Reserve Bank of Australia Annual Report – 1979 Financial Markets in 1978/79

Financial Conditions

The year as a whole

Financial conditions in 1978/79 were generally easier than in the year before. The expansion in bank and other private holdings of liquid assets and Government securities (LGS) was about the same as in 1977/78 when releases to the banks from Statutory Reserve Deposits (SRDs) provided substantial support; however, the accumulation of LGS in the first three quarters of 1978/79 was greater and net purchases of Commonwealth Government securities by non-bank groups were much lower. These factors and the composition of the rise in liquidity over earlier months contributed to the seasonal run-down being negotiated comfortably by the private sector.

Although the magnitudes varied, the general pattern of flows of funds between the major sectors of the economy was broadly similar to that in the previous year. Public authorities had an aggregate deficit (on a national accounts basis) of around $5.3 billion, about 10 per cent higher than in 1977/78. The deficit of corporate trading enterprises was also, perhaps, larger than in the previous year. These deficits were met by net borrowing from households and unincorporated enterprises and from overseas. Boosted by strong growth in farm incomes, households and unincorporated enterprises seem to have increased their net lending in 1978/79. Borrowing from overseas, indicated by net capital flows and net monetary movements, also increased.

As a ratio to gross domestic product, the public sector's deficit was about the same in 1978/79 as in the previous year, but in absolute terms it was the largest on record, comparing with about $4.8 billion in 1977/78 and $2.9 billion in 1974/75. While the deficit of the Commonwealth's budget sector has been kept about steady since the sharp jump in the mid 1970s, the deficits of the other tiers of the public sector have increased. Until a few years ago Commonwealth authorities “outside the budget” were financed almost entirely by advances from budget funds; subsequently these bodies have undertaken substantial borrowings on their own account and in 1978/79 their projected deficits, after some contribution from budget funds, amounted to over $500 million. Net borrowings by State and local authorities have also grown apace. The borrowing programmes of State semi-government authorities expanded furtherwith Loan Council approval, in principle, in November 1978 of a forward infrastructure financing programme amounting to almost $1.8 billion over eight years.

The Commonwealth Government's budget deficit in 1978/79 was $3.5 billion, somewhat higher than in 1977/78 and well above the figure of $2.8 billion estimated in the Budget. After allowing for net borrowing overseas and miscellaneous financing transactions, the Commonwealth's domestic borrowing requirement in 1978/79 came to almost $2.1 billion, which was over $500 million greater than in the previous year.

As well as being considerably larger in 1978/79, the way in which this borrowing requirement was financed was quite different from that in 1977/78; this is shown in the bottom segment of graph 6. In 1978/79, private non-bank groups contributed just over $700 million, about one-third of the total borrowing requirement; this share compares with 82 per cent in 1977/78 and 48 per cent the year before. Among the influences acting to depress non-bank demand for Commonwealth securities in the year past were:

• the abatement after October of expectations that yields on bonds would fall further in the near future; this was influenced by revised expectations about inflation, increases in interest rates overseas, signs of rising monetary growth in Australia and by gradually increasing awareness that the Commonwealth deficit and the borrowing requirement of the rest of the public sector were remaining high;
• changes in various interest rates since the end of 1977, which made Australian Savings Bonds, until their yield was raised in April 1979, a less attractive investment in comparison with some competing claims; Savings Bonds raised a net $280 million in 1978/79 compared with about $400 million in each of the previous two years; and
• the fact that substantial purchases in the previous couple of years had left portfolios well stocked with Government paper.

6. GOVERNMENT FINANCE

The counterpart of the reduced take-up by non-bank groups was a greater contribution to Government financing by the banking system. Since this component of financing contributes to the formation of bank deposits, its greater use was part of the basis ofthehigherrateofgrowthinmoneyin 1978/79. Net purchases of Commonwealth securities by the trading and savings banks were $900 million compared with no increase in holdings over the previous year. Through net purchases of securities and a run-down in the Government's cash balances, residual financing by the Reserve Bank was about $350 million ($260 million in 1977/78).

Apart from the Government's operations, other factors bearing importantly on financial conditions in 1978/79 were:

• the balance of payments;
• rural credits advances from the Reserve Bank; and
• bank advances.

The private sector had a deficit on balance of payments with the rest of the world of about $250 million, substantially lower than in the previous year. There was a marked within-year swing in private sector foreign exchange transactions; a deficit of about $650 million in the first half of the year was followed by a surplus of about $400 million in the six months to June.

Advances through the Rural Credits Department of the Reserve Bank, which provides finance to rural marketing authorities, contributed to easy conditions in the March quarter when, boosted by large advances to the Wheat Board, they added about $940 million to LGS holdings of the private sector. The Wheat Board's later refinancing of some of these advances provided some offset to the generally comfortable conditions during the seasonal run-down. The net increase in rural credits advances outstanding over the year was not substantial.

Advances outstanding of the trading and savings banks increased by almost $3.3 billion (not including purchases of about $500 million in local and semi-government securities) or 13 per cent; this growth was about the same as in the previous year. Outstandings increased more strongly in the first half of the year when trading banks purchased a large volume of commercial bills. Details of the operations of the banks and other financial intermediaries are in the second part of this chapter.

Bringing the various contributions together (see graph 4 on page 13), the volume of money (M3) increased by 11.8 per cent during 1978/79; with private external transactions in small deficit, domestic credit grew a little more rapidly, by 12.4 per cent. Both money and domestic credit rose at a pace faster than in 1977/78.

Seasonal movements

Variations in financial conditions were, following the usual seasonal pattern, dominated by swings in the public sector's accounts, with major financial aggregates expanding over the first three quarters of the year and contracting in the June quarter (see graph 3 on page 11). The fluctuations due to the Commonwealth's budgetary operations were augmented in 1978/79 by the big rural credits advances from the Reserve Bank in the March quarter, and the later refinancing of some of these loans.

The spreading of collections of company income tax, which has been introduced in recent years, has smoothed somewhat the swings in the Government's contribution to liquidity; 1978/79 was the first financial year with a collection in each quarter. However, there are still wide within-year fluctuations in Government financing; with the bulk of provisional tax from persons, plus still about two-fifths of company tax, collected near the end of the year, the depletion of private liquidity in the June quarter remains substantial. The Commonwealth Government's surplus in the final quarter of 1978/79 was about the same as in the June quarter of the previous year.

The accumulation, from the previous July, of private LGS ended in March at around $3.1 billion and was followed by a run-down amounting to about $1.4 billion; the comparable figures for the previous year, when there were SRD releases of almost $500 million in the June quarter, were a peak of almost $2.8 billion (in February) and a run-down of $1 billion.

Although larger than in 1977/78, the downswing in LGS in 1978/79 was negotiated comfortably. Despite calls to the SRDs of major trading banks in the March quarter, it commenced from a higher peak. In addition, within non-official take-up of Government debt during the upswing, a proportion much higher than in the corresponding period ot 1977/78 was in Treasury notes and other short-dated securities. In the first nine months of 1978/79, non-official groups increased their holdings of Treasury notes by around $2 billion, representing about 70 per cent of non-official purchases of Commonwealth securities in that period; comparable figures for the same months of 1977/78 were about $700 million and 28 per cent. The strong demand for short securities no doubt reflected, in part, the taking of proper precautions against the run-down, but the difference in behaviour in comparison with the previous year had much to do with the sharp reduction after the early months of 1978/79 in appetites for longer-dated paper.

7 FINANCIAL GROUPS: INTEREST RATES

Interest rates

Most official interest rates and yields (see graph 3) continued to move down over the first part of 1978/79; however, the pace of decline was considerably less than during 1977/78. For longer securities this largely reflected the low demand prevailing after October. Following the November conversion loan, yields stabilised for a time and then drifted up. In the second half of the year, with demand for bonds staying weak, yields on all maturities rose further and in June 1979 were about a percentage point higher than in June 1978.

Private short-term interest rates—such as trading yields on commercial bills—fell in July 1978. Soon after, even though financial conditions were generally quite comfortable, they rose and stayed up for a couple of months. In the December quarter, with conditions easier still, they came down and in December were around one percentage point lower than a year before. In the early months of 1979, private market rates began to rise but generally remained below levels ruling in the corresponding periods of 1978.

Corporate industrial borrowers met resistance around mid year to their demand for long-term funds. As with official debt, it appeared that interest rates offered had been reduced to levels lower than lenders, with expectations changed, would accept for new funds; in the second half of the year these rates also increased.

The share market

Share prices, although moving erratically at times and levelling off in the final months of the year, generally made strong gains during 1978/79. At the end of June, the “all ordinaries” index for the Sydney Stock Exchange was almost 20 per cent higher than its level twelve months earlier. The main contributors to this growth were the steel and engineering and the metals and minerals groups. Over the year, dividend yields declined slightly.

Financial Intermediation

In 1978/79, balance sheets of financial institutions in Australia seem to have expanded, in aggregate, by close to 13 per cent; this was near the average rate of growth for the years since 1972/73 when the rise, fuelled by buoyant external accounts was exceptionally rapid.

In the year past, assets of the banks appear to have grown less rapidly than the aggregate for financial groups. The counterpart of this, on the other side of balance sheets, was that the most commonly used measure of money, M3 (mainly deposit liabilities of the banks), again increased less rapidly than broader financial measures that include the liabilities of institutions such as the permanent building societies, money market corporations and finance companies.

Deposits and borrowings

Aggregate inflow of funds to the major financial groups was stronger in 1978/79 than in the previous year.

Deposits with major trading banks increased by just over 11 per cent, much more rapidly than in 1977/78. Current deposits rose at a pace considerably faster than fixed deposits while holdings of certificates of deposit fell once more.

In 1978/79, deposits with savings banks grew by 10 per cent, about the same as in each of the previous two years. After allowing for seasonal influences, deposits seem to have grown more quickly in the second half of the year than in the first; buoyant rural incomes no doubt had some part in this. The disposition of the increase in deposits between investment and other accounts was about the same as in 1977/78.

Permanent building societies once again expanded strongly in 1978/79. Withdrawable funds with societies grew by about 19 per cent, close to the increase in 1977/78; growth was stronger in the six months to December than subsequently. Reductions in societies' interest rates were made around the middle of the year and inflow in New South Wales was affected by a disturbance experienced by one society in March following unfounded rumours about its stability. In April an increase in the interest rate on Australian Savings Bonds made them more competitive with the liabilities of those institutions holding household savings. During the year, the Government continued its study of a scheme for insurance of deposits with permanent building societies and of other measures to increase the stability of building societies.

Funds with finance companies grew by about 11 per cent during 1978/79, somewhat less rapidly than in other recent years. With demand for loans generally not pressing available funds, companies reduced interest rates on their debentures over the first three-quarters of the year. The placing in receivership of one finance company in February and subsequent publicity about the problems of some other companies may also have affected inflows at a time when demand for finance seemed to be picking up. Towards the end of the year there were some increases in rates on debentures.

Borrowings outstanding of money market corporations expanded strongly in 1978/79.

Advances

Aggregate finance outstanding of most of the major intermediaries in 1978/79 expanded a little less rapidly than in 1977/78. Consumer lending was prominent in the overall increase and finance for purchasing or building dwellings also rose. The rate of new lending to the rural sector increased and rural debt outstanding seems likely also to have risen. Apart from some particular areas of strength, demand for funds by business was subdued and once again corporate trading enterprises seem to have financed a large part of their needs internally or through new issues; the cut in the investment allowance at the start of the year may have reduced demands for finance during 1978/79.

8. FINANCIAL GROUPS: SELECTED LIABILITIES

9. FINANCIAL GROUPS: ADVANCES OUTSTANDING

Loans, advances and bills discounted by the major trading banks in 1978/79 increased by almost 12 per cent, close to the average for the previous three years. Growth was particularly rapid in the first half of the year when holdings of commercial bills increased apace and contributed about two-fifths of the rise in total outstandings (compared with about one-quarter in the corresponding period of 1977/78). After January, holdings of bills were reduced and by mid May were back to the level at the beginning of the financial year.

The bulk of the increase in total new commitments approved by major trading banks in 1978/79 as compared to the previous year was in personal loans (including instalment loans and finance to individuals for housing) and lending to the rural sector (partly through loans refinanced by the Primary Industry Bank of Australia which began operations in November 1978). Lending for industrial and commercial purposes was much the same as in 1977/78.

Over the first half of 1978/79, new and increased overdraft approvals by major trading banks fell back from the high figures recorded around the end of 1977/78. Since cancellations and reductions stayed relatively high, net new approvals (see graph 3) also dropped to a trough around December/January. Subsequently, with seasonally greater demand for finance, both gross and net new approvals rose; for net lending, the average weekly rate increased from $27 million in the first half of the year to $34 million in the second. The usage ratio for overdraft limits was 66.4 per cent around the end of the year, compared with 65.5 per cent twelve months earlier; however, on average, this ratio was lower over 1978/79 than during 1977/78.

Savings banks' advances outstanding for housing increased in 1978/79 by 15 per cent. Although this was somewhat below the average increase for recent years, it was still faster than the increase in deposits during 1978/79 and reflected a continuation of longer term shifts in the banks' portfolios. Allocation of a larger share of funds to housing has been made possible by reductions in the proportion of deposits required to be invested in liquid assets and public sector securities; this proportion was reduced again, from 45 to 40 per cent, in August 1978. Loans for housing represented about 48.5 per cent of deposits in June 1979 compared with 46.5 per cent in June 1978 and about 29 per cent in June 1969. The value of finance approvals for housing expanded strongly in 1978/79 but, reflecting borrowers' preferences, a reduced proportion went to new dwellings.

Advances outstanding of permanent building societies increased by 20 per cent in 1978/79, compared with the rise of 21 per cent in the previous year. The value of new loan approvals was about $2,250 million, 25 per cent higher than in 1977/78. As with loans by savings banks, the proportion of finance going to new dwellings edged down.

Loans outstanding of finance companies in 1978/79 increased by about 11 per cent, roughly in line with the growth in their borrowings. Outstandings for housing and other loans to individuals, where competition from banks was strong, rose less rapidly than did other business.

Advances outstanding of money market corporations rose considerably faster in 1978/79 than in 1977/78. The extent to which the increased lending of these corporations reflected financing of ultimate borrowers, rather than other financial corporations, is not readily identifiable.

Liquidity

Liquidity in financial markets was at comfortable levelsduring much of 1978/79.

The liquidity of major trading banks was considerably higher, on average, than in 1977/78. The banks' LGS ratio rose from 21.4 per cent in June 1978, to a monthly average peak of 27.2 per cent in February. Liquidity was reduced by calls to SRD (the first since February 1977), each of one percentage point, in January and March. In June 1979 the LGS ratio averaged 21.4 per cent.

With their advances growing faster than their deposits, savings banks reduced the proportion of liquid assets and public sector securities in their portfolios a little further during 1978/79. As in other recent years, they cut back their holdings of Commonwealth Government bonds but their portfolios of local and semi-government paper increased by a little more than in 1977/78.

10. FINANCIAL GROUPS: LIQUIDITY

Liquid assets (broadly defined) of permanent building societies represented about 17 per cent of withdrawable funds at June 1978. With inflow buoyant, this was augmented steadily in the first part of 1978/79. However, in the second half, as growth in withdrawable funds eased, liquidity ratios declined and the overall liquidity ratio at June 1979 was about the same as twelve months before but societies were more liquid, on average, during 1978/79 than they had been in the previous year.

With conditions comfortable for much of the time, authorised dealers in the short term money market maintained loans from clients well above levels in 1977/78; the average for the year, about $1.4 billion, was some 18 per cent above the figure of $1.2 billion recorded in 1977/78. However, the expansion in the dealers' liabilities to clients within the year, about 16 per cent, was much less than that recorded during 1977/78. In most months, the average interest rate on loans from clients was below that ruling in the corresponding periods of the previous year. Dealers reduced appreciably the average length of their portfolios during 1978/79.

Institutional Developments

Primary Industry Bank of Australia

In September 1978, authority to conduct banking business in Australia was granted to the Primary Industry Bank of Australia (PIBA). Its initial share capital was contributed equally by the major trading banks, four State banks (in combination) and the Commonwealth Government.

PIBA refinances loans (with terms of eight to thirty years), which have been made to primary producers by other lenders. Its objective is to facilitate the provision of fixed-term finance to primary producers for longer terms and at a lower cost than would otherwise be available. In June 1979 PIBA had about $110 million outstanding in loans to other financial institutions.

Currency futures trading facilities

In January 1979, the Treasurer announced that the Government had no objection to the establishment of facilities for trading in currency futures; this was in response to representations by various organisations. These facilities would have to be operated in accordance with existing exchange control policy, which meant, among other things, that trading by non-residents and arbitrage transactions by residents between the Australian and overseas markets would not be allowed. Plans were subsequently announced by interested parties for the establishment of such facilities and later in the year the major trading banks began operating a currency hedge market.

The new facilities will supplement the unofficial currency hedge market that has operated for some time and the arrangements for official provision of forward cover on eligible international trade transactions.

Committee of Inquiry into the Australian Financial System

In January, the Treasurer announced the establishment of a committee, chaired by Mr. J.K. Campbell, to inquire into the Australian financial system.

The Committee's terms of reference instruct it to inquire into and report on the structure and methods of operation of the financial system and the regulation and control of the system. It is to make recommendations on these matters and may also inquire into, report and make recommendations on other matters which the Committee believes are relevant to its inquiries.

The Bank welcomes this inquiry, the first into the workings of the financial system since the 1937 Royal Commission into Monetary and Banking Systems in Australia. As an initial contribution to its work, the Bank has prepared a series of papers, containing both factual and analytical material, for the Committee's use.

Arrangements for marketing Commonwealth securities

In April, the Loan Council considered proposals from the Commonwealth Government for changes in the arrangements for marketing Commonwealth securities.

The Council agreed to a new system of issuing Treasury notes which will provide for their sale by periodic tender through the Reserve Bank acting on behalf of the Commonwealth. This will replace the existing system whereby Treasury notes have been available on continuous issue at predetermined prices.

The Loan Council also agreed, in principle, to replace the present system of selling Commonwealth bonds in periodic cash loans with a “tap” issue system. Under this system, new securities would be available more or less continuously to investors.

At a meeting in late June, the Loan Council further considered technical aspects of the proposed “tap” system. Under the new system, maximum interest rates for local and semi-government borrowings will continue to be set at a margin above the yields on Commonwealth bonds of comparable periods to maturity; the maximum rates on these borrowings will be adjusted as necessary to allow for movements in yields on bonds.

These changes in arrangements for marketing Commonwealth securities are expected to come into effect during 1979/80.

The Bank of Adelaide/Finance Corporation of Australia Limited

Following the release in February of its financial statements for the period ended December 1978, the affairs of Finance Corporation of Australia Limited (FCA), a finance company wholly owned by The Bank of Adelaide, came increasingly under discussion in markets and the media. The concern expressed related particularly to the value in its balance sheet of its holdings of developmental land. Early in April, having in mind its responsibilities towards bank depositors, the Reserve Bank (which was carefully monitoring the situation) told The Bank of Adelaide that the Reserve Bank would view with concern any suggestion of an increase in the then-existing level of support of FCA by The Bank of Adelaide.

As it became clear that the situation of The Bank of Adelaide group was such as to need outside support, The Bank of Adelaide explored alternative sources of assistance, including a possible merger with another Australian bank. Early in May it sought assistance from the major trading banks.

With the Reserve Bank kept informed at each stage, those banks formed a working party which made a prompt study of the position of The Bank of Adelaide group. The working party formed the view that it would be appropriate and prudent for FCA to make substantial specific and general provisions for possible losses in relation to certain of its assets. In these circumstances it was clear that, to maintain its borrowing capacity under the debenture trust deed, FCA would need further subscriptions of capital when making such provisions. A consequence of such actions would be a reduction of The Bank of Adelaide's own capital accounts — importantly, a support for its deposit liabilities. This was a matter of concern to the Reserve Bank.

In the event, on 14 May the major trading banks agreed to make a subordinated loan of $50 million (drawn initially to $30 million) to The Bank of Adelaide and to provide management support to FCA. At the same time, the Reserve Bank provided The Bank of Adelaide with a specific liquidity facility, initially drawn to $10 million, in addition to customary arrangements under the LGS convention. The Bank of Adelaide subsequently subscribed capital to FCA.

As part of the understandings connected with these short-term arrangements, and to provide a firm basis for resolution of the situation, the Reserve Bank advised The Bank of Adelaide to seek a merger with a major Australian trading bank. On 22 May, the Board of Directors of The Bank of Adelaide unanimously decided to recommend to shareholders a scheme for the merger of the interests of The Bank of Adelaide with Australia and New Zealand Banking Group Limited.

Early in June, the Treasurer announced that he had informed the two banks that, from the Commonwealth Government's viewpoint, there would be no objections in principle to their proceeding to merge their interests on the broad basis outlined to him. He had also informed them that it would be his intention, subject to detailed examination of the specific proposals yet to be formulated, to facilitate the processes involved in obtaining the necessary consents and authorisations so far as Commonwealth legislation was concerned. At the close of the financial year, the legal and administrative processes necessary to present formally the merger scheme to shareholders for their decision were in train.

11. OVERSEAS ECONOMIC INDICATORS I