Reserve Bank of Australia Annual Report – 2009
2008/09 was an even more turbulent year for the global financial system than the year before. After a lengthy period of escalating tension, the failure of Lehman Brothers in mid September 2008 was the catalyst for the most serious and widespread financial crisis in generations. Confidence in the soundness of financial institutions and systems was seriously impaired. Share prices fell heavily, and demand for durable goods slumped as households and firms all over the world adopted a much more precautionary attitude both to current spending and to their financial positions.
Governments and central banks of major countries had to resort to extraordinary measures to stabilise financial systems and institutions, including issuing guarantees, taking ownership stakes in key institutions, and greatly expanding programs of asset purchases and lending. In many other countries that were not central to the crisis, spillover effects nonetheless were very significant, and governments and central banks needed to protect system stability by issuing guarantees and providing additional liquidity. Subsequently, as the likely effects on economic activity and inflation became clearer, central banks cut interest rates rapidly and governments announced large-scale discretionary fiscal stimulus programs.
These actions averted a much more serious economic and financial disaster. But the legacy of the excesses of the earlier part of this decade, and of the steps needed to cope with their subsequent unwinding, is likely to be quite persistent. Significant private wealth has been destroyed. Expectations of future income have been correspondingly reduced and the need to save is now higher. Governments of major countries have assumed, one way or another, a significant part of the obligations associated with earlier poor decisions by lenders and investors. Some are issuing very large quantities of debt to fund these obligations, as well as to pay for stimulus programs. As one simple metric, the ratio of gross government debt to GDP for the advanced countries as a group is likely to reach 100 per cent within a year or two. So constraints on economic policy are likely to last, in some countries, for some time.
On this score, as on a number of others, Australia is relatively well positioned. The economy has been significantly affected by the crisis, but has not experienced the sharp contraction seen elsewhere. The financial system remains strong (and privately owned), public finances are in reasonable shape and resort to unconventional monetary measures has not been needed. The exposure to China has proved a boon. It is not surprising that, over recent months, confidence has recovered some ground.
The global events continued to affect the work of the Reserve Bank, across many dimensions. Most obviously, the Reserve Bank Board adjusted monetary policy to suit the economy’s changing circumstances, reducing the cash rate on six occasions by a total of 425 basis points, the most active use of the policy instrument for many years. As usual, the rationale for the policy decisions was spelled out in other documents, and so is not discussed further here.
There were many other effects on the Reserve Bank’s activities. Throughout the period of financial distress since mid 2007, the Bank has adjusted its financial operations as needed to help markets continue to function. During the past year, particularly during the last few months of 2008 as the crisis intensified, the Bank further expanded its domestic dealing operations, increasing system liquidity, accepting a wider range of collateral and dealing over longer terms. It worked along with the US Federal Reserve and other central banks to facilitate the provision of US dollar funding against appropriate local currency collateral. As a result, the Bank’s balance sheet expanded significantly, with assets reaching over $165 billion at the peak, though by the end of the financial year they had fallen back to about $100 billion as usage of the various facilities unwound.
Unusual volatility of the Australian dollar during the worst of the turmoil saw the Reserve Bank undertake intervention transactions, selling foreign currency acquired earlier at a high exchange rate and purchasing Australian dollars at a much lower exchange rate. These transactions realised substantial valuation gains. Subsequently, as the exchange rate has risen, the reserves run down in the intervention episode have been replenished. The dealing, settlements, reserves management and risk management areas all had higher workloads associated with these activities.
The Reserve Bank responded to a surge in demand for banknotes around the time of the global banking crisis, as some depositors withdrew cash from banks. Although this demand was met from the Bank’s contingency stocks, Note Printing Australia stepped up production as these stocks fell sharply. As calm was restored this flow abated, but by the end of the financial year currency in the hands of the public, at about $48 billion, was still about $4 billion higher than would have been expected based on trend growth in the economy.
The Banking Department trebled its daily cheque-processing capacity to facilitate the increased volume of cheques associated with government stimulus payments issued by the Australian Tax Office. The Risk Management Unit took responsibility for administration of the Government’s wholesale funding guarantee, involving assessment of applications and collection of fees on behalf of the Government, which are now running at an annual rate of about $1 billion.
The Bank’s staff responded to increased demands for participation in international efforts to grapple with the crisis, organised under the auspices of the G-20 and the Bank for International Settlements. These demands will continue to grow, as Australia has been asked to take part more fully in bodies such as the Financial Stability Board, the Basel Committee on Banking Supervision and the Committee on Payment and Settlement Systems.
All up, these unusual events added around $5 million (2½ per cent) to the Reserve Bank’s cost of operation in the year. Ongoing programs to improve the Bank’s capacity to meet its various public policy obligations also continued, with significant upgrades to key systems adding to costs but improving quality and resilience.
The Reserve Bank earned a profit, measured in accordance with Australian equivalents to International Financial Reporting Standards, of over $8.8 billion in 2008/09. This measure includes not only the net interest earnings of $2.2 billion and realised valuation gains of $4.4 billion, but unrealised gains on the portfolio of $2.3 billion, principally owing to the effects of the decline in the Australian dollar on the valuation of foreign assets. Earnings available for distribution to the Australian Government, as determined by the provisions of the Reserve Bank Act 1959, are limited to the net interest earnings plus realised valuation gains. This sum, $6.6 billion, was the highest in the Bank’s history.
To keep the Reserve Bank’s capital commensurate with the size of its balance sheet and the associated risks, and in line with its longstanding policy on capital, the Board recommended to the Treasurer that $577 million be transferred to the Reserve Bank Reserve Fund. The Treasurer agreed to the recommendation, resulting in a dividend to the Australian Government from 2008/09 earnings of almost $6 billion. This is the highest dividend ever paid by the Bank, but it reflects unusual circumstances. It can be expected with a high degree of confidence that future dividends will generally be much smaller. On average, they can be expected to be approximately equal to net interest earnings.
Were there to be a large rise in either the Australian dollar or local and global interest rates (or both), the Reserve Bank would sustain, as on many past occasions, significant valuation losses. It is entirely possible under such conditions that the Bank could record an overall loss, as it did in 2006/07. This reflects the large exposures to interest rate and foreign currency risk that are part and parcel of being a central bank.
The staff of the Reserve Bank have once again exhibited a high level of professionalism and dedication. The Board joins me in thanking them for their tireless efforts, during what has proved to be a formidable year, but a successful one.
In a few months’ time, on 14 January 2010, the Reserve Bank will mark 50 years of operation. While the Reserve Bank is the continuing legal entity established as the Commonwealth Bank of Australia in 1911, and technically therefore is nearly 100 years old, it is only since ‘separation’ in 1960 that it has been purely a central bank. It will be appropriate to commemorate the anniversary, and some suitable events are being planned.
Chairman, Reserve Bank Board
13 August 2009