Reserve Bank of Australia Annual Report – 1997 The Bank's Earnings

The Bank's substantial holdings of domestic and foreign currency assets are the source of large profits in most years. However, the Bank does not pursue profit maximisation as a narrow goal and, as noted earlier, has only limited discretion to take actions to increase the return on its assets. For these reasons, the level of profits in any year is not an indication of the Bank's performance in meeting its monetary and banking policy objectives.

In 1996/97, the Bank's balance sheet was boosted by a sharp increase in balances in Exchange Settlement Accounts held by banks, and by some large year-end flows into the Commonwealth Government's accounts (see page 20 of ‘Operations in Financial Markets’). Some of this balance sheet growth has been unwound in the first months of 1997/98.

The Bank's profits in 1996/97 amounted to $3,705 million, the second highest result recorded. Of this, $1,637 million represented realised gains on gold sales. The remaining $2,068 million derived from the Bank's normal operations and was very close to the average result over the past decade.

There are two components to the Bank's profits – ‘underlying’ earnings, and the capital gains (and losses) on its holdings of financial assets. Underlying earnings reflect the margin between the interest received on assets and the interest paid on liabilities, less the Bank's operating expenses. The largest source of liabilities is currency notes on issue, on which no interest is paid; the recent growth in Exchange Settlement Account balances, however, means that more of the Bank's liabilities pay market-related rates of interest. In 1996/97, underlying earnings amounted to $1,715 million, a little below the previous year because of lower average yields prevailing in domestic and foreign markets.

Capital gains (and losses), the more volatile component of profits, normally arise in one of two ways. First, the capital value of domestic and foreign securities in the Bank's portfolio changes as interest rates change. When interest rates fall, for example, the value of securities in the Bank's portfolio rises, and vice versa. Capital gains and losses are reflected, in the first instance, in the appropriate asset revaluation reserve but, as the securities are sold, the gains and losses are realised and reflect in profits. The net decline in bond yields over the course of 1996/97 generated realised gains of $226 million from sales of securities.

Secondly, gains (and losses) can occur through changes in the Australian-dollar value of foreign-currency-denominated securities held in official reserve assets, as a consequence of exchange rate movements. If, for example, the Australian dollar falls against the currency in which securities are denominated, the value of those holdings in Australian dollars rises. In 1996/97, realised foreign exchange gains totalled $127 million. The recent decline in the Australian dollar also led to unrealised gains which returned the foreign currency revaluation reserve to surplus. The previous year, in contrast, a rise in the Australian dollar had generated substantial unrealised losses, which more than extinguished the unrealised gains built up in this reserve over earlier years. This required a charge (of $1,010 million) against 1995/96 earnings which was not repeated in 1996/97.

In 1996/97, the major source of capital gains was gold sales. The realised gains represented the difference between the market price of the gold sold and the former official price of US$35 per ounce at which it had been purchased many years earlier. Taken together, realised gains from gold sales and from sales of financial assets resulted in a net capital gain for the year of $1,990 million. This brought the Bank's net operating earnings to $3,705 million, an increase of $1,219 million on the previous year.

The Bank's profits are paid to the Commonwealth Government, after any transfers to the two reserve funds which the Bank maintains to deal with contingencies. With the Treasurer's approval, realised gains on gold sales have been retained in the Reserve Bank Reserve Fund and a modest transfer was made to the Reserve for Contingencies and General Purposes. The Bank's dividend out of 1996/97 profits is $1,700 million, to be paid in August.

The Bank's 1996/97 Financial Statements are presented in the following pages.