RDP 2001-07: A History of Last-Resort Lending and Other Support for Troubled Financial Institutions in Australia 9. The Post-war Period

War-time banking controls gave the Commonwealth Bank authority to regulate trading banks' lending and purchases of government securities, and required banks to lodge surplus funds in a ‘Special Account’. The emergency measures also gave the Commonwealth Bank comprehensive powers over foreign exchange transactions and bank interest rates. The aim of the regulations was to minimise the inflationary impact of war expenditure, to divert financial resources to war purposes and to control banks' profits.

While efforts to nationalise the Australian banking system were defeated, banking legislation in 1945 put into permanent form much of the banking structure that had emerged during the war and cemented the Commonwealth Bank's role as the central bank. For both financial stability and consumer protection reasons, the Commonwealth Bank was given responsibility for the protection of bank depositors.[57] The prime focus of the extension of central banking powers, however, was macroeconomic policy. Controls on interest rates and the supply of liquidity constrained banks' ability to lend. In such an environment, credit rationing on a non-price basis left little room for banks to take risks. As a result, loans to banks were made for monetary policy reasons rather than out of need for last-resort support.

In mid 1947, the Commonwealth Bank offered the banks short-term loans as an alternative to the release of special accounts as a means of improving banks' liquidity without adding to their profitability. The Commonwealth Bank regarded the loans as temporary to permit banks to make ‘essential’ advances.[58] However, the loans were renewed fairly automatically. Although the rate charged was intended to be high enough to encourage banks to quickly repay any borrowings, some banks found it profitable to remain substantially in debt to the central bank (Butlin 1983).

By mid 1949, the banks' reliance on loans from the Commonwealth Bank became a matter of concern. Several banks had virtually abandoned liquidity management and relied on the central bank for their day-to-day cash needs. In January 1950, therefore, withdrawals from special accounts were permitted on the condition that the funds were used to either buy government securities or repay central bank advances (Butlin 1983). In 1952, the Commonwealth Bank moved away from providing loans to banks virtually on demand.[59] This left the central bank to focus on cyclical and last-resort liquidity.

The Liquid Assets and Government Securities (LGS) convention came into force in March 1956. Under the convention, banks agreed to keep a certain proportion of their depositors' funds in liquid assets and Commonwealth Government securities. If a bank fell below the minimum it was required to borrow from the central bank. The terms and conditions of any loan were at the central bank's discretion, and depended on whether the bank was complying with the central bank's overall credit policy. In practice, lending under the convention was not infrequent, particularly during the seasonal run-down in liquidity at the end of each financial year as tax payments fell due. The interest rate charged on the loans was not always penal, although higher rates were charged on larger loans. The loans were intended to be short term (up to 30 days), but, on occasion, they were outstanding for several months. Depending on the circumstances, higher interest rates were sometimes charged on such longer-term loans. By smoothing seasonal and other short-term fluctuations in liquidity such lending served as a tool of the Commonwealth Bank's monetary operations rather than financial stability policy.

Similarly, the development of the official short-term money market in 1959 saw the Commonwealth Bank agree to provide liquidity support to authorised dealers. Although loans, which were termed last-resort loans, were made on a regular basis, they were not so much directed at overall financial system stability as the smooth day-to-day functioning of the short-term money market and the operation of monetary policy.[60]

In 1955, the private banks entered the savings bank market. This prompted the Commonwealth Bank to revisit the support it was prepared to offer to savings banks. In 1959, the Commonwealth Bank agreed to help savings banks sell their holdings of government securities if they found themselves losing liquidity.[61] In 1959, the central banking and commercial banking operations of the Commonwealth Bank were separated with the formation of the Reserve Bank of Australia. In 1965, the Reserve Bank extended the degree of support it was prepared to provide, indicating that the savings banks would be eligible to receive emergency support in the form of direct loans, although the conditions to be placed on such loans were left open (Schedvin 1992).


Paragraphs 11–13, Banking Act (1945) No 14, Commonwealth Government Printer, Canberra. [57]

The value of these loans outstanding averaged a little under $70 million between June 1947 and June 1952 (Schedvin 1992). [58]

For example, the Governor of the Commonwealth Bank wrote to the ANZ Bank stating that it had been guilty of misusing loans from the central bank; these were a temporary source of funds, and not to be used as a means of expanding banks' lending. The Governor indicated penal interest rates would be increased to ensure the ANZ did not continue to rely on central bank loans for other than exceptional and temporary purposes (Merrett 1985). [59]

Total loans outstanding reached upwards of $70 million in the 1960s, $370 million in the 1970s, and $825 million in the 1980s. In May 1989 this line of credit was changed to an end-of-day repurchase facility. This repurchase facility was withdrawn in August 1996 as part of broader changes to the Reserve Bank's domestic market operations. This marked the end of the official short-term money market, and the authorised dealing companies were either wound up or absorbed into their parent organisations. [60]

For example, a confidential agreement between the Commonwealth Bank and the State Bank of Victoria specified that, if depositors' withdrawals were exceeding deposit inflows and the State Bank was not at the same time making new loans, the Commonwealth Bank would buy Commonwealth Government securities from the State Bank at a price that would guarantee the rate of return earned by the State Bank (Murray and White 1992). [61]