Reserve Bank of Australia Annual Report – 2015 Financial Statements Note 15 – Financial Instruments and Risk

As the central bank in 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 shares in the BIS. As to financial liabilities, the RBA issues Australia's banknotes and takes deposits from its customers, mainly the Australian Government, and eligible financial institutions, including other central banks. 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 that reflect 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 the RBA's foreign currency assets and liabilities will fluctuate because of movements in exchange rates. 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. The RBA's net foreign currency exposure as at 30 June 2015 was $50.1 billion ($42.3 billion as at 30 June 2014). 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 six currencies – the US dollar, the euro, the Canadian dollar, the Japanese yen, the Chinese renminbi and the UK pound sterling.

The RBA also undertakes foreign currency swaps to assist its daily domestic liquidity management and in managing foreign reserve assets. These instruments carry no foreign exchange risk since the RBA agrees the exchange rates at which both legs of the transaction are settled at the time the swap is undertaken.

Concentration of foreign exchange

During 2014/15, the RBA began purchasing UK pound sterling and increased its holding of renminbi and US dollars by reducing the proportion of euros held in its reserves. 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
2015 2014
US dollar 55 52
Euro 25 35
Canadian dollar 5 5
Japanese yen 5 5
Chinese renminbi 5 3
UK pound sterling 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.

2015 $M 2014 $M
Change in profit/equity due to a 10 per cent appreciation in the reserves-weighted value of the A$ (4,547) (3,849)
Change in profit/equity due to a 10 per cent depreciation in the reserves-weighted value of the A$ 5,557 4,704

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 that have a fixed income stream, such as Australian dollar and foreign currency securities. The price of such securities increases when market interest rates decline, while it falls if market rates rise. Interest rate risk increases with the maturity of a security and, accordingly, interest rate risk on foreign assets is controlled through limits on the duration of the portfolio. Interest rate risk on Australian dollar assets is relatively low as the bulk of the portfolio is held under short-term reverse repurchase agreements.

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.

2015 $M 2014 $M
Change in profit/equity due to movements of +/−1 percentage point
across yield curves:		    
Foreign currency securities −/+300 −/+365
Australian dollar securities −/+156 −/+131

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 with other central banks, which is to Australia's advantage. 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 as a discount to the BIS' net asset value. 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 asset 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 managed within a highly risk-averse framework. In particular, credit risk is controlled by: holding securities issued by a limited number of highly rated governments, government-guaranteed agencies and supranational organisations; and holding high-quality collateral against reverse repurchase agreements.

Cash invested under reverse 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 Australian dollar reverse 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 equivalent to the amount invested plus a margin according to the risk profile of the collateral held. If the current value of collateral 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 management of collateral and cash associated with tri-party repurchase agreements is conducted through a third party, in this case the Australian Securities Exchange. The terms and requirements of tri-party repurchase agreements are broadly consistent with bilateral agreements and the RBA manages the risk of holding them in a similar way.

The RBA does not sell or re-pledge securities held as collateral under reverse repurchase agreements.

The RBA's maximum exposure to credit risk for 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:

  1. Foreign exchange swaps – As at 30 June 2015, the RBA was under contract to purchase $17.2 billion of foreign currency ($5.5 billion at 30 June 2014) and sell $28.8 billion of foreign currency ($20.0 billion at 30 June 2014). As of that date there was a net unrealised gain of $218 million on these swap positions included in net profit ($42 million unrealised gain at 30 June 2014).

    The RBA has a credit exposure from foreign exchange swaps because of the risk that a counterparty might fail to deliver the second leg of a swap which would have to be replaced in the market, potentially at a loss if the exchange rate had moved from the level at which the second leg of the swap was to be completed. To manage credit risk on swaps, the RBA exchanges collateral with counterparties under credit support annexes (CSAs), which cover the potential cost of replacing the swap position in the market if a counterparty fails to deliver. 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. At 30 June 2015, cash collateral received was $673 million ($129 million at 30 June 2014), while cash collateral provided was nil (nil at 30 June 2014).
  2. Interest rate futures – As at 30 June 2015, the amount of credit risk on margin accounts associated with interest rate futures contracts held by the RBA was approximately $0.5 million ($0.6 million at 30 June 2014). As at 30 June 2015 there was an unrealised loss brought to account on those contracts of $0.2 million ($0.2 million unrealised loss at 30 June 2014).

The RBA held no past due or impaired assets at 30 June 2015 or 30 June 2014.

Collateral pledged

At 30 June 2015, the carrying amount of securities sold and contracted for purchase under repurchase agreements was $1,781 million ($5,243 million at 30 June 2014). Terms and conditions of repurchase agreements are consistent with those for reverse repurchase agreements disclosed above.

Concentration of credit risk

As noted, the RBA operates to minimise its credit risk exposure through comprehensive risk management policy guidelines. The following table indicates the concentration of credit risk in the RBA's investment portfolio. This disclosure has been updated to align with the Bank's current internal credit framework, which utilises an average of the credit ratings of the three major ratings agencies. The prior period figures have been presented accordingly.

Risk rating of security/issuer(a) Risk rating of counterparties(a) Per cent of investments
2015 2014
Australian dollar securities
Holdings of Australian Government Securities Aaa na 3.8 3.3
Holdings of semi-government securities Aaa na 0.6 0.8
Aa na 2.0 1.8
Securities purchased under reverse Aaa Aa 27.4 23.5
repurchase agreements Aaa A 7.3 6.6
Aaa Other(b) 1.6 2.8
Aa Aa 6.8 7.3
Aa A 3.1 3.5
Aa Baa 0.2 0.0
Aa B 0.1 0.0
Aa Other(b) 0.3 0.6
A Aa 1.2 0.8
A A 0.6 0.4
A Other(b) 0.0 0.1
Baa Aa 0.0 0.1
Foreign investments
Holdings of securities Aaa na 14.7 18.0
Aa na 3.9 16.7
A na 18.0 0.0
Securities sold under repurchase agreements Aaa Aa 0.9 0.0
Aaa A 0.2 3.7
Securities purchased under reverse Aaa Aa 1.1 0.1
repurchase agreements Aaa A 0.5 4.7
Aaa Baa 0.2 0.0
Aa A 0.1 0.4
A A 0.8 0.0
Deposits na Aaa 0.5 1.2
Other Aaa A 0.0 0.1
A A 0.4 0.0
Other(b) Aa 0.1 0.0
Other(b) A 0.1 0.0
Other     3.5 3.5
    100.0 100.0
(a) Average of the credit ratings of the three major rating agencies, where available.
(b) This category includes counterparties which are not rated.

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 can 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 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 less than its fair value. The RBA manages this risk by holding a diversified portfolio of highly liquid Australian dollar and foreign currency assets.

The maturity analysis table that follows is based on the RBA's contracted portfolio as reported in the RBA's Statement of Financial Position. All financial instruments are shown at their remaining term to maturity, which is equivalent to the repricing period. Other liabilities include amounts outstanding under 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 2015

Balance sheet total $M Contracted maturity $M No specified maturity $M 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 438 32 405 – – – 1 1.75
Australian dollar investments                
Securities sold under
repurchase agreements		 – – – – – – – na
Securities purchased under
repurchase agreements		 76,183 – 52,800 1,969 – – 21,414 2.02
Other securities 9,930 – 1,404 6,318 899 1,309 – 2.15
Accrued interest 181 – 137 44 – – – na
86,294              
Foreign exchange                
Balances with central banks 832 116 716 – – – – 0.13
Securities sold under
repurchase agreements		 1,780 – 544 1,118 118 – – 0.02
Securities purchased under
repurchase agreements		 4,090 – 4,090 – – – – 0.11
Other securities 58,467 – 33,609 12,037 5,832 495 6,494 0.16
Deposits 1 – 1 – – – – (0.03)
Cash collateral pledged – – – – – – – na
Accrued interest 71 – 42 29 – – – na
65,241              
Gold                
Gold loans 49 – – 49 – – – 0.25
Gold holdings 3,866 – – – – – 3,866 na
3,915              
Property, plant & equipment 549 – – – – – 549 na
Loans and advances 3 – – – – 3 – 2.76
Other assets 473 – 23 3 – – 447 na
Total assets 156,913 148 93,771 21,567 6,849 1,807 32,771 1.18
Liabilities                
Deposits 60,486 26,236 34,250 – – – – 1.98
Distribution payable to
the Commonwealth		 2,501 – 1, 559 – 942 – – na
Cash collateral received 673 – 673 – – – – 2.00
Other liabilities 3,903 – 3,687 – – – 216 (0.02)
Australian notes on issue 65,481 – – – – – 65,481 0.07
Total liabilities 133,044 26,236 40,169 – 942 – 65,697 0.94
Capital and reserves 23,869              
Total balance sheet 156,913              
Swaps                
Australian dollars                
Contractual outflow (40) – (40) – – – –  
Contractual inflow 11,676 – 11,676 – – – –  
11,636 – 11,636 – – – –  
Foreign currency                
Contractual outflow (28,846) – (28,846) – – – –  
Contractual inflow 17,210 – 17,210 – – – –  
(11,636) – (11,636) – – – –  

Maturity Analysis – as at 30 June 2014

Balance sheet total $M Contracted maturity $M No specified maturity $M 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 273 16 256 – – – 1 2.25
Australian dollar investments                
Securities sold under repurchase agreements – – – – – – – na
Securities purchased under repurchase agreements 64,394 – 42,587 1,206 – – 20,601 2.50
Other securities 8,298 – 1,030 5,118 903 1,247 – 2.69
Accrued interest 194 – 131 63 – – – na
72,886              
Foreign exchange                
Balances with central banks 622 32 590 – – – – 0.07
Securities sold under repurchase agreements 5,241 – 2,820 1,532 776 113 – 0.15
Securities purchased under repurchase agreements 7,421 – 7,421 – – – – 0.12
Other securities 49,388 – 26,483 10,536 6,248 955 5,166 0.22
Deposits 1,067 2 1,064 – – – 1 0.02
Cash collateral pledged – – – – – – – na
Accrued interest 68 – 36 32 – – – na
63,807              
Gold                
Gold loans 45 – – 45 – – – 0.40
Gold holdings 3,539 – – – – – 3,539 na
3,584              
Property, plant & equipment 523 – – – – – 523 na
Loans and advances 4 – – – – 4 – 2.92
Other assets 408 – 32 – – – 376 na
Total assets 141,485 50 82,450 18,532 7,927 2,319 30,207 1.39
Liabilities                
Deposits 53,574 26,474 27,100 – – – – 2.43
Distribution payable to the Commonwealth 1,235 – 618 – 617 – – na
Cash collateral received 129 – 129 – – – – 2.50
Other liabilities 7,459 – 7,101 – – – 358 (0.09)
Australian notes on issue 60,778 – – – – – 60,778 0.13
Total liabilities 123,175 26,474 34,948 – 617 – 61,136 1.12
Capital and reserves 18,310              
Total balance sheet 141,485              
Swaps                
Australian dollars                
Contractual outflow (14) – (14) – – – –  
Contractual inflow 14,556 – 14,556 – – – –  
14,542 – 14,542 – – – –  
Foreign currency                
Contractual outflow (20,026) – (20,026) – – – –  
Contractual inflow 5,484 – 5,484 – – – –  
(14,542) – (14,542) – – – –