Reserve Bank of Australia Annual Report – 2011 Financial Statements Note 15 – Financial Instruments and Risk
As the central bank of Australia, the RBA is responsible for implementing monetary policy and managing Australia's foreign reserve assets. As a consequence, the RBA holds a range of financial assets, including Australian dollar securities, foreign government securities, repurchase agreements, deposits with the Bank for International Settlements, foreign currency working accounts, interest rate futures contracts, foreign currency swaps, gold loans, cash and cash equivalents. The RBA also holds a shareholding in the Bank for International Settlements. As to financial liabilities, the RBA issues Australia's banknotes and offers deposit facilities to its customers, mainly the Australian Government, and eligible financial institutions. Accordingly, the main financial claims on the RBA are banknotes on issue as well as deposit liabilities. The RBA also provides banking services to its customers, and operates Australia's high-value payments and inter-bank settlement systems. These payments and settlements occur through accounts held on the RBA's balance sheet.
AASB 7 – Financial Instruments: Disclosures requires disclosure of information relating to financial instruments; their significance and performance; terms and conditions; fair values; risk exposures and risk management.
Financial Risk
The RBA is exposed to a range of financial risks reflecting its policy and operational responsibilities. These risks include market risk, credit risk and liquidity risk. The chapters in the Annual Report on the Reserve Bank's Operations in Financial Markets and Risk Management provide additional information on the RBA's management of these financial risks.
Market Risk
Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises: foreign exchange risk; interest rate risk; and other price risk.
Foreign exchange risk
Foreign exchange risk is the risk that the fair value or cash flows of foreign currency assets and liabilities will fluctuate because of movements in exchange rates. Foreign exchange risk arises from the RBA's foreign currency assets, which are held to support its operations in the foreign exchange market. The value of these assets, measured in Australian dollars, varies with movements in the value of the Australian dollar exchange rate against the currencies in which the assets are invested. An appreciation in the exchange rate results in valuation losses, while a depreciation leads to valuation gains. The overall level of foreign currency exposure is determined by policy considerations and cannot otherwise be managed to reduce foreign exchange risk. The RBA's net foreign currency exposure as at 30 June 2011 was $35.8 billion ($41.8 billion as at 30 June 2010). Within the overall exposure and to a limited extent, foreign currency risk can be reduced by holding assets across a diversified portfolio of currencies. The RBA holds foreign reserves in four currencies – the US dollar, the euro, the Canadian dollar and the yen – because the markets for these currencies are typically liquid and suitable for investing foreign exchange reserves. Canadian dollars were introduced following a review of the RBA's benchmark for the portfolio in July 2010; the RBA switched 5 percentage points of the portfolio into Canadian dollars from Japanese Yen (which had had a weight of 10 per cent); weights of the other currencies were unchanged (see ‘Concentration of foreign exchange’ below).
The RBA also undertakes foreign currency swaps to assist its daily domestic market operations. These instruments carry no foreign exchange risk since the exchange rates at which both legs of the transaction are settled are agreed at the time the swap is undertaken.
Concentration of foreign exchange
The RBA's net holdings of foreign exchange (excluding its holding of Special Drawing Rights) were distributed as follows as at 30 June:
| % of foreign exchange | ||
|---|---|---|
| 2011 | 2010 | |
| US dollar | 45 | 45 |
| Euro | 45 | 45 |
| Canadian dollars | 5 | – |
| Japanese yen | 5 | 10 |
| Total foreign exchange | 100 | 100 |
Sensitivity to foreign exchange risk
The sensitivity of the RBA's profit and equity to a movement of +/−10 per cent in the value of the Australian dollar exchange rate as at 30 June is shown below. These figures are generally reflective of the RBA's exposure over the financial year.
| 2011 $M | 2010 $M | |
|---|---|---|
| Change in profit/equity due to a 10 per cent appreciation in the reserves-weighted value of the A$ | −3,258 | −3,804 |
| Change in profit/equity due to a 10 per cent depreciation in the reserves-weighted value of the A$ | 3,982 | 4,650 |
Interest rate risk
Interest rate risk is the risk that the fair value or cash flows of financial instruments will fluctuate because of movements in market interest rates. The RBA's balance sheet is exposed to considerable interest rate risk because most of its assets are financial assets, such as domestic and foreign securities, which have a fixed income stream. The price of such securities increases when market interest rates decline, while the price of a security will fall if market rates rise. Interest rate risk increases with the maturity of a security because the associated income stream is fixed for a longer period.
Sensitivity to interest rate risk
The figures below show the effect on the RBA's profit and equity of a movement of +/–1 percentage point in interest rates, given the level, composition and modified duration of the RBA's foreign currency and Australian dollar securities as at 30 June. The valuation effects shown are generally reflective of the RBA's exposure over the financial year.
| 2010 $M | 2009 $M | |
|---|---|---|
| Change in profit/equity due to movements of +/−1 percentage point across yield curves: |
||
| Foreign currency securities | −/+456 | −/+568 |
| Australian dollar securities | −/+169 | −/+158 |
A rise in interest rates would be associated with a valuation loss; a fall in interest rates would be associated with a valuation gain.
Other price risk
The RBA holds shares as a member of the Bank for International Settlements. This membership is mainly to maintain and develop strong relationships with other central banks which are to Australia's advantage. Shares in the BIS are owned exclusively by its member central banks and monetary authorities. For accounting purposes, the RBA treats BIS shares as ‘available-for-sale’ and the fair value of these shares is estimated on the basis of the BIS' net asset value, less a discount of 30 per cent. Accordingly, these shares are revalued to reflect movements in the net asset value of the BIS and in the Australian dollar. The price risk faced on BIS shares is incidental to the general reasons for holding them and is immaterial compared with other market risks faced by the RBA. For this reason, this exposure is not included as part of the RBA's net foreign currency exposure outlined above.
Credit Risk
Credit risk is the potential for financial loss arising from an issuer or counterparty defaulting on its obligations to: repay the principal; make interest payments due on an asset; or settle a transaction. For the RBA, credit risk arises from exposure to: the issuers of securities that it holds; banks with which it deposits funds; and counterparties which are yet to settle transactions. The RBA's credit exposure is low compared with that of most commercial financial institutions, as it manages such risks within a highly risk-averse framework. In particular, credit risk is managed by: holding securities issued by a limited number of highly-rated governments, government-guaranteed agencies and supranational organisations; holding government-guaranteed issues of certain commercial banks; and holding collateral only of low credit risk against buy repurchase agreements and gold loans.
Cash invested under repurchase agreements in overseas markets is secured by collateral in the form of government securities or securities issued by US agencies; the RBA takes and maintains collateral to the value of 102 per cent of the cash invested. Cash invested under domestic buy repurchase agreements is secured by securities issued by Australian governments, Australian banks and various corporate and asset-backed securities (see Note 1(b)). The RBA holds collateral to a value of between 102 and 110 per cent of the amount invested according to the risk profile of the collateral held. If the current value of collateral offered by a counterparty to a repo transaction falls by more than a pre-determined amount, the counterparty is required to provide additional collateral to restore this margin; the thresholds are specified in the legal agreements which govern these transactions. Gold loans are secured by Australian dollar securities to 110 per cent of the market value of the gold loaned.
The RBA does not sell or re-pledge securities held as collateral under buy repurchase agreements.
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 maximum credit risk exposure in relation to off-balance sheet items is:
- Foreign exchange swaps – As at 30 June 2011, the RBA was under contract to purchase $0.2 billion of foreign currency ($4.9 billion at 30 June 2010) and sell $0.3 billion of foreign currency ($1.9 billion at 30 June 2010). As of that date there was a net unrealised gain of $4 million on these swap positions included in net profit ($26 million unrealised gain at 30 June 2010). The exposure of these contracts to credit risk is the cost of re-establishing the contract in the market if a counterparty fails to fulfill its obligations.
- Interest rate futures – As at 30 June 2011, the amount of credit risk on interest rate futures contracts was approximately $1.4 million ($1.4 million at 30 June 2010). As at 30 June 2011 there was an unrealised loss brought to account on those contracts of $0.6 million ($0.5 million unrealised loss at 30 June 2010).
Concentration of credit risk
As noted, 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.
The RBA held no past due or impaired assets at 30 June 2011 or 30 June 2010.
|
Risk rating of security/issuer1 |
Risk rating of counterparties1 |
% of total assets | ||
|---|---|---|---|---|
| 2011 | 2010 | |||
| Australian Dollar Securities | ||||
| Holdings – Commonwealth Government securities | AAA | n/a | 0.6 | 0.9 |
| Holdings – Semi Government securities | AAA | n/a | 4.3 | 3.8 |
| AA | n/a | 5.9 | 1.0 | |
| Securities sold under repurchase agreements | AAA | AA | 0.2 | 0.1 |
| AAA | A | 0.2 | 0.2 | |
| AA | AA | 0.1 | – | |
| Securities held under repurchase agreements | AAA | AA | 11.9 | 9.8 |
| AAA | A | 7.4 | 10.0 | |
| AAA | BBB | 0.1 | 1.2 | |
| AAA | Other3 | 0.3 | 0.8 | |
| AA | AA | 6.1 | 9.7 | |
| AA | A | 2.6 | 2.0 | |
| AA | BBB | – | 0.1 | |
| AA | Other3 | 0.1 | 0.1 | |
| A | AA | 1.8 | 2.3 | |
| A | A | 0.5 | 0.1 | |
| A | BBB | 0.1 | – | |
| Other2 | AA | – | 0.9 | |
| Foreign Investments | ||||
| Holdings of securities | AAA | n/a | 29.9 | 29.2 |
| AA | n/a | 1.5 | 4.7 | |
| A | n/a | 0.5 | 0.5 | |
| Securities sold under repurchase agreements | AAA | AA | 0.9 | 3.6 |
| AAA | A | 0.8 | 0.9 | |
| AA | A | – | 0.1 | |
| Securities held under repurchase agreements | AAA | AAA | 0.4 | – |
| AAA | AA | 8.3 | 6.8 | |
| AAA | A | 5.5 | 2.8 | |
| AA | AA | – | 0.1 | |
| AA | A | 0.5 | 0.1 | |
| Deposits | n/a | AAA | 1.7 | 0.4 |
| n/a | AA | – | 1.2 | |
| Gold Loans | n/a | AAA | 0.1 | 0.2 |
| Other | 7.7 | 6.4 | ||
| 100 | 100 | |||
|
1 Standard & Poor's equivalent ratings.
2 This category includes Asset Backed Commercial Paper (ABCP), which does not have a long-term credit rating. 3 This category includes counterparties which are not rated. |
||||
Liquidity Risk
Liquidity risk is the risk that the RBA will not have the resources required at a particular time to meet its obligations associated with its financial liabilities. As the ultimate source of liquidity in Australian dollars, the RBA has the powers and operational wherewithal to create liquidity in unlimited amounts in Australian dollars at any time. A small component of the RBA's liabilities is in foreign currencies, namely foreign sale repurchase agreements.
Liquidity risk is also associated with financial assets to the extent that the RBA may in extraordinary circumstances be forced to sell a financial asset at a price which is less than its fair value. The RBA manages this risk by holding a diversified portfolio of highly liquid domestic and foreign assets.
The maturity analysis table (over page) is based on the RBA's contracted portfolio as reported in the RBA's balance sheet. All financial instruments are shown at their remaining term to maturity, which is equivalent to the repricing period. Other liabilities include amounts outstanding under sale repurchase agreements. Foreign currency swaps reflect the gross settlement amount of the RBA's outstanding foreign currency swap positions.
|
Balance sheet total $M |
Contracted maturity $M | No Specified Maturity $M | Weighted average coupon rate % | Weighted average effective rate % | |||||
|---|---|---|---|---|---|---|---|---|---|
| On Demand | 0 to 3 months | 3 to 12 months | 1 to 5 years |
Over 5 years |
|||||
| Assets | |||||||||
| Gold | |||||||||
| Gold loans | 46 | – | – | 46 | – | – | – | 0.30 | 0.30 |
| Gold holdings | 3,553 | – | – | – | – | – | 3,553 | n/a | n/a |
| 3,599 | |||||||||
| Foreign exchange | |||||||||
| Balances with central banks | 305 | 7 | 298 | – | – | – | – | 0.12 | 0.12 |
| Securities sold under repurchase agreements |
1,234 | – | – | 186 | 467 | 581 | – | 2.14 | 2.14 |
| Securities purchased under repurchase agreements |
10,797 | – | 10,797 | – | – | – | – | 0.45 | 0.45 |
| Other securities | 24,011 | – | 3,275 | 7,653 | 5,275 | 2,824 | 4,984 | 1.60 | 1.22 |
| Deposits with BIS | 1,261 | 2 | 1,258 | – | – | – | 1 | 0.06 | 0.06 |
| Accrued interest | 119 | – | 67 | 50 | 2 | – | – | n/a | n/a |
| 37,727 | |||||||||
| Australian dollar securities | |||||||||
|
Securities sold under repurchase agreements |
404 | – | 41 | – | 156 | 207 | – | 6.55 | 5.29 |
|
Securities purchased under repurchase agreements |
23,203 | – | 23,078 | 125 | – | – | – | 4.82 | 4.82 |
| Other securities | 8,111 | – | 3,247 | 1,721 | 1,961 | 1,182 | – | 5.47 | 4.99 |
| Accrued interest | 116 | – | 78 | 38 | – | – | – | n/a | n/a |
| 31,834 | |||||||||
| Property, plant & equipment | 454 | – | – | – | – | – | 454 | n/a | n/a |
| Cash and cash equivalents | 1,209 | – | 1,187 | – | – | – | 22 | 4.50 | 4.50 |
| Loans and advances | 6 | – | – | – | – | 6 | – | 3.91 | 3.91 |
| Other | 484 | – | 33 | – | – | – | 451 | n/a | n/a |
| Total assets | 75,313 | 9 | 43,359 | 9,819 | 7,861 | 4,800 | 9,465 | 2.79 | 2.61 |
| Liabilities | |||||||||
| Australian notes on issue | 50,059 | – | – | – | – | – | 50,059 | 0.23 | 0.23 |
| Deposits | 17,504 | 6,854 | 10,650 | – | – | – | – | 4.53 | 4.53 |
| Distribution payable to Australian Government |
– | – | – | – | – | – | – | n/a | n/a |
| Other | 2,411 | – | 2,273 | – | – | – | 138 | 1.12 | 1.12 |
| Total liabilities | 69,974 | 6,854 | 12,923 | – | – | – | 50,197 | 1.34 | 1.34 |
| Capital and reserves | 5,339 | ||||||||
| Total balance sheet | 75,313 | ||||||||
| Local Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (7) | – | (7) | – | – | – | – | n/a | n/a |
| Contractual inflow | 163 | – | 163 | – | – | – | – | n/a | n/a |
| 156 | – | 156 | – | – | – | – | |||
| Foreign Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (340) | – | (340) | – | – | – | – | n/a | n/a |
| Contractual inflow | 184 | – | 184 | – | – | – | – | n/a | n/a |
| (156) | – | (156) | – | – | – | – | |||
|
Balance sheet total $M |
Contracted maturity $M | No Specified Maturity $M | Weighted average coupon rate % | Weighted average effective rate % | |||||
|---|---|---|---|---|---|---|---|---|---|
| On Demand | 0 to 3 months | 3 to 12 months | 1 to 5 years |
Over 5 years |
|||||
| Assets | |||||||||
| Gold | |||||||||
| Gold loans | 141 | – | 47 | 47 | 47 | – | – | 0.27 | 0.28 |
| Gold holdings | 3,606 | – | – | – | – | – | 3,606 | n/a | n/a |
| 3,747 | |||||||||
| Foreign exchange | |||||||||
| Balances with central banks | 376 | 2 | 374 | – | – | – | – | 0.03 | 0.03 |
| Securities sold under repurchase agreements |
3,142 | – | 409 | 1,026 | 678 | 1,029 | – | 1.57 | 1.33 |
| Securities purchased under repurchase agreements |
8,348 | – | 8,348 | – | – | – | – | 0.19 | 0.19 |
| Other securities | 30,092 | – | 6,320 | 7,548 | 7,867 | 2,551 | 5,806 | 1.32 | 0.73 |
| Deposits | 997 | 3 | 993 | – | – | – | 1 | 0.31 | 0.31 |
| Accrued interest | 141 | – | 79 | 62 | – | – | – | n/a | n/a |
| 43,096 | |||||||||
| Australian dollar securities | |||||||||
|
Securities sold under repurchase agreements |
248 | – | – | – | 130 | 118 | – | 6.52 | 5.27 |
|
Securities purchased under repurchase agreements |
31,634 | – | 29,252 | 2,382 | – | – | – | 4.63 | 4.63 |
| Other securities | 4,889 | – | 1,245 | 866 | 1,198 | 1,580 | – | 5.57 | 4.96 |
| Accrued interest | 201 | – | 116 | 85 | – | – | – | n/a | n/a |
| 36,972 | |||||||||
| Property, plant & equipment | 449 | – | – | – | – | – | 449 | n/a | n/a |
| Cash and cash equivalents | 852 | – | 845 | – | – | – | 7 | 4.25 | 4.25 |
| Loans and advances | 7 | – | – | – | – | 7 | – | 3.68 | 3.68 |
| Other | 529 | – | 30 | – | – | – | 499 | n/a | n/a |
| Total assets | 85,652 | 5 | 48,058 | 12,016 | 9,920 | 5,285 | 10,368 | 2.63 | 2.38 |
| Liabilities | |||||||||
| Australian notes on issue | 48,759 | – | – | – | – | – | 48,759 | 0.23 | 0.23 |
| Deposits | 20,987 | 5,967 | 15,020 | – | – | – | – | 4.44 | 4.44 |
| Distribution payable to Australian Government |
750 | – | 750 | – | – | – | – | n/a | n/a |
| Other | 4,762 | – | 4,615 | – | – | – | 147 | 0.53 | 0.53 |
| Total liabilities | 75,258 | 5,967 | 20,385 | – | – | – | 48,906 | 1.42 | 1.42 |
| Capital and reserves | 10,394 | ||||||||
| Total balance sheet | 85,652 | ||||||||
| Local Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (4,172) | – | (4,172) | – | – | – | – | n/a | n/a |
| Contractual inflow | 1,231 | – | 1,231 | – | – | – | – | n/a | n/a |
| (2,941) | – | (2,941) | – | – | – | – | |||
| Foreign Currency | |||||||||
| Swaps | |||||||||
| Contractual outflow | (1,916) | – | (1,916) | – | – | – | – | n/a | n/a |
| Contractual inflow | 4,857 | – | 4,857 | – | – | – | – | n/a | n/a |
| 2,941 | – | 2,941 | – | – | – | – | |||
Fair Value of Financial Instruments
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms' 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 repurchase agreements, BIS 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.
AASB 7 requires that the fair value of financial assets and liabilities be disclosed according to their accounting classification under AASB 139.
| 2011 $M | 2010 $M | |
|---|---|---|
| Assets accounted for under AASB 139 | ||
| At fair value through Profit or Loss | 33,366 | 38,071 |
| Loans and receivables | 37,487 | 43,025 |
| Available-for-sale | 302 | 328 |
| Assets accounted for under other standards | 4,158 | 4,228 |
| Total assets as at 30 June | 75,313 | 85,652 |
| Liabilities accounted for under AASB 139 | ||
| At fair value through Profit or Loss | 1 | 7 |
| Not at fair value through Profit or Loss | 69,842 | 75,104 |
| Liabilities accounted for under other standards | 131 | 147 |
| Total liabilities as at 30 June | 69,974 | 75,258 |
AASB 7 also requires that financial assets and liabilities measured at fair value be disclosed according to their position in the fair value hierarchy. This hierarchy has three levels for financial instruments valued at fair value: Level 1 is based on quoted prices in active markets for identical assets; Level 2 is based on quoted prices or other observable market data not included in Level 1; while Level 3 valuations are based on inputs other than observable market data.
| Level | |||||||
|---|---|---|---|---|---|---|---|
| One $M |
Two $M |
Three $M |
Total $M |
||||
| As at 30 June 2011 | |||||||
| Assets at fair value through Profit or Loss | |||||||
| Domestic government securities | 4,927 | 3,587 | – | 8,514 | |||
| Foreign government securities | 22,370 | 2,477 | – | 24,847 | |||
| Foreign currency swap gains | – | 5 | – | 5 | |||
| Available-for-sale | |||||||
| Shares in international and other institutions | – | – | 302 | 302 | |||
| 27,297 | 6,069 | 302 | 33,668 | ||||
| Liabilities at fair value through Profit or Loss | |||||||
| Foreign currency swap losses | – | 1 | – | 1 | |||
| – | 1 | – | 1 | ||||
| As at 30 June 2010 | |||||||
| Assets at fair value through Profit or Loss | |||||||
| Domestic government securities | 4,077 | 1,091 | – | 5,168 | |||
| Foreign government securities | 28,966 | 3,903 | – | 32,869 | |||
| Foreign currency swap gains | – | 34 | – | 34 | |||
| Available-for-sale | |||||||
| Shares in international and other institutions | – | – | 328 | 328 | |||
| 33,043 | 5,028 | 328 | 38,399 | ||||
| Liabilities at fair value through Profit or Loss | |||||||
| Foreign currency swap losses | – | 7 | – | 7 | |||
| – | 7 | – | 7 | ||||