Reserve Bank of Australia Annual Report – 2006 Financial Statements Note 16

Note 16 FINANCIAL INSTRUMENTS

Australian Accounting Standard AASB 132 – Financial Instruments: Disclosure and Presentation requires disclosure of information relating to financial instruments; their significance and performance; accounting policies; terms and conditions; fair values and risk information. The Risk Management chapter in this report provides additional information on the RBA's management of financial risks.

Fair valueis 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 net of transaction costs. The RBA's Australian dollar securities, foreign government securities, interest rate futures, foreign currency swap contracts and its shareholding in the Bank for International Settlements are carried in the balance sheet (and shown in this note) at fair value. The RBA's bank 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.

Financial riskof financial instruments embodies market risk (currency risk and interest rate risk); credit risk; liquidity risk and cash flow risk.

The interest rate risk and credit risk tables are based on the RBA's contracted portfolio as reported in the RBA's balance sheet.

Foreign exchange risk

Foreign exchange risk is the risk that the value of a financial instrument will fluctuate due to changes in exchange rates. The RBA's net foreign currency exposure as at 30 June 2006 was $28.1 billion ($23.8 billion as at 30 June 2005).

Interest rate risk

Interest rate risk is the risk that the fair value of a financial instrument will fluctuate due to changes in market interest rates. The following table shows the RBA's balance sheet restated in compliance with AASB 132.

Interest rate risk
As at 30 June 2006
Balance sheet
total $M
Floating
interest
rate $M
Repricing Period $M Not
bearing
interest $M
Weighted
average
coupon rate %
Weighted
average
effective
rate %
0 to 3 months 3 to 12 months 1 to 5
years
Over 5 years
Assets
Gold loans 1,434 105 238 1,055 36   1.38 1.38
Gold holdings 717 717   n/a n/a
Sub-total 2,151                  
Foreign exchange
Balances with central banks 676 673 3   4.49 4.49
Securities sold under
repurchase agreements
9,650 1,432 3,780 4,438   3.69 4.91
Securities purchased under
repurchase agreements
29,121 29,121   4.63 4.63
Other securities 19,581 267 10,648 1,562 3,762 2,957 385   2.16 2.24
Deposits 12,310 28 12,279 3   4.40 4.40
Accrued interest -
foreign exchange
351 351   n/a n/a
Sub-total 71,689                  
Australian dollar securities
Securities sold under
repurchase agreements
172 112 60   7.26 5.86
Securities purchased under
repurchase agreements
26,195 26,195   5.77 5.77
Other securities 3,824 243 2,195 1,386   6.66 5.82
Accrued interest – Australian
dollar securities
115 115   n/a n/a
Sub-total 30,306                  
Property, plant & equipment 329 329   n/a n/a
Cash and cash equivalents 575 560 15   5.75 5.75
Loans and advances 20 20   3.79 3.79
Other 377 377   n/a n/a
Total assets 105,447 1,548 78,348 3,587 10,852 8,781 2,331   3.87 3.95
Liabilities
Australian notes on issue 38,065 2,543 35,522   0.38 0.38
Deposits 43,204 3,177 35,935 2,400 1,692   5.78 5.78
Distribution payable to
Australian Government
1,477 1,477   n/a n/a
Other 11,493 10,467 1,026   4.26 4.26
Total liabilities 94,239 5,720 46,402 2,400 39,717   3.33 3.33
Capital and reserves 11,208                  
Total balance sheet 105,447                  
Off balance sheet items
Interest rate futures 2,594 2,594   n/a n/a
Interest rate risk
As at 30 June 2005
Balance sheet
total $M
Floating
interest
rate $M
Repricing Period $M Not
bearing
interest $M
Weighted
average
coupon rate %
Weighted
average
effective
rate %
0 to 3 months 3 to 12 months 1 to 5
years
Over 5 years
Total assets 85,271 1,626 59,010 3,207 12,097 7,204 2,127   3.83 3.60
Total liabilities 75,668 5,184 32,912 1,354 36,218   4.82 4.41
Capital and reserves 9,603                  
Total balance sheet 85,271                  
Off balance sheet items 65 65   n/a n/a

Other liabilities include amounts outstanding under sale repurchase agreements.

All financial instruments are shown at their repricing period which is equivalent to the remaining term to maturity.

Interest rate futures reflect the positions in interest rate contracts traded in foreign futures exchanges to manage interest rate risk on Official Reserve Assets.

Sensitivity to risks

The sensitivity of the fair value of the RBA's financial assets to fluctuations in the exchange rate and interest rates is shown below.

Change in fair value $M
Impact on:
Net foreign exchange holdings of:
 
A rise of 10 per cent in the value of the A$ 2,456
An increase of 1 percentage point in yield curves overseas 769
Australian dollar securities of:  
An increase of 1 percentage point in the yield curve in Australia 159

Concentration of foreign exchange

The Bank's net holdings of foreign exchange were distributed as follows as at 30 June:

% of foreign exchange
as at 2006
% of foreign exchange
as at 2005
US dollar 45 45
Euro 45 45
Japanese yen 10 10
Total foreign exchange 100 100

Fair value of financial instruments

AASB 130 requires that the fair value of financial assets and liabilities be disclosed according to their accounting classification under AASB 139.

2006 $M 2005 $M
Assets
At fair value through Profit or Loss 33,493 25,355
Loans and receivables 69,956 57,969
Available-for-sale 842 1,249
Total financial assets as at 30 June 104,291 84,573
Non-financial assets 1,156 698
Total assets as at 30 June 105,447 85,271
Liabilities
At fair value through Profit or Loss 1,310 555
Not at fair value through Profit or Loss 91,323 73,302
Non-financial liabilities 1,606 1,811
Total liabilities as at 30 June 94,239 75,668

Credit risk

Credit riskin relation to a financial instrument is the risk that a customer, bank or other counterparty will not meet its obligations (or not be permitted to meet them) in accordance with agreed terms.

The RBA's maximum exposure to credit risk in relation to each class of recognised financial assets, other than derivatives (off-balance sheet items), is the carrying amount of those assets as indicated in the balance sheet. The RBA's exposures are to highly-rated counterparties and its credit risk is low.

The RBA's maximum credit risk exposure in relation to off-balance sheet items is:

  1. Foreign exchange swaps – As at 30 June 2006 the RBA was under contract to purchase $16.2 billion of foreign currency and sell $49.5 billion of foreign currency. As of that date there was an unrealised net loss of $261 million on these swap positions included in net profit. The credit risk exposure of these contracts is the cost of re-establishing the contract in the market in the event of the failure of the counterparty to fulfil its obligations.
  2. Interest rate futures – As at 30 June 2006 the amount of credit risk on interest rate futures contracts was approximately $3.4 million ($0.3 million at 30 June 2005). As at 30 June 2006 there was an unrealised loss brought to account on those contracts of $1.6 million ($0.1 million unrealised gain at 30 June 2005).

Concentration of credit risk

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. See Note 1(b).

Credit Risk
Risk rating of
security issuer*
Risk rating of
counterparties*
% of total assets
as at 2006
% of total assets
as at 2005
Domestic Government Securities
Holdings – Commonwealth Government
securities
AAA n/a 2.1 2.9
Holdings – Semi Government securities AAA n/a 1.5 1.1
AA n/a 0.0 0.3
Securities sold under repurchase
agreements
AAA AA 0.1 0.5
AAA A 0.1 0.2
Securities held under repurchase
agreements
AAA AA 9.0 10.4
AAA A 0.7 1.6
AAA other 1.9 1.6
AA AA 11.5 3.6
AA A 0.2 1.6
AA other 0.0 0.0
A AA 1.4 0.3
A A 0.1 0.4
Foreign investments
Holdings of securities AAA n/a 10.2 12.0
A n/a 8.8 3.4
Securities sold under repurchase
agreements
AAA AA 7.2 8.5
AAA A 1.7 0.6
A AA 0.2 0.0
A A 0.1 0.0
Securities held under repurchase
agreements
AAA AAA 0.2 0.0
AAA AA 25.1 32.0
AAA A 2.1 2.5
A AAA 0.0 0.0
A AA 0.1 0.0
A A 0.1 0.0
Deposits n/a AAA 0.6 1.1
n/a AA 11.1 10.7
n/a A 0.0 0.6
Other n/a AAA/other 0.3 0.3
Gold loans n/a AAA 0.1 0.1
n/a AA 0.7 0.7
n/a A 0.6 0.6
Other     2.2 2.4
      100 100
* Standard & Poor's equivalent ratings