plans to manage liquidity under different circumstances. The policy will need to cater for two specific scenarios - day-to-day liquidity management in normal circumstances and a bank-specific or "name" crisis. The Bank will be paying particular regard to banks' strategies for dealing with a "name" crisis; banks must satisfy the Bank that they would be able to withstand outflows for a minimum of five business days, a period expected to allow sufficient time for a bank to address any underlying problems. Banks can use a range of strategies to manage liquidity, including setting limits on maturity mismatches, holding liquid assets, diversifying liability sources and developing asset sales strategies.

No formal PAR ratio will apply under the new arrangements. This reflects the Bank's view that it is no longer appropriate to mandate a common ratio or minimum holdings of liquid assets for all banks. Such an approach does not adequately take account of the different structure of banks' business, both on- and off-balance sheet. Nonetheless, the Bank expects that banks would hold minimum quantities of high quality liquid assets for prudent liquidity management, and it will impose a minimum holding on a bank where it considers this necessary. Further, in its domestic market operations and in respect of the new Real-Time Gross Settlement System (RTGS) for interbank payments, the Bank will continue to deal only in assets which meet the current definition of PAR.

The Bank will meet with individual banks over the remainder of the year to review their approach to liquidity management; once a liquidity policy is agreed, that bank will no longer be required to meet the PAR ratio. Since banks will be assessed against their peer groups, final approval of a bank's liquidity policy will occur when the Bank has reviewed the policies of all banks in a particular group.

The implementation of these new arrangements will be taken over by the Australian Prudential Regulation Authority later in the year. It is expected that they will come fully into effect by the end of 1998.

A copy of Prudential Statement D1 is attached. It is also available on the Reserve Bank Web Site.

Enquiries:
Manager, Information Office
Reserve Bank of Australia
SYDNEY
(02) 9551 9720

Mr LJ Phelps
Head of Bank Supervision
Reserve Bank of Australia
SYDNEY
(02) 9551 8600