Reserve Bank of Australia Annual Report – 2005 Business Services

The Reserve Bank provides a range of services to the community, the most important of which are:

• the provision of banking services to the Australian Government for the core public accounts operated by the Department of Finance and Administration, and transactional banking services to various government agencies;
• the operation of Australia's high-value payments and interbank settlement systems; and
• the supply of currency notes for distribution in Australia.

In addition to these core services, some banking services are also provided to central banks abroad and international agencies, and registry services are provided to the Australian Government. The Reserve Bank's transactional banking and registry services are provided on a commercial basis. These activities are run as individual businesses under competitive neutrality guidelines, which require full cost recovery, including earning an appropriate rate of return on notional capital, through fees and charges paid by the users of these services.

These activities are carried out by Business Services Group, which comprises the Banking, Payments Settlements and Note Issue Departments. Services are delivered through Head Office in Sydney, the branch in Canberra, and for currency services through the National Note Processing and Distribution Centre (NNPDC) at Craigieburn in Victoria.

Banking

Banking services are provided to the Australian Government and to other customers, including around 46 official institutions and central banks abroad.

The Reserve Bank provides a facility to the Australian Government that is used to manage a group of bank accounts, known as the Official Public Account (OPA) Group, the aggregate balance of which represents the Government's daily cash position. These banking arrangements include the provision of a term-deposit facility for the investment of surplus funds, the sweeping of balances to and from agencies' accounts held with transactional bankers, and access to a strictly limited overdraft facility. To assist in monetary policy and liquidity management, this service also includes the electronic collection of forecasting data and reporting on high-value transactions from agencies and transactional bankers. The Department of Finance and Administration manages this facility on behalf of the Australian Government.

The Reserve Bank also provides transactional banking facilities to Australian Government agencies. These services are provided only to a specific range of customers, which tend to have banking requirements that are similar to each other but different from those of most other users of banking products. Because of its particular focus, the Reserve Bank is able to provide facilities tailored to the specific requirements of this group. These facilities include features such as extremely high standards of system reliability and availability, and the flexibility to adapt quickly when changes in government policy require consequent changes in payment arrangements. The Reserve Bank also has dedicated internal IT resources and business analysts involved in researching and developing new banking solutions specifically for the needs of government. Under the Australian Government's competitive neutrality and procurement policies, the Reserve Bank is required to compete with other potential providers when making these services available to customers.

Transactional banking services offered by the Reserve Bank include bank account facilities and the processing of transactions such as deposits, cheques and bulk direct entry payments. Access to these services is usually by way of ReserveLink, the Reserve Bank's electronic desktop banking package, or by way of a direct connection over leased communications lines. Account and transaction enquiries are also available over an internet-based delivery system known as RBANet. The major services provided to government agencies are described below.

The Government Direct Entry Service (GDES) receives and processes bulk electronic direct credit and direct debit transactions from government agencies and distributes these to financial institutions. This service makes use of an extensive communication network and warehousing capabilities, and is the main vehicle used for transactional banking activities by government customers. GDES transactions include welfare, Medicare, salaries and vendor payments; 255.7 million transactions were processed in 2004/05, an increase of 38.7 million or 18 per cent from the previous year. This volume increase was mainly the result of government policy initiatives and the splitting of Part A and Part B fortnightly family tax benefit payments.

Overseas banking services enable customers electronically to request overseas payments to be made via cheque, electronic funds transfer (wires) or direct entry. This service provides government agencies with a secure, timely and cost-effective delivery mechanism for regular overseas payments. The largest group of such payments consists of the payments on behalf of Centrelink of Australian pensions to recipients living abroad, which are made directly to recipients' bank accounts in local currencies through Automated Clearing House arrangements, which the Reserve Bank has established in 22 countries.

Document Printing services enable customers electronically to request the Reserve Bank to issue cheques and electronic documents on their behalf. For cheques, the service includes the production, enveloping and mailing of the cheque together with an attached remittance advice. For electronic payments, the service provides for the delivery (by post, email or facsimile) of a remittance advice, with the actual payment occurring via direct entry. The volumes of transactions processed via this service increased by 11 per cent in 2004/05.

Cheque reconciliation and verification services consist of a full cheque reconciliation and cheque repository service for government agencies as well as a verification system to detect whether or not a cheque has been fraudulently altered. The verification service, developed by the Reserve Bank, provides customers with high-resolution images of cheques presented for payment (both front and back) and allows the issuing agency to confirm that the details of each cheque match details of the cheque when it was originally issued. This system enables the Reserve Bank to detect changes to cheque information quickly, thereby protecting itself and its customers from losses arising from fraudulent alteration of cheques. The system has proven to be highly beneficial to government agencies because it substantially minimises their exposure to cheque fraud.

Payment collection services allow government agencies to receive payments from clients using major credit cards over the telephone or internet or over the counter using cash, cheques and EFTPOS payments. The volume of over-the-counter collections increased significantly during 2004/05. The Reserve Bank also joined the BPAY system in June 2005 as a biller financial institution, preparing the way to offer payment collection services using the BPAY network from later in 2005.

Earnings after tax in 2004/05 for the Reserve Bank's transactional banking services were $3.4 million, compared with $3.0 million in the previous year.

Registry

The Reserve Bank provides registry services to the Australian Government and a number of official foreign institutions which have Australian dollar debt programs. Services provided to all clients include the issue, transfer and registration of securities, the maintenance of ownership records, the distribution of interest payments and the redemption of securities at maturity. Additional services that are specific to the Commonwealth Registry include management and encashment of physical securities; maintenance of records relating to unclaimed CGS monies; provision of reports to the AOFM summarising transactions arising from its CGS lending facility; undertaking historical searches; and the provision of a small-investor facility, which enables retail investors to access CGS. Information relating to the small-investor facility, including indicative buying/selling prices, is now available on the Reserve Bank's website.

With most large institutions holding and settling their transactions in CGS electronically outside the Reserve Bank's registry system, the level of traditional paper-based registry activity is extremely low and consists mainly of small retail holdings. Earnings after tax for the CGS registry business in 2004/05 were $0.1 million, the same as in the previous year.

RTGS and Other Settlement Services

The Reserve Bank provides the real-time interbank payment and settlement service for the Australian financial market through its Reserve Bank Information and Transfer System (RITS).

Interbank settlements take place across Exchange Settlement Accounts (ESAs) conducted by banks and other approved institutions with the Reserve Bank, and largely occur on a real-time gross settlement (RTGS) basis. About 90 per cent of the value of interbank payments is settled by RTGS; this includes all wholesale debt and money market settlements, a range of time-critical customer payments and Australian dollar foreign exchange settlements (including those settled by CLS Bank for which net settlement is made each day across RITS).

Following strong growth in 2003/04, RTGS turnover through RITS increased more modestly in 2004/05. On an average daily basis, around 23,500 payments totalling $140 billion were settled across RITS during the year. This represented growth of around 3.7 per cent and 3.2 per cent, respectively, on the corresponding figures for the previous financial year.

In addition to RTGS payments, RITS settles two batches of netted interbank payments each day: the 9:00 am batch consists mainly of positions collated by the Reserve Bank on behalf of the Australian Payments Clearing Association arising from the previous day's ‘low-value’ clearings (paper, and bulk and retail electronic). The second batch settles net positions for equity transactions in CHESS, the electronic settlement system operated by the Australian Stock Exchange.

RITS also provides a facility for members to participate in electronic tenders for CGS. Since February 2002, settlement of successful tender bids has occurred in the Austraclear System, owned by SFE Corporation Limited.

In 2005/06, the Reserve Bank expects to implement two significant enhancements to RITS:

• The first is a major upgrade to the user interface for online access to RITS, used by holders of ESAs to manage interbank payments across their accounts. The new interface is of a modern browser-based style, which will provide significant benefits to users of the system in terms of ease of operation and more efficient management of RTGS payments. It will also provide the Reserve Bank with a good technical platform for system support and future redevelopment. Members will be able to choose an implementation date for usage of the new interface that is convenient to them in the light of other priorities. It is expected that most members will be using the new interface by around the middle of 2006.
• The Reserve Bank has also been working for some time on the development of improved facilities for the net settlement of batches of related payments. Development of this facility has been completed and it is expected that processing of the CHESS batch for equities will be shifted to this new facility during the first half of 2006. Another potential use for this new facility is an initiative in various States to move towards electronic conveyancing and settlement of property transactions, to replace the current use of bank cheques.

Settlement services are also provided for financial market transactions undertaken by the Reserve Bank in the domestic securities and foreign exchange markets, and other transactions such as those relating to currency note lodgements and withdrawals. Settlement services are also provided to the Australian Government for its high-value transactions, including, for example, the settlement of tenders in CGS and the stock lending activities of the AOFM.

At end June 2005, 36 central banks and official institutions abroad were using the settlement and safe custody services provided by the Reserve Bank to settle their Australian dollar investment transactions.

Note Issue

The Reserve Bank's note issue activities cover three main areas:

• the issue and redemption of currency notes, including organising the production of new notes and making arrangements with banks for the distribution of notes;
• maintaining the quality of notes in circulation, including quality control for new notes, making arrangements with banks for sorting of notes, machine processing and evaluation of notes returned from circulation, and the destruction of notes no longer fit for further use; and
• research into and development of note designs and security features and research into counterfeiting activity.

Notes on Issue

During 2004/05 the value of Australian notes issued by the Reserve Bank rose by $1.6 billion or 4.7 per cent, to $35.6 billion. Among the different denominations, the $50 continues to account for the largest number of notes on issue as well as the largest value. Together, the $50 and $100 account for about 89 per cent of the value of notes on issue.

Volatility in the growth rate of the value of notes on issue in recent years has arisen from changes in the ownership arrangements for the cash-distribution working stocks. In 2001/02, working stock ownership was transferred from the Reserve Bank to the commercial banks, resulting in a large increase in notes on issue in 2002. As banks became more comfortable with the new arrangements, they economised on working stocks and there was only a small rise in 2003. Growth over 2004 and 2005 was more representative of underlying demand, at a rate broadly in line with growth in economic activity.

Note Quality

The Reserve Bank pursues a goal of maintaining a high quality of notes in circulation, to ensure that notes remain fit for use (including in the growing number of note accepting and dispensing machines in the community) and that counterfeits are able to be detected readily. Achievement of this goal requires that notes are sorted for quality by those institutions involved in the distribution process, with the unfit notes returned to the Reserve Bank for replacement. In order to monitor note-sorting performance and its impact on note quality, the Reserve Bank conducts a program of sampling notes from those in approved cash centres; notes collected in the sampling program are transported to the Bank's NNPDC for evaluation.

In the past year, the Reserve Bank strengthened its work with commercial banks and armoured car companies to correct a decline in the quality of the lower denomination notes received in its sampling program and to improve further the general quality of notes in circulation. As a result of this work, some changes were made to the note-sorting standards and the arrangements between the commercial banks and the Reserve Bank to reduce the costs to banks of holding unfit notes awaiting return to the Reserve Bank. There was a consequent sharp increase – to 98 million, from 67 million in 2003/04 – in the number of notes returned by banks and armoured car companies designated as unfit. A working group, comprising representatives of the commercial banks and the Reserve Bank, has been formed to examine further existing arrangements between the commercial banks and the Reserve Bank for the identification and removal of unfit notes from circulation. The work of this group is likely to lead to a renegotiation of existing agreements between the commercial banks and the Reserve Bank, with the scope of the agreements widened to place the objectives for note quality into sharper focus.

Work has also been completed during the past year for the upgrading of high-speed note-processing equipment at the NNPDC, incorporating improved detectors for identifying unfit notes. The new machines will enhance the Reserve Bank's monitoring of compliance with sorting standards by commercial banks and armoured car companies.

Some notes become accidentally damaged in circulation, beyond the normal levels of wear and tear, and become unsuitable for sorting using processing equipment. The Reserve Bank has always had a policy of paying value for these severely damaged notes, depending on the amount of the note which remains recognisable and can be authenticated. Under this policy, most damaged notes receive full value, but where a large piece of a note is missing, and the different pieces of the note could be presented to the Reserve Bank at different times, only partial value is paid on each piece. These incomplete notes can be assessed manually by banks, although many are passed directly to the Reserve Bank for assessment, in which case the assessment is done at the NNPDC. During the year, the NNPDC assessed over 24,000 note claims, with a total value of $3.0 million. The volume of claims assessed was more than double the previous year's volume, but the total value was only 20 per cent higher.

As the emphasis on note quality was increased during the year, some confusion occasionally arose in the community about the differences between notes with normal wear and tear (for which full value would be paid) and those which are incomplete or have other severe damage (for which full value might not be paid, if large pieces were missing). This confusion appeared to result from a misunderstanding of the guide issued to commercial banks for their use in determining note fitness. The Reserve Bank moved to correct this situation through media interviews to clarify the policy on damaged notes as well as by providing clearer explanatory material on damaged notes to staff of commercial banks and to the public, including on the Reserve Bank's website.

New Note Orders

The Reserve Bank took delivery of a total of 160 million new notes in 2004/05 from Note Printing Australia; this amounts to 10 new notes for every person in Australia aged 15 years and over. This was made up of 42 million $5 notes, 34 million $20 notes and 84 million $50 notes. In 2004/05 the number of notes printed was about double that of the previous financial year, reflecting the desire to improve the quality of notes in circulation and to rebuild the Reserve Bank's new note stocks.

In recent years, the level of new note purchases has been considerably lower than was the case over most of the 1990s. In the first half of the 1990s, the replacement of paper notes with polymer required large new note orders, as did contingency plans for Y2K towards the end of the decade. The size of new note orders subsequently declined as the change to polymer was completed. The high durability of polymer notes also contributed to the decline in the magnitude of new note orders – as polymer notes last considerably longer in circulation than paper notes, fewer unfit notes are required to be replaced each year.

Distribution

Under the arrangements introduced in November 2001, whereby commercial banks own the working stocks of notes and coin required to operate the cash distribution system, the banks deal directly and actively with each other in order to manage short-term surpluses or deficits in their individual holdings of currency. Notes required to meet increased demand, typically at peak periods, and to replace unfit notes withdrawn from circulation, are purchased from the Reserve Bank and added to working stocks. Commercial bank holdings of working stocks over the past year have, on average, seen little change compared with the previous year.

The Reserve Bank operates a central distribution point for notes at the NNPDC. Armoured car companies transport notes to and from the NNPDC on behalf of the commercial banks. Under agreements with the commercial banks, unfit notes, surplus fit notes (following Christmas and Easter seasonal peaks in demand) and notes sought by the Reserve Bank for quality-assessment purposes are returned to the NNPDC. As surplus fit notes have already been sorted by banks, generally they are not re-sorted by the NNPDC. Commercial banks also draw notes from the NNPDC to meet demand when they cannot meet their requirements from their own holdings or from other banks. Notes that have been previously returned to the NNPDC by banks as surplus fit notes are used first in meeting banks' orders.

During 2004/05, 287 million notes ($9 billion) were issued (despatched from the NNPDC) and 256 million ($7 billion) were redeemed (returned to the NNPDC). This level of activity was some 4 per cent higher than the previous year. Of the notes issued in 2004/05, 160 million were new notes and 127 million were previously circulated notes that were reissued after they had been returned to the NNPDC, processed as necessary and judged fit for reissue. Greater quantities of new notes were used by the NNPDC to meet orders in line with the Reserve Bank's aim for high-quality notes in circulation. Of the notes returned to the NNPDC, 216 million notes were returned for processing through high-speed note-processing equipment for verification, authentication and quality control. The remaining 40 million notes were surplus fit notes returned to the NNPDC by commercial banks after Christmas or Easter. During 2004/05, 205 million notes were processed, compared with 196 million notes during 2003/04. Notes deemed fit for reissue represented 45 per cent of notes processed, compared with 47 per cent in the previous year.

The Reserve Bank pays commercial banks interest forgone on their working stocks of notes and coin up to a specified amount, provided the stocks are held in approved cash centres and notes are sorted for quality. The sorting standard is set and monitored by the Reserve Bank. The Reserve Bank also bears the cost of producing new notes and costs associated with the return of unfit and sampling notes. All other costs associated with the distribution of cash are met by others, including commercial banks, retailers and the public.

Counterfeiting Activity

Counterfeiting activity remained low in 2004/05. The number of counterfeits passed was about 4,300, with a face value of about $220,700. Although an increase on 2003/04, when 3,600 counterfeits were passed, the number of counterfeits passed per million notes in circulation remained at around 5. By international standards, this is a very low rate of counterfeiting.

In 2004/05, around two-thirds of polymer series counterfeits were of the $50; the remainder were mostly $100 and $20 counterfeits. Almost all were reproduced on paper. Although many now include a simulation of the clear window in a genuine note, they are typically crude and the counterfeits are easily detected by visual inspection, as well as by feel. Notwithstanding the low level of counterfeiting activity, the Reserve Bank continues to conduct research to improve the security of polymer notes. The aim is to make counterfeits more difficult, time-consuming and costly to produce, and easier for the public to detect.