Reserve Bank of Australia Annual Report – 2007 Financial Statements Note 16

Note 16 FINANCIAL INSTRUMENTS

Australian Accounting Standard AASB 132 – Financial Instruments: Disclosure and Presentation requires disclosure of information relating to financial instruments; their significance and performance; accounting policies; terms and conditions; fair values and risk information. The RBA is exposed to a range of financial risks due to its policy and operational responsibilities. The RBA holds financial assets for purposes of market operations to implement monetary policy, provides banking services to its customers, operates Australia's high value payments and inter-bank settlement systems and issues Australia's currency notes. Reflecting its policy responsibilities, the RBA has no discretion to manage the foreign exchange risk on its foreign currency reserves. In addition, the RBA has limited scope to manage the interest rate exposure on its holdings of foreign and domestic securities. The Operations in Financial Markets chapter in this Annual Report provides additional information on the RBA's management of financial risks.

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction, and is usually determined by the quoted market price. The RBA's Australian dollar securities, foreign government securities, interest rate futures, foreign currency swap contracts and its shareholding in the Bank for International Settlements are carried in the balance sheet (and shown in this note) at fair value. The RBA's bank deposits, cash and cash equivalents, notes on issue and deposit liabilities are carried in the balance sheet (and shown in this note) at face value, which is equivalent to their amortised cost using the effective interest method; this approximates fair value.

Financial risk of financial instruments embodies market risk (currency risk and interest rate risk); credit risk; liquidity risk and cash flow risk.

The interest rate risk and credit risk tables are based on the RBA's contracted portfolio as reported in the RBA's balance sheet.

Foreign exchange risk

Foreign exchange risk is the risk that the value of a financial instrument will fluctuate due to changes in exchange rates. The RBA's net foreign currency exposure as at 30 June 2007 was $29.9 billion ($28.1 billion as at 30 June 2006).

Interest rate risk

Interest rate risk is the risk that the fair value of a financial instrument will fluctuate due to changes in market interest rates. The following table shows the RBA's balance sheet restated in compliance with AASB 132.

Interest rate risk
As at 30 June 2007
Balance sheet
total $M		 Floating
interest
rate $M		 Repricing Period $M Not
bearing
interest $M		 Weighted
average
coupon rate %		 Weighted
average
effective
rate %
0 to 3 months 3 to 12 months 1 to 5
years		 Over 5 years
Assets
Gold loans 1,064 – – 390 640 – 34   1.35 1.35
Gold holdings 937 – – – – – 937   n/a n/a
Sub-total 2,001                  
Foreign exchange
Balances with central banks 357 352 – – – – 5   4.27 4.27
Securities sold under
repurchase agreements		 13,652 – 1,282 2,223 4,145 6,002 –   4.26 4.71
Securities purchased under
repurchase agreements		 49,778 – 49,778 – – – –   4.93 4.93
Other securities 12,268 – 3,991 2,090 2,365 1,800 2,022   2.53 2.63
Deposits 16,928 27 16,899 – – – 2   5.02 5.02
Accrued interest -
foreign exchange		 555 – – – – – 555   n/a n/a
Sub-total 93,538                  
Australian dollar securities
Securities sold under
repurchase agreements		 663 – – 168 300 195 –   7.11 6.35
Securities purchased under
repurchase agreements		 30,351 – 29,551 800 – – –   6.29 6.29
Other securities 3,772 – 125 305 1,945 1,397 –   6.45 6.50
Accrued interest – Australian
dollar securities		 169 – – – – – 169   n/a n/a
Sub-total 34,955                  
Property, plant & equipment 421 – – – – – 421   n/a n/a
Cash and cash equivalents 586 571 – – – – 15   6.25 6.25
Loans and advances 18 18 – – – – –   4.04 4.04
Other 375 – – – – – 375   n/a n/a
Total assets 131,894 968 101,626 5,976 9,395 9,394 4,535   4.90 4.95
Liabilities
Australian notes on issue 40,289 2,588 – – – – 37,701   0.40 0.40
Deposits 65,830 2,996 61,106 50 – – 1,678   6.25 6.25
Distribution payable to
Australian Government		 1,085 – – – – – 1,085   n/a n/a
Other 16,072 – 14,470 – – – 1,602   4.20 4.20
Total liabilities 123,276 5,584 75,576 50 – – 42,066   4.01 4.01
Capital and reserves 8,618                  
Total balance sheet 131,894                  
Off balance sheet items
Interest rate futures 56 – – – – – 526   n/a n/a
Interest rate risk
As at 30 June 2006
Balance sheet
total $M		 Floating
interest
rate $M		 Repricing Period
$M		 Not
bearing
interest $M		 Weighted
average
coupon rate %		 Weighted
average
effective
rate %
0 to 3 months 3 to 12 months 1 to 5
years		 Over 5 years
Total assets 105,477 1,548 78,348 3,587 10,852 8,781 2,331   3.87 3.95
Total liabilities 94,239 5,720 46,402 2,400 – – 39,717   3.33 3.33
Capital and reserves 11,208                  
Total balance sheet 105,447                  
Off balance sheet items 2,594 – – – – – 2,594   n/a n/a

Other liabilities include amounts outstanding under sale repurchase agreements.

All financial instruments are shown at their repricing period which is equivalent to the remaining term to maturity.

Interest rate futures reflect the positions in interest rate contracts traded in foreign futures exchanges to manage interest rate risk on Official Reserve Assets.

Sensitivity to risks

The sensitivity of the fair value of the RBA's financial assets to fluctuations in the exchange rate and interest rates is shown below.

Change in fair value $M
Impact on:
Net foreign exchange holdings of:
A rise of 10 per cent in the value of the A$ 2,684
An increase of 1 percentage point in yield curves overseas 768
Australian dollar securities of:
An increase of 1 percentage point in the yield curve in Australia 159

Concentration of foreign exchange

The RBA's net holdings of foreign exchange were distributed as follows as at 30 June:

% of foreign exchange
as at 2007		 % of foreign exchange
as at 2006
US dollar 45 45
Euro 45 45
Japanese yen 10 10
Total foreign exchange 100 100

Fair value of financial instruments

AASB 130 requires that the fair value of financial assets and liabilities be disclosed according to their accounting classification under AASB 139.

2007 $M 2006 $M
Assets
At fair value through Profit or Loss 30,631 33,493
Loans and receivables 98,944 69,956
Available-for-sale 839 842
Total financial assets as at 30 June 130,414 104,291
Non-financial assets 1,480 1,156
Total assets as at 30 June 131,894 105,447
Liabilities
At fair value through Profit or Loss 1,321 1,310
Not at fair value through Profit or Loss 120,668 91,323
Non-financial liabilities 1,287 1,606
Total liabilities as at 30 June 123,276 94,239

Credit risk

Credit risk in relation to a financial instrument is the risk that a customer, bank or other counterparty will not meet its obligations (or not be permitted to meet them) in accordance with agreed terms.

The RBA's maximum exposure to credit risk in relation to each class of recognised financial assets, other than derivatives (off-balance sheet items), is the carrying amount of those assets as indicated in the balance sheet. The RBA's exposures are to highly-rated counterparties and its credit risk is low.

The RBA's maximum credit risk exposure in relation to off-balance sheet items is:

  1. Foreign exchange swaps – As at 30 June 2007 the RBA was under contract to purchase $11.3 billion of foreign currency and sell $59.9 billion of foreign currency. As of that date there was an unrealised net gain of $1,091 million on these swap positions included in net profit. The credit risk exposure of these contracts is the cost of re‑establishing the contract in the market in the event of the failure of the counterparty to fulfil its obligations.
  2. Interest rate futures – As at 30 June 2007 the amount of credit risk on interest rate futures contracts was approximately $1.6 million ($3.4 million at 30 June 2006). As at 30 June 2007 there was an unrealised gain brought to account on those contracts of $1.1 million ($1.6 million unrealised loss at 30 June 2006).

Concentration of credit risk

The RBA operates to minimise its credit risk exposure through comprehensive risk management policy guidelines. The following table indicates the concentration of credit risk in the RBA's investment portfolio. See Note 1(b).

Credit Risk
Risk rating of
security issuer*		 Risk rating of
counterparties*		 % of total assets
as at 2007		 % of total assets
as at 2006
Domestic Government Securities
Holdings – Commonwealth Government
securities		 AAA n/a 1.1 2.1
Holdings – Semi Government securities AAA n/a 1.6 1.5
AA n/a 0.2 0.0
Securities sold under repurchase
agreements		 AAA AA 0.5 0.1
AAA A 0.1 0.1
Securities held under repurchase
agreements		 AAA AA 9.4 9.0
AAA A 1.1 0.7
AAA other 1.4 1.9
AA AA 10.0 11.5
AA A 0.0 0.2
AA other 0.0 0.0
A AA 1.1 1.4
A A 0.0 0.1
Foreign investments
Holdings of securities AAA n/a 4.3 10.2
AA n/a 3.9 0.0
A n/a 0.3 8.8
Securities sold under repurchase
agreements		 AAA AA 9.0 7.2
AAA A 1.2 1.7
AA AA 0.1 0.0
AA A 0.1 0.0
A AA 0.0 0.2
A A 0.0 0.1
Securities held under repurchase
agreements		 AAA AAA 0.3 0.2
AAA AA 34.9 25.1
AAA A 2.1 2.1
AA AAA 0.0 0.0
AA AA 0.7 0.0
AA A 0.2 0.0
A AAA 0.0 0.0
A AA 0.0 0.1
A A 0.0 0.1
Deposits n/a AAA 0.6 0.6
n/a AA 12.3 11.1
n/a A 0.0 0.0
Other n/a AAA 0.0 0.0
n/a AA 0.7 0.0
n/a A 0.1 0.0
n/a other 0.0 0.3
Gold loans n/a AAA 0.1 0.1
n/a AA 0.6 0.7
n/a A 0.1 0.6
n/a BBB 0.1 0.0
Other     1.8 2.2
      100 100
*Standard & Poor's equivalent ratings