Reserve Bank of Australia Annual Report – 1962 Monetary Policy

Reserve Bank policies throughout 1961/62 were designed to encourage a revival of business activity and economic growth. Monetary restraints were progressively reduced or removed.

Discussions involving the Government, the Reserve Bank and the trading banks resulted in agreement upon some new banking arrangements. The object of the new arrangements is to enable the trading banks to contribute more effectively to recovery and development by allowing them greater flexibility and range in the conduct of their business, while maintaining adequate control in the hands of the monetary authorities over bank credit and banking operations generally. The arrangements, which were announced by the Treasurer in April, 1962, concern bank interest rates, the provision of some new forms of lending by the banks and the investment of bank liquid funds in the newly available Treasury Notes.

Bank lending

Some relaxation of the selective restraints on bank lending imposed in 1960 had been possible in the first part of 1961 and by June, 1961, the Bank had restored to trading banks much wider discretion in the allocation of loans. However, banks were still required to be especially restrictive where bank finance was contributing to the demand for imports and to avoid lending for hire purchase and instalment selling and for speculative activities. In October, the Bank considered it appropriate to remove the remaining restrictions and so restored to the banks general discretion about the classes of lending they could undertake. At the same time, the banks were asked to exercise this discretion with a view to discouraging the re-emergence of speculative activities and excessive levels of certain types of expenditure that had made necessary the selective controls of November, 1960. In addition, they were asked to give special weight to the need to increase employment and productivity in Australia and to continue the preferential treatment being given to housing and export production.

With bank liquidity rising to unusually high levels and with the encouragement of the now moderately expansive credit policy of the Reserve Bank, the rate at which new loans were being approved by the banks was quickly expanded and continued at a fairly high level throughout the financial year. However, towards the end of the year with economic recovery under way, public liquidity high and a substantial volume of overdraft limits undrawn, there was no longer the same need for positive stimulus to the economy through additional bank lending and a steadying of the rate of new lending commitments seemed appropriate.

Despite the fact that the rate of new lending commitments by banks was relatively high through-out most of 1961/62, the decline in bank advances outstanding which had begun late in 1960 continued until early in 1962. It was only in the closing months of the year that an upward trend emerged, and there was almost no net movement in advances outstanding over the year.

The sluggish response of bank advances outstanding to the change to a much easier bank lending policy was a notable feature of the year. A lag of an opposite kind had been evident during the period of credit tightening early in 1960/61 when advances outstanding had continued to rise after new lending approvals had begun to fall.

The relationship between loan approvals and drawings against them is complex and varies with circumstances. Disparity between movements in these two series is to be expected in periods of sharp change in bank lending policies. Changes in policy operate in the first instance upon the rate at which new loans are being approved and tend to be in the opposite direction to the current pressures of bank borrowing as manifested in movements in advances outstanding. The relationship between current rates of new lending and actual movements of advances also reflects time lags in adjusting expenditure to changes in available finance and in business conditions. Moreover, in periods of major economic change, factors peculiar to that period may have a strong influence. This was obviously the case in 1961/62 when economic activity was recovering slowly from a sharp fall and when liquidity generally was rising. In these conditions, repayments of loans drawn in the earlier boom period were heavy and the need to draw on limits established with banks was relatively light.

However, in a system based on lending by overdraft, the level of expenditure can be influenced not only by the final drawing of bank advances but at an earlier stage by the approval of loans. Notwithstanding the time lags between the approval of loans and their drawing, a stimulus can be given to the economy when approvals are high and rising by providing assurances of financial accommodation; when approvals are low or falling, expenditure can be dampened by the lack of such assurances. But if economic activity were quickly to regain boom proportions the substantial addition to aggregate undrawn lending commitments of the banks during the year could be a problem.

Major Trading Banks Lending Statistics 1961/62

Information is not available over a sufficiently long period to indicate the extent to which aggregate overdraft limits are likely to be drawn at any time. However, between June, 1960, and June, 1962, which includes the period of 1960/61 when the rate of new lending commitments by the banks was very restrictive in relation to the demand for credit, the proportion of aggregate limits actually drawn varied between the high and low points of 63.4 per cent at July, 1961, and 54.8 per cent at March, 1962. At the end of 1961/62, the figure was 57.4 per cent.

Bank liquidity

Pressures on bank liquidity had been eased late in 1960/61 by reductions by the Reserve Bank in the Statutory Reserve Deposit ratio. There was a strong rise in liquidity during subsequent months assisted initially by a further reduction in the Statutory Reserve Deposit ratio in July, 1961, but resulting mainly from the increase in international reserves and the Government's financing operations over the year.

Absorption of part of the high liquidity into Statutory Reserve Deposit Accounts could have been made as the year progressed as a precaution against the possibility of excessive pressure for loans developing in the future. Such action need not have affected current lending. In other circumstances, it could be equally appropriate to reduce the S.R.D. ratio if necessary to maintain adequate banking liquidity even if current credit policy was restrictive. Determination of a different S.R.D. ratio—either higher or lower — may at times be no more than a technical adjustment to other influences on banking liquidity and have no special policy significance. However, in the circumstances of 1961/62, when it was important to promote confidence and a reasonably expansive outlook, and when bank lending was supporting these objectives in conformity with Reserve Bank policy, it was thought unnecessary to make increases in the S.R.D. ratio, especially as these might have been misinterpreted as indicating restriction. Accordingly, after the initial reduction of one per cent in the ratio at the beginning of the year, the only other change was a further reduction of 2 per cent as part of the special term lending arrangements introduced in April, 1962. Over the closing months of the year a number of factors operated to reduce the earlier very large margin of liquidity above the conventional minimum level. These influences included the sharp seasonal fall in liquidity, the one per cent transfer from L.G.S. assets to the term loan funds and the increase in the conventional minimum L.G.S. ratio from 16 per cent to 18 per cent. By the end of the financial year, the L.G.S. ratio was about 24 per cent which still left a “free” margin of 6 per cent compared with about 3 per cent at June, 1961.

Many factors may be relevant in determining a bank's attitude to new lending in a given situation. Clearly one of these, and at times a dominant one, is its liquidity. The operation of the L.G.S. convention has given greater certainty to judgments as to the likely response of the banks to a given level of current liquidity. The items comprising the L.G.S. assets of the banks for the purpose of the liquidity convention are notes and coin, cash with the Reserve Bank (which does not include Statutory Reserve Deposits or Term Loan Fund Accounts), Commonwealth Treasury Notes and bills and other Commonwealth Government securities.

This convention, first established in its present form in 1956, codified certain firm understandings reached between the Reserve Bank and the trading banks, namely—

1. each bank undertook to direct its policy to ensuring that its L.G.S. ratio would not fall below an agreed uniform minimum;
2. each bank undertook that if, for any reason, its L.G.S. ratio fell below the agreed minimum, it would borrow from the central bank; the terms could be penal if the central bank thought this was justified;
3. the central bank undertook to administer the statutory reserves of the trading banks so that, if bank lending was in accord with central bank credit policy, banks generally would be able to maintain the L.G.S. ratios above the agreed minimum.

Initially, the uniform minimum L.G.S. ratio was 14 per cent, although this was regarded by the central bank as too low for a long term objective. Since then, the ratio has been increased on two occasions, by agreement with the banks; to 16 per cent in 1959 and to 18 per cent in April, 1962.

Bank Liquidity – Percentage of Deposits

The margin of “free” liquidity in the banks' hands as measured by the difference between the actual level of the L.G.S. ratio at any time and the conventional minimum level serves both as an indicator and a support for credit policy. This can be illustrated by the following example. If the Reserve Bank thought a more restrictive policy was needed, it would, in addition to informing the trading banks of this view, consider the desirability of administering Statutory Reserve Deposits so as to bring the actual L.G.S. ratios of the banks closer to the conventional minimum. On the other hand, if a more expansive credit policy was appropriate, the Reserve Bank, as well as so informing the banks, would tend to administer the Statutory Reserve Deposits so as to increase the banks' L.G.S. ratios above the minimum and so provide them with the means for and a stimulus to expansion.

In addition to the greater certainty which this convention has introduced into credit policy, it also operates to leave banks with the major part of their liquid and short term assets under their own management and earning market rates of interest. Before the establishment of the convention, banks' L.G.S. assets fell at times to very low levels and Special Account balances (the forerunner of the present Statutory Reserve Deposits) were high. For instance, at the end of 1954, out of a total for L.G.S. assets plus Special Accounts of £670 million, more than half (namely, £352 million) was in Special Accounts whereas, in June, 1962, less than a third (namely, £195 million) was in Statutory Reserve Deposits out of a total of £642 million for L.G.S. assets plus S.R.D.'s.

Bank interest rates

One of the economic measures taken in November, 1960, to restrain boom conditions was an increase in bank interest rates. Both fixed deposit and lending rates were increased, the former very sharply. The increase in fixed deposit rates was intended, among other things, to slow down the turnover of funds through the various non-bank financial institutions which was contributing to the inflationary situation. Other influences operating at the time make it difficult to assess the effects of this change and also the effects of the higher rate on bank advances in discouraging borrowing from the banks. It is clear, however, that the sharp change in bank interest rates was followed by a very marked increase in fixed deposits, both as an absolute amount and as a percentage of total deposits. By the end of 1961/62 fixed deposits represented about 30 per cent of total deposits compared with 21 per cent in June, 1960.

At the beginning of 1961/62, interest rates on fixed deposits were 4 per cent per annum for periods of three months but less than twelve months and 4¼ per cent for periods of twelve months. With the change in economic conditions during the year some reduction in rates seemed desirable, both as a minor adjustment to the changed economic situation and to preserve the scope for flexibility in rates. Accordingly, fixed deposit rates were reduced by ¼ per cent in April, 1962.

No changes in overdraft interest rates were made during the year but an important change in the form of their official regulation was announced by the Treasurer in April, 1962. Under the new arrangements a maximum interest rate (currently 7 per cent) on overdrafts is being continued, subject to possible agreed exemptions but the requirement that each bank should not exceed a specific average rate of interest over all its advances has been terminated. For the future, within the maximum established for bank overdraft rates, the banks will in general be free to adjust rates for individual borrowers and classes of borrowers. However, upon the maximum overdraft rate being moved upwards or downwards by the Reserve Bank, there would be, in the light of discussion between the banks and the Reserve Bank, general movement of most other lending rates in the same direction and to broadly the same extent. This would not necessarily mean that all other rates would be changed by exactly the same amount as the maximum rate. There would be scope for adjusting some rates more or less than others and it might be that, whilst indicating an order of magnitude for the desired general change in rates, the Reserve Bank would request that some classes of borrowers should receive differential treatment. Various classes of rural and other borrowers already receive preferred treatment in the matter of interest rates and this preference is being continued not only in respect of past borrowers but also for current borrowers in the same classes.

The objective of the changed overdraft interest arrangements is to preserve an effective and identifiable mechanism for bringing about changes in the general level of bank lending rates yet to leave as much flexibility as possible to the trading banks in conducting their lending business. It was not intended that there should be any general change in overdraft interest rates at the time.

Term lending by banks

Following the discussions mentioned earlier, the Treasurer announced in April, 1962, a set of arrangements designed to encourage the trading banks to develop some new forms of lending.

Under these arrangements, the trading banks will make fixed term loans for capital expenditure for production in the rural, industrial, and, to a lesser extent, commercial fields and to finance exports. Generally, loans will be for not less than three years and the range will be from three to eight years or possibly a little longer. As examples of typical purposes for term loans, it is contemplated that loans will be made within rural industry for the purchase of land for development, for heavy equipment, for building and fencing, for land clearing, pasture development and herd improvement. In secondary industry they will include factory extensions, plant and machinery, the financing of special reserve stocks and contracts. As to export finance, loans will be generally for capital goods and in some cases for activities associated with the supply of capital goods such as installation costs. In appropriate cases, service industries may be financed but it is not intended that the banks should finance consumption expenditure through these loans.

The broad pattern of interest rates on these loans is to be consistent with overall interest rate policy as determined from time to time.

Fixed term lending has not been a common practice for trading banks in Australia, where most loans are granted on an overdraft basis. Under the overdraft system, although loans may be allowed to run on for lengthy periods, they are repayable on demand. The trading banks considered that, if they were to carry longer fixed term finance in either the domestic or export field, they would need to be assured of having the necessary liquid resources for doing so. By way of allocating specific resources on which the trading banks can operate, special Term Loan Fund Accounts in the name of each trading bank have been established with the Reserve Bank. Amounts equal to 3 per cent of each bank's deposits were transferred to these accounts on 18th April, provided to the extent of one per cent from the existing L.G.S. assets of each bank and 2 per cent from each bank's Statutory Reserve Deposit Account. The aggregate amount of the accounts of the individual banks at the outset was £57 million. These accounts will represent a revolving fund for term lending. The amounts transferred should permit the new lending facilities to be developed steadily over the next few years in accordance with current credit policy.

A small amount of term loans had been approved by the end of the financial year.

GOVERNMENT SECURITIES MARKET

The high degree of liquidity in the economy throughout most of the year was reflected in the Government securities market. Strong buying pressures developed in the bond market and there was a greater response to Government loans issued to finance the borrowing programme for State works and housing than had been expected.

The State works and housing programme was originally set at £240 million but was increased in February, 1962, to £247.5 million. The strong response by the domestic loan market resulted in £225 million being raised internally. This was supplemented by about £16 million from drawings accruing to the Commonwealth against oversea loans. Only an amount of £7 million then needed to be financed by Special loan.

The three domestic loans offered during the year attracted subscriptions of £202 million—£73.5 million in September, £90.4 million in February and £38.5 million in May, the February flotation attracting the highest level of subscriptions for any peace-time loan. Substantial subscriptions were made to these loans by the large institutional investors, particularly the trading banks and life assurance companies, while the public also gave strong support. However, although the May, 1962 loan also succeeded in attracting funds from a wide range of investors, its result reflected the seasonal contraction in liquidity which had commenced to be felt at that time. The issues of Special Bonds also met with considerable success, attracting a net £20 million in cash, while £3 million came from domestic raisings by the State governments.

Market Yields on Commonwealth Government Securities

A total debt of £287 million fell due for repayment during the year, of which £224 million was converted, leaving £63 million to be redeemed.

By comparison with the preceding financial year when the Bank was a net purchaser of some £40 million, during 1961/62 the Reserve Bank was, on balance, a net seller of securities. To a major extent this resulted from a movement of securities from the Reserve Bank to the rest of the banking system (including savings banks) whose holdings increased by about £150 million during the year.

For most of the financial year, but especially during the opening months, the trading banks experienced a high degree of liquidity and for the first six months they were heavy purchasers of securities from the Reserve Bank. The Reserve Bank's net selling to the trading banks continued until March, but during the seasonal downswing in liquidity for the final three months of the year, the trend was reversed and the trading banks became heavy sellers of securities to the Reserve Bank. There was also special selling by the trading banks in connection with the establishment of the new Term Loan Fund Accounts. In the main, Reserve Bank sales to the savings banks were spread unevenly throughout the year but the greater proportion occurred in the first six months when savings bank deposits were increasing rapidly.

There was also a marked increase in the volume of Government debt (including Special Bonds) outstanding in non-official hands apart from the banking system. In particular, the holdings of the life assurance companies rose substantially in this period while authorised dealers in the short term money market added to their portfolios by some £20 million.

In the on ’change market, as the financial year opened, yields on short dated securities were already falling under buying pressure. During July and August, short term yields fell by over ½ per cent as higher levels of liquidity gave rise to increased buying pressures in the market. This decline continued throughout the remainder of 1961 although the rate of decline slackened in December. Yields on medium and long term securities, on the other hand, reacted much less quickly to these highly liquid conditions and remained relatively steady through the September quarter but by the end of 1961, strong buying pressures in the market reduced these yields by about ⅜ per cent. The pattern of yields established in the on ’change market by the end of 1961 was maintained with only minor fluctuations throughout the remainder of 1961/62.

The terms offered in the three loans issued during the year reflected the pattern of yields in the on ’change market. The coupons on all securities offered in the February loan were lower than those offered in September, the long term rate reverting to 5 per cent. The coupons on the May loan were identical with those offered in February. The terms of loans raised in Australia by the Commonwealth Government in 1961/62 are shown opposite.

Seasonal securities were again on issue and were offered on a daily basis as they had been during 1960/61. The 1961/62 series commenced on 15th September at a price of £99/-/6 per cent, equivalent to a yield of £3/19/- per cent per annum, the same as the opening issue yield in the preceding financial year. However, in keeping with the general decline in yields in the bond market, the issue price was increased to £99/1/6 per cent on 27th January, 1962, to give a yield of £3/14/11 per cent per annum. The issue was strongly supported and closed on 30th March, 1962, with total subscriptions amounting to £173 million (compared with £86 million in 1960/61), the maximum amount outstanding at any time being £99 million in February.

In April, 1962, the Government stated its intention of issuing a new form of short term security to be called Treasury Notes. On 11th July, the Treasurer announced that as from 16th July Treasury Notes would be available on a daily basis during the whole of each year. The notes replace seasonal securities and have the same currency of 13 weeks. The opening price of Treasury Notes was £99/2/- per cent, representing an approximate yield of £3/12/10 per cent per annum if held to maturity. The Reserve Bank provides rediscount facilities for Treasury Notes.

Following the reduction in the coupon rate on the long term security in the Commonwealth's February, 1962 loan, public issues by semi-governmental bodies were offered at £5/7/6 per cent compared with earlier issues of £5/15/- per cent, thus maintaining the same margin above long term bond rate. Earlier, market yields on existing semi-governmental loans had fallen slightly from those in the second half of 1960/61 but throughout 1961/62 were still at higher levels than yields offering on new issues. Interest rates on private borrowings by these bodies also were reduced in February by 7/6d. per cent to a maximum of £5/10/- per cent.

A feature of 1961/62 was the marked increase in the aggregate amount of public issues by semi-governmental bodies from £39 million in 1960/61 to £69 million. This reflected the much higher content of maturing securities covered which rose from £17 million to £50 million.

SHORT TERM MONEY MARKET

The Bank progressively raised the limits on the amounts of funds which dealers in the short term money market may accept and there was a net increase in loans outstanding to the end of June, 1962, of £23 million. Loans accepted by dealers had increased in 1959/60 and 1960/61 by £28 million and £18 million respectively.

The market had risen to about £110 million by the end of October, 1961, and moved around this level until the end of the March quarter. A further increase in limits was allowed by the Bank at the beginning of the June quarter and the market reached a peak of some £118 million during May. However, the usual seasonal pressures during this period caused some fluctuations in the market aggregate and total loans stood at £118 million at the end of the year. Dealers again had marginal recourse to the Bank for loans under the lender-of-last-resort arrangements, but to an even lesser extent than in previous years.

Short Term Money Market – Interest Rates

There was a marked fall in interest rates paid by dealers during the early months of the year and rates generally continued at lower levels than in the previous year. This position reflected both the availability of funds and the generally lower yields on Commonwealth Government securities against which loans accepted from clients are secured. There was some temporary increase in rates during the December quarter but it was not until February, 1962, that the general trend in rates again moved upwards. Towards the end of June, 1962, call rates ranged from £2/-/- per cent to £4/-/- per cent compared with £2/10/- per cent to £4/17/6 per cent a year earlier.

With funds generally more readily available to the market, fluctuations in the market aggregate tended to be less marked than in previous years. It is of interest that a greater proportion of funds is being placed with the market on a call basis, generally accounting for some 90 per cent of the total. This may be indicative of a greater awareness of the market's ability to provide a medium for very short term investment; it could also have reflected the attractiveness of seasonal securities as an alternative avenue for some investors wishing to place funds for fixed periods.

EXCHANGE CONTROL

The long-standing policy of allowing the unrestricted transfer of all forms of current income earned by oversea residents remained in force, and Exchange Control continued to be administered with the prime objective of preventing unauthorised transfers of capital by or on behalf of Australian residents. Withdrawals or repatriation of overseas owned capital continued to be permitted where this was sought.

Some proposals involving the acceptance of obligations by Australian residents borrowing abroad were not approved where, for example, the purposes were considered speculative or the charges involved too high.

The supervision of the return to Australia of the proceeds of exports has been influenced by the policy of encouraging exports; for instance, the extension of trade credit by exporters in excess of the normal maximum of six months after shipment was allowed in some cases where the terms offered were the minimum necessary for Australia to obtain the business. Forward exchange cover was also provided where it could satisfactorily be given in some cases to assist exports.