Reserve Bank of Australia Annual Report – 2021 Financial Statements Note 15 – Financial Instruments and Risk

As the central bank in Australia, the RBA is responsible for implementing monetary policy, facilitating the smooth functioning of the payments system and managing Australia's foreign reserve assets. Consequently, the RBA holds a range of financial assets, including government securities, repurchase agreements and foreign currency swaps. With regard to financial liabilities, the RBA issues Australia's banknotes and takes deposits from its customers, mainly the Australian Government, and eligible financial institutions. The RBA also provides banking services to its customers and operates Australia's high-value payments and interbank settlement systems.

Financial risk

The RBA is exposed to a range of financial risks that reflect its policy and operational responsibilities. These risks include market risk, liquidity risk and credit risk. The chapters on ‘Operations in Financial Markets’ and ‘Risk Management’ provide information on the RBA's management of these financial risks. The RBA's approach to managing financial risk is set out in the Risk Appetite Statement available on the RBA website.

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. In the RBA's case, market risk comprises foreign exchange risk and interest rate 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. The RBA's net foreign currency exposure as at 30 June 2021 was $51.6 billion ($55.7 billion as at 30 June 2020). An appreciation in the Australian dollar would result in valuation losses, while a depreciation would lead to valuation gains. The overall level of foreign currency exposure is determined by policy considerations. Foreign currency risk can be mitigated to a limited extent by holding assets across a diversified portfolio of currencies. The RBA holds foreign reserves in seven currencies – the US dollar, euro, Japanese yen, Canadian dollar, Chinese renminbi, UK pound sterling and South Korean won.

The RBA also undertakes foreign currency swaps to assist its daily domestic liquidity management and in managing foreign reserve assets and Australia's foreign currency commitments as a member of the IMF. These instruments carry no foreign exchange risk.

Concentration of foreign exchange

The RBA's net holdings of foreign exchange (excluding Special Drawing Rights and Asian Bond Fund 2) were distributed as follows as at 30 June:

  Per cent of foreign exchange
2021 2020
US dollar 55 55
Euro 20 20
Japanese yen 5 5
Canadian dollar 5 5
Chinese renminbi 5 5
UK pound sterling 5 5
South Korean won 5 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.

  2021
$M
2020
$M
Change in profit/equity due to a 10 per cent:    
appreciation in the reserves-weighted value of the A$ (4,693) (5,066)
depreciation in the reserves-weighted value of the A$ 5,736 6,192

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 faces 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 rises when market interest rates decline, and it falls if market rates rise. Interest rate risk increases with the maturity of a security. Interest rate risk on foreign assets is controlled through limits on the duration of these portfolios.

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. The significant increase in interest rate risk on Australian dollar securities is primarily due to purchases under the bond purchase program, which have increased the amount and average duration of the RBA's holdings at 30 June 2021.

  2021
$M
2020
$M
Change in profit/equity due to movements
of +/–1 percentage point across yield curves:
   
Foreign currency securities −/+294 −/+321
Australian dollar securities −/+13,650 −/+3,135

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 and obligations to repurchase gold sold under gold swap agreements.

Liquidity risk may also be associated with the RBA, in extraordinary circumstances, being 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 analysis of portfolio maturity in the 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 and obligations to repurchase gold sold under gold swap agreements. Foreign currency swaps reflect the gross contracted amount of the RBA's outstanding foreign currency swap positions.

Maturity Analysis – as at 30 June 2021

  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 721 14 704 3 0.00
Australian dollar investments
Securities sold under repurchased agreements 979 960 19 0.43
Securities purchased under repurchase agreements 221,994 7,704 187,722 26,568 0.14
Other securities 250,587 355 4,572 92,076 153,584 0.90
Accrued interest 1,414 352 875 187 na
  474,974  
Foreign currency investments
Balance with central banks 14,756 14,024 732 0.00
Securities sold under repurchase agreements na
Securities purchased under repurchase agreements 281 281 0.05
Other securities 41,047 16,786 7,886 10,103 93 6,179 0.22
Deposits 524 0 524 2.53
Cash collateral provided 52 52 0.03
Accrued interest 50 33 17 na
  56,710  
Gold
Gold holdings on loan 454 303 151 0.09
Gold holdings 5,568 5,568 na
  6,022  
Property, plant & equipment 754 754 na
Other assets 716 39 10 3 1 663 na
Total assets 539,897 14,038 27,865 13,511 291,051 153,697 39,735 0.50
   
Liabilities
Deposits 415,576 359,025 56,551 0.01
Distribution payable to the Commonwealth 2,671 2,671 na
Cash collateral received 163 163 0.03
Australian banknotes on issue 95,485 95,485 0.00
Other liabilities 2,997 2,596 2 188 3 208 (0.04)
Total liabilities 516,892 359,025 61,981 2 188 3 95,693 0.01
Capital and reserves 23,005  
Total balance sheet 539,897  
     
Swaps
Australian dollars    
Contractual outflow (29) (29)  
Contractual inflow 4,449 75 4,374  
  4,420 46 4,374  
Foreign currency    
Contractual outflow (28,159) (23,785) (4,374)
Contractual inflow 23,739 23,739
(4,420) (46) (4,374)
 

Maturity Analysis – as at 30 June 2020

  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 516 38 477 1 0.09
Australian dollar investments
Securities sold under repurchase agreements 22 11 11 0.27
Securities purchased under repurchase agreements 138,626 81,367 15,326 13,922 28,011 0.23
Other securities 72,793 215 15,643 22,042 34,893 0.52
Accrued interest 473 178 292 3 na
  211,914  
Foreign currency investments
Balance with central banks 16,046 15,245 801 (0.01)
Securities sold under repurchase agreements na
Securities purchased under repurchase agreements 3,509 3,509 (0.01)
Other securities 38,197 13,984 10,858 6,133 111 7,111 0.16
Deposits 319 319 1.69
Cash collateral provided 49 49 0.14
Accrued interest 80 62 18 na
58,200  
Gold  
Gold holdings on loan 1,096 590 506 0.12
Gold holdings 5,519 5,519 na
  6,615  
Property, plant & equipment 729 729 na
Other assets 697 25 9 4 1 658 na
Total assets 278,671 15,283 101,576 42,663 42,115 35,005 42,029 0.27
   
Liabilities  
Deposits 153,541 82,032 71,509 0.18
Distribution payable to the Commonwealth  
2,567 2,567 na
Cash collateral received 27 27 0.14
Australian banknotes on issue 90,102 90,102 0.00
Other liabilities 2,102 1,651 1 10 12 428 (0.05)
Total liabilities 248,339 82,032 75,754 1 10 12 90,530 0.11
Capital and reserves 30,332  
Total balance sheet 278,671
   
Swaps  
Australian dollars  
Contractual outflow (107) (107)
Contractual inflow 988 988
  881 881
Foreign currency
Contractual outflow (20,844) (20,844)
Contractual inflow 19,963 19,963
  (881) (881)
 

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. The RBA's credit exposure is managed within a framework designed to contain risk to a level consistent with its very low appetite for such risk. 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 under reverse repurchase agreements.

The RBA held no past due or impaired assets at 30 June 2021 or 30 June 2020.

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 to derivative financial instruments is:

1. Foreign exchange swaps – As at 30 June 2021, the RBA was under contract to purchase $23.7 billion of foreign currency ($20.0 billion at 30 June 2020) and sell $28.2 billion of foreign currency ($20.8 billion at 30 June 2020). As of that date there was a net unrealised loss of less than $0.1 billion on these swap positions included in net profit ($0.1 billion unrealised gain at 30 June 2020).

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, a sum that would then have to be replaced in the market, potentially at a loss. To manage credit risk on both foreign exchange swaps (excluding swaps with the Fed under the US dollar swap facility) and gold swaps (see ‘Gold exchanged under gold swap agreements’ below), the RBA exchanges collateral with counterparties under terms specified in 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 2021, the RBA held $0.1 billion of collateral (less than $0.1 billion of collateral was provided at 30 June 2020).

2. Bond futures – As at 30 June 2021, the amount of credit risk on margin accounts associated with bond futures contracts held by the RBA was approximately $2.4 million ($2.4 million at 30 June 2020). As at 30 June 2021, there was an unrealised loss of less than $0.1 million brought to account on those contracts ($1.1 million unrealised gain at 30 June 2020).

Assessment of expected credit loss under AASB 9

The RBA assesses its financial assets carried at amortised cost, mainly its reverse repurchase agreements, gold swaps and foreign currency-denominated balances held with other central banks, for any deterioration in credit quality which could result in losses being recorded. The RBA's assessment is done on an individual exposure basis and takes account of: the counterparties with which balances are held; the collateral, if any, it holds against exposures and the terms upon which collateral is margined; and the remaining terms to maturity of such exposures. Based on the assessment at 30 June 2021, the provision for expected credit losses was immaterial.

Collateral held under reverse repurchase agreements

Cash invested under reverse repurchase agreements in overseas markets is secured against 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, supranational organisations, banks and various corporate and asset-backed securities. 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 agreement that governs 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 in a similar way. The RBA does not sell or re-pledge securities held as collateral under reverse repurchase agreements.

Collateral provided under repurchase agreements

At 30 June 2021, the carrying amount of securities sold and contracted for purchase under repurchase agreements was $996 million ($22 million at 30 June 2020). Terms and conditions of repurchase agreements are consistent with those for reverse repurchase agreements disclosed above.

Gold exchanged under gold swap agreements

Credit exposure from gold swaps is managed under CSAs the RBA has established with its swap counterparties, which cover both gold swaps and foreign exchange swaps. Australian dollar cash collateral is exchanged to cover the potential cost of replacing swap positions in the market if a counterparty fails to meet their obligations. The potential cost is assessed as the net costs of replacing all outstanding swap positions covered by the CSA.

As at 30 June 2021, there was no gold sold and contracted for purchase under gold swap agreements ($0.9 billion at 30 June 2020). There was no gold purchased and contracted for sale under gold swap agreements at 30 June 2021 or 30 June 2020.

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 at 30 June.

  Risk rating of security/issuer(a) Risk rating of counterparties(a) Per cent of investments
2021 2020
Australian dollar investments
Holdings of Australian Government Securities Aaa na 37.8 21.2
Holdings of semi-government securities Aaa na 0.1 2.2
  Aa na 8.7 2.8
Securities purchased under reverse repurchase agreements Aaa Aaa 0.2
Aaa Aa 29.1 24.0
  Aaa A 7.0 9.9
  Aaa Baa 1.4 1.2
  Aaa Other(b) 0.5 2.2
  Aa Aaa 0.2
  Aa Aa 0.5 5.4
  Aa A 1.3 3.1
  Aa Baa 0.1 0.2
  Aa Other(b) 0.3 0.1
  A Aa 0.2 0.9
  A A 0.7 2.0
  A Baa 0.1 0.2
  Baa Aa 0.0 0.1
  Baa A 0.1 0.1
  Baa Baa 0.0 0.1
Securities sold under repurchase agreements Aaa Aa 0.1 0.0
Foreign investments
Holdings of securities Aaa na 3.5 6.5
  Aa na 1.5 4.3
  A na 2.5 2.8
Securities purchased under reverse repurchase agreements Aaa Aa 0.1 1.0
Aa A 0.3
Deposits na Aaa 0.4 0.4
  na Aa 0.0 0.1
  na A 2.4 5.4
  na Other 0.1
Other Aaa Aa 0.1
  Aaa A 0.1
Other assets 1.4 3.0
  100.00 100.00

(a) Average of the credit ratings of the three major rating agencies, where available
(b) This category includes counterparties that are not rated