Committed Liquidity Facility

Since January 2015, those ADIs to which APRA applies the Basel III liquidity standards have been required to hold high-quality liquid assets (HQLA) sufficient to withstand a 30-day period of stress under the liquidity coverage ratio (LCR) requirement.

In the Australian dollar securities market, only Australian Government Securities (AGS) and securities issued by the borrowing authorities of the states and territories (semis) have been assessed by APRA as meeting the Basel criteria for HQLA.[1] A large proportion of the current stock of AGS and semis (HQLA securities) on issue is held by non-residents, and ADIs' holdings are well below the amount that would be needed if all ADIs were to meet their LCR requirement through this means (Table 1). Compelling ADIs to acquire most of the stock of HQLA securities would very likely interfere with the properties of the market that qualified it as HQLA in the first place; namely, its depth and liquidity.

Table 1: Holdings of HQLA Securities by Domestically Incorporated LCR ADIs and Non-residents
  HQLA securities(a)
$A billion
Share of HQLA securities held by domestically incorporated LCR ADIs
Per cent
Share of HQLA securities held by non-residents
Per cent
31 Dec 2014 685 22 49
31 Dec 2015 731 24 48
31 Dec 2016 788 26 45
31 Dec 2017 840 24 46
31 Dec 2018 875 23 46

(a) Market value of Australian dollar denominated AGS and semis; since 14 July 2016, includes debt securities of EFIC

Sources: ABS; RBA

Apart from AGS and semis, the only other significant assets recognised as HQLA are liabilities of the Reserve Bank; namely, banknotes and ES balances. While banknotes yield no return, the rate paid on surplus ES balances is set at 15 basis points below the cash rate target. The Basel III standards allow jurisdictions to use an alternative treatment for holdings in the stock of HQLA when there is insufficient supply of HQLA. The Committed Liquidity Facility (CLF) is the Reserve Bank and APRA's alternative treatment and, under this arrangement, certain ADIs are able to use a contractual liquidity commitment from the Reserve Bank towards meeting their LCR. The Reserve Bank's CLF was approved by the Reserve Bank Board in November 2010 and announced via media release in the subsequent month. Any drawdown on the CLF must meet certain conditions, including that APRA does not object to the drawdown and the RBA assesses that the ADI has positive net worth. Accordingly, the potential funding under the CLF is disclosed as a contingent liability in the Reserve Bank's Annual Report. (See the CLF Operational Notes for further details on the facility.) With the introduction of the Term Funding Facility (TFF) in April 2020, ADIs can also use their TFF allowance towards meeting their LCR.

The aggregate size of the CLF is the difference between APRA's assessment of the overall LCR requirements of locally-incorporated ADIs and the Reserve Bank's assessment of the amount of AGS and semis that could reasonably be held by these ADIs without unduly affecting market functioning. For 2015–2019, the Reserve Bank assessed that the CLF ADIs could reasonably hold 25 per cent of the stock of HQLA securities. Over recent years, the volume of HQLA securities has risen and they have become more readily available in bond and repo markets. Given this, the Reserve Bank has assessed that the CLF ADIs can increase their holdings to 30 per cent of the stock. To minimise the effect on market functioning, the increase in the CLF ADIs' reasonable holdings of HQLA securities is occurring at a pace of 1 percentage point per year until 2024, and commenced with an increase to 26 per cent in 2020.

For calculating the aggregate size of the CLF in 2020, the market value of HQLA securities was projected in June 2019 to be $934 billion at the end of 2020 (the market value of AGS was projected to be around $622 billion and the market value of semis was projected to be around $312 billion). The Reserve Bank assessed that the amount of AGS and semis that could reasonably be held by locally incorporated LCR ADIs at the end of 2020 was $243 billion (Table 2).

Table 2: Reasonable Holdings of HQLA Securities and the Committed Liquidity Facility
$A billion
  Projection of HQLA securities outstanding(a) Locally incorporated LCR ADIs
Reasonable holdings of HQLA securities(a) LCR requirements(b) CLF Amount(b)
31 Dec 2015 700 175 449 274
31 Dec 2016 780 195 441 246
31 Dec 2017 880 220 437 217
31 Dec 2018 905 226 474 248
31 Dec 2019 898 225 468 243
31 Dec 2020 934 243 469 226

(a) Ahead of APRA's assessment of the CLF amounts to take effect in the following calendar year, the RBA publishes its projection of the market value of HQLA securities (Australian dollar denominated AGS and semis) that will be outstanding at the end of the following calendar year; this projection is based on information available from the Australian Government and state government borrowing authorities.
(b) ‘LCR requirements’ refers to APRA's assessment of the aggregate Australian dollar net cash outflows for the locally-incorporated LCR ADIs at the end of the calendar year, including an allowance for the ADIs to have buffers over the minimum LCR requirement of 100 per cent; it also takes into account ADIs' projected holdings of banknotes and ES balances. ‘CLF Amount’ is the difference between the LCR requirements and reasonable holdings of HQLA securities.

Sources: APRA; RBA

ADIs that wish to count the CLF towards their LCR requirement must first seek approval from APRA, which determines which institutions have access to the facility and the CLF amounts available. Under the CLF, the Reserve Bank commits to providing an amount of funding to approved ADIs via repurchase agreement.

A per annum fee is assessed on the size of the Reserve Bank's commitment, regardless of whether it is drawn or not (see Box below). The fee is set so that the CLF ADIs face similar financial incentives to meet their liquidity requirements through the CLF or by holding HQLA. For 2015–2019, the Reserve Bank charged a CLF fee of 15 basis points per annum on the commitment to each CLF ADI. From 1 January 2020, the Reserve Bank increased the CLF fee to 17 basis points and it will increase to 20 basis points on 1 January 2021.

In practice, the CLF does not change the way ADIs access the Reserve Bank's existing standing facilities. The only difference is that in the absence of a CLF the Reserve Bank has made no contractual commitment ahead of time to transact repos with any ADI under its standing facilities; each individual repo is subject to the Reserve Bank's agreement. The CLF provides a means by which ADIs may obtain a contractual commitment from the Reserve Bank to extend funding subject to certain conditions. In particular, the Reserve Bank's commitment is always contingent on the ADI having positive net worth in the opinion of the Reserve Bank, following consultation with APRA.

The CLF allows ADIs to hold towards their LCR requirement securities eligible in the Reserve Bank's operations that are not HQLA securities, provided a fee is paid on the CLF amount. As noted above, the Reserve Bank is willing to purchase certain other debt securities (in addition to AGS and semis) in its operations. As is its standard practice, the RBA applies haircuts to the securities available to be presented, such that ADIs need to hold securities with a higher value than the size of the CLF.

Box: Pricing the CLF

For the payment of a fee, the CLF gives ADIs the option of selling eligible securities to the Reserve Bank under repurchase agreement, with the (effective) repo rate set 25 basis points above the cash rate target.

In many respects, this arrangement is little different to how the Reserve Bank's standing facilities operate for an ADI without a CLF. However, for such an ADI, there is no contractual commitment by the Reserve Bank to provide standing liquidity arrangements and hence there is no fee. In this sense, the CLF fee can be seen as a means of charging the large ADIs an appropriate price for a liquidity option they have always implicitly held.

Ideally, the CLF is priced so as to replicate the cost to an ADI of holding HQLA should there have been sufficient supply. However, this does not mean that the CLF fee should simply reflect the differential between yields on available HQLA (such as government bonds) and yields on those other securities eligible for the CLF.

Under the CLF, the Reserve Bank is only committing to provide funding against the value of a security at the time the facility is utilised, not the value at the time the commitment is established. Moreover, when the facility is utilised, the Reserve Bank discounts the security's value by a margin (or ‘haircut’); these margins vary depending on the type of security. Hence, the CLF is only (and not completely) insuring an ADI against the liquidity risk on its securities. The credit and market risks attached to the securities remain with the ADI. As is the case with all repos contracted by the Reserve Bank, should the value of a security sold to the Reserve Bank decline, the Reserve Bank demands that additional securities be delivered to restore the original value of the repo. Similarly, should the credit quality of a security held by the Reserve Bank fall below a certain threshold, the ADI is required to replace the security with one that meets the eligibility criteria.

Consequently, to derive the appropriate CLF fee from the yields of eligible securities, an adjustment has to be made for the non-liquidity premia embedded in these yields as well as for that part of the liquidity risk which the Reserve Bank is not insuring (namely, the haircut).

In practice, the task of estimating any such premia is not straightforward and is further complicated by the influence that the comparative scarcity of HQLA in Australia has had on relative yields. For example, in recent years AGS have generally been more expensive (relative to bank rates) than sovereign debt in other currencies, partly because of the modest amount on issue.

Theoretically, some indication of the cost of hedging liquidity risk can be extracted from term repo rates on eligible securities. For example, if a security can be funded overnight at the cash rate, the spread over cash at which a twelve-month repo in that security is priced indicates how expensive it is to hedge against not being able to roll the overnight repo at the cash rate continuously through that period.[2]

Few such long-term repos are contracted in the Australian market, however. As noted above, the CLF is similar to an option with a strike price set 25 basis points above the cash rate. Of course, during periods of market stress, the cost of liquidity can rise significantly and it is the potential for this to occur that gives the option some value.

Separate to any market-derived estimates, an equally important consideration in pricing the CLF is to ensure that it is consistent with the Reserve Bank's operating framework for monetary policy and does not compromise the Reserve Bank's ability to implement that policy.

As discussed above, an important feature of the Reserve Bank's framework is that surplus ES funds are remunerated at a rate that is slightly below ‘fair’ market levels during normal times (so as not to be viewed as a primary store of liquidity for banks), but not so low that the cash market is disrupted by unexpected changes in system liquidity. By design, the spread of 25 basis points to the cash rate exceeds the credit risk premium generally priced into overnight interbank loans. A similar argument can be made for the 25 basis point margin attached to repos accessed via the Reserve Bank's standing facility; the rate is high enough to discourage routine use (such borrowings only occur a few times a year) but not so high as to prevent ADIs from drawing on it when appropriate (in preference to failing on payments or otherwise disrupting the financial system).

Endnotes

APRA has determined that for the purposes of the LCR requirement, Australian Government Securities include Australian dollar debt securities of the Export Finance and Insurance Corporation (EFIC). [1]

‘Spread over cash’ in this context means the spread over an overnight indexed swap (OIS) rate for that term to maturity. As OIS are referenced to the cash rate, these spreads abstract from any expectation of a change in the cash rate that has been incorporated in longer-term repo rates. [2]