Reserve Bank of Australia Annual Report – 2016 Financial Statements Note 15 – Financial Instruments and Risk
As the central bank in Australia, the RBA is responsible for implementing monetary policy and managing Australia's foreign reserve assets. Consequently, the RBA holds a range of financial assets, including government securities, repurchase agreements and foreign currency swaps. As to financial liabilities, the RBA issues Australia's banknotes and takes deposits from its customers, mainly the Australian Government, and eligible financial institutions. The RBA also provides banking services to its customers and operates Australia's high-value payments and interbank settlement systems.
Financial Risk
The RBA is exposed to a range of financial risks that reflect its policy and operational responsibilities. These risks include market risk, credit risk and liquidity risk. The chapters in the Annual Report on ‘Operations in Financial Markets' and ‘Risk Management’ provide additional information on the RBA's management of these financial risks. The RBA's approach to managing financial risk is set out in the Risk Appetite Statement available on the RBA website.
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 and interest rate risk.
Foreign exchange risk
Foreign exchange risk is the risk that the fair value or cash flows of the RBA's foreign currency assets and liabilities will fluctuate because of movements in exchange rates. 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. The RBA's net foreign currency exposure as at 30 June 2016 was $53.3 billion ($50.1 billion as at 30 June 2015). Within the overall exposure and to a limited extent, foreign currency risk can be mitigated by holding assets across a diversified portfolio of currencies. The RBA holds foreign reserves in seven currencies – the US dollar, euro, Japanese yen, Canadian dollar, Chinese renminbi, UK pound sterling and South Korean won.
The RBA also undertakes foreign currency swaps to assist its daily domestic liquidity management and to manage foreign reserve assets. These instruments carry no foreign exchange risk.
Concentration of foreign exchange
The RBA's net holdings of foreign exchange (excluding Special Drawing Rights) were distributed as follows as at 30 June:
| Per cent of foreign exchange | ||
|---|---|---|
| 2016 | 2015 | |
| US dollar | 55 | 55 |
| Euro | 20 | 25 |
| Japanese yen | 5 | 5 |
| Canadian dollar | 5 | 5 |
| Chinese renminbi | 5 | 5 |
| UK pound sterling | 5 | 5 |
| South Korean won | 5 | – |
| 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.
| 2016 $M |
2015 $M |
|
|---|---|---|
| Change in profit/equity due to a 10 per cent appreciation in the reserves-weighted value of the A$ | (4,845) | (4,547) |
| Change in profit/equity due to a 10 per cent depreciation in the reserves-weighted value of the A$ | 5,922 | 5,557 |
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 faces interest rate risk because most of its assets are financial assets that have a fixed income stream, such as Australian dollar and foreign currency securities. The price of such securities rises when market interest rates decline, and it falls if market rates rise. Interest rate risk increases with the maturity of a security. Interest rate risk on foreign assets is controlled through limits on the duration of these portfolios. Interest rate risk on Australian dollar assets is relatively low as most of the portfolio is held in short-term reverse repurchase agreements.
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.
| 2016 $M |
2015 $M |
|
|---|---|---|
| Change in profit/equity due to movements of +/–1 percentage point across yield curves: | ||
| Foreign currency securities | −/+339 | −/+300 |
| Australian dollar securities | −/+144 | −/+156 |
Liquidity risk
Liquidity risk is the risk that the RBA will not have the resources required at a particular time to meet its obligations to settle its financial liabilities. As the ultimate source of liquidity in Australian dollars, the RBA can 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 repurchase agreements.
Liquidity risk may also be associated with the RBA, in extraordinary circumstances, being forced to sell a financial asset at a price less than its fair value. The RBA manages this risk by holding a diversified portfolio of highly liquid Australian dollar and foreign currency assets.
The analysis of portfolio maturity in the table that follows is based on the RBA's contracted portfolio as reported in the RBA's Statement of Financial Position. All financial instruments are shown at their remaining term to maturity, which is equivalent to the repricing period. Other liabilities include amounts outstanding under repurchase agreements. Foreign currency swaps reflect the gross settlement amount of the RBA's outstanding foreign currency swap positions.
Maturity Analysis – as at 30 June 2016
| Balance sheet total $M |
Contracted maturity $M |
No specified maturity $M |
Weighted average effective rate % | |||||
|---|---|---|---|---|---|---|---|---|
| On demand | 0 to 3 months | 3 to 12 months | 1 to 5 years | Over 5 years | ||||
| Assets | ||||||||
| Cash and cash equivalents | 367 | 30 | 336 | – | – | – | 1 | 1.50 |
| Australian dollar investments | ||||||||
| Securities sold under repurchase agreements | 35 | – | – | – | – | 35 | – | 2.51 |
| Securities purchased under repurchase agreements | 83,223 | – | 58,315 | 1,828 | – | – | 23,080 | 1.83 |
| Other securities | 5,069 | – | – | – | 3,922 | 1,147 | – | 1.80 |
| Accrued interest | 173 | – | 163 | 10 | – | – | – | na |
| 88,500 | ||||||||
| Foreign currency investments | ||||||||
| Balances with central banks | 8,135 | 7,394 | 741 | – | – | – | – | 0.04 |
| Securities sold under repurchase agreements | 4,491 | – | – | 3,463 | 1,028 | – | – | 0.40 |
| Securities purchased under repurchase agreements | 5,873 | – | 5,873 | – | – | – | – | 0.67 |
| Other securities | 51,931 | – | 28,411 | 11,356 | 6,139 | 510 | 5,515 | 0.09 |
| Deposits | 42 | – | 42 | – | – | – | – | 0.44 |
| Cash collateral provided | 2,329 | – | 2,329 | – | – | – | – | 1.75 |
| Accrued interest | 78 | – | 56 | 22 | – | – | – | na |
| 72,879 | ||||||||
| Gold | ||||||||
| Gold loans | 402 | – | 230 | 172 | – | – | – | 0.22 |
| Gold holdings | 4,165 | – | – | – | – | – | 4,165 | na |
| 4,567 | ||||||||
| Property, plant & equipment | 640 | – | – | – | – | – | 640 | na |
| Other assets | 536 | – | 23 | 4 | 6 | 2 | 501 | na |
| Total assets | 167,489 | 7,424 | 96,519 | 16,855 | 11,095 | 1,694 | 33,902 | 1.03 |
| Liabilities | ||||||||
| Deposits | 61,210 | 30,943 | 30,267 | – | – | – | – | 1.69 |
| Distribution payable to the Commonwealth | 3,222 | – | 3,222 | – | – | – | – | na |
| Cash collateral received | – | – | – | – | – | – | – | na |
| Australian banknotes on issue | 70,209 | – | – | – | – | – | 70,209 | 0.06 |
| Other liabilities | 8,936 | – | 8,346 | – | – | – | 590 | 0.26 |
| Total liabilities | 143,577 | 30,943 | 41,835 | – | – | – | 70,799 | 0.77 |
| Capital and reserves | 23,912 | |||||||
| Total balance sheet | 167,489 | |||||||
| Swaps | ||||||||
| Australian dollars | ||||||||
| Contractual outflow | (115) | – | (115) | – | – | – | – | |
| Contractual inflow | 9,255 | – | 9,255 | – | – | – | – | |
| 9,140 | – | 9,140 | – | – | – | – | ||
| Foreign currency | ||||||||
| Contractual outflow | (34,472) | – | (34,472) | – | – | – | – | |
| Contractual inflow | 25,332 | – | 25,332 | – | – | – | – | |
| (9,140) | – | (9,140) | – | – | – | – | ||
Maturity Analysis – as at 30 June 2015
| Balance sheet total $M |
Contracted maturity $M |
No specified maturity $M |
Weighted average effective rate % | |||||
|---|---|---|---|---|---|---|---|---|
| On demand | 0 to 3 months | 3 to 12 months | 1 to 5 years | Over 5 years | ||||
| Assets | ||||||||
| Cash and cash equivalents | 438 | 32 | 405 | – | – | – | 1 | 1.75 |
| Australian dollar investments | ||||||||
| Securities sold under repurchase agreements | – | – | – | – | – | – | – | na |
| Securities purchased under repurchase agreements | 76,183 | – | 52,800 | 1,969 | – | – | 21,414 | 2.02 |
| Other securities | 9,930 | – | 1,404 | 6,318 | 899 | 1,309 | – | 2.15 |
| Accrued interest | 181 | – | 137 | 44 | – | – | – | na |
| 86,294 | ||||||||
| Foreign currency investments | ||||||||
| Balances with central banks | 832 | 116 | 716 | – | – | – | – | 0.13 |
| Securities sold under repurchase agreements | 1,780 | – | 544 | 1,118 | 118 | – | – | 0.02 |
| Securities purchased under repurchase agreements | 4,090 | – | 4,090 | – | – | – | – | 0.11 |
| Other securities | 58,467 | – | 33,609 | 12,037 | 5,832 | 495 | 6,494 | 0.16 |
| Deposits | 1 | – | 1 | – | – | – | – | (0.03) |
| Cash collateral provided | – | – | – | – | – | – | – | na |
| Accrued interest | 71 | – | 42 | 29 | – | – | – | na |
| 65,241 | ||||||||
| Gold | ||||||||
| Gold loans | 49 | – | – | 49 | – | – | – | 0.25 |
| Gold holdings | 3,866 | – | – | – | – | – | 3,866 | na |
| 3,915 | ||||||||
| Property, plant & equipment | 549 | – | – | – | – | – | 549 | na |
| Other assets | 476 | – | 23 | 3 | – | 3 | 447 | na |
| Total assets | 156,913 | 148 | 93,771 | 21,567 | 6,849 | 1,807 | 32,771 | 1.18 |
| Liabilities | ||||||||
| Deposits | 60,486 | 26,236 | 34,250 | – | – | – | – | 1.98 |
| Distribution payable to the Commonwealth | 2,501 | – | 1,559 | – | 942 | – | – | na |
| Cash collateral received | 673 | – | 673 | – | – | – | – | 2.00 |
| Australian banknotes on issue | 65,481 | – | – | – | – | – | 65,481 | 0.07 |
| Other liabilities | 3,903 | – | 3,687 | – | – | – | 216 | (0.02) |
| Total liabilities | 133,044 | 26,236 | 40,169 | – | 942 | – | 65,697 | 0.94 |
| Capital and reserves | 23,869 | |||||||
| Total balance sheet | 156,913 | |||||||
| Swaps | ||||||||
| Australian dollars | ||||||||
| Contractual outflow | (40) | – | (40) | – | – | – | – | |
| Contractual inflow | 11,676 | – | 11,676 | – | – | – | – | |
| 11,636 | – | 11,636 | – | – | – | – | ||
| Foreign currency | ||||||||
| Contractual outflow | (28,846) | – | (28,846) | – | – | – | – | |
| Contractual inflow | 17,210 | – | 17,210 | – | – | – | – | |
| (11,636) | – | (11,636) | – | – | – | – | ||
Credit risk
Credit risk is the potential for financial loss arising from an issuer or counterparty defaulting on its obligations to: repay principal; make interest payments due on an asset; or settle a transaction. The RBA's credit exposure is managed within a framework designed to contain risk to a level consistent with its very low appetite for such risk. In particular, credit risk is controlled by: holding securities issued by a limited number of highly rated governments, government-guaranteed agencies and supranational organisations; and holding high-quality collateral against reverse repurchase agreements.
The RBA's maximum exposure to credit risk for each class of recognised financial assets, other than derivatives, is the carrying amount of those assets as indicated in the balance sheet.
The RBA's maximum credit risk exposure to derivative financial instruments is:
-
Foreign exchange swaps – As at 30 June 2016, the RBA was under contract to purchase $25.3 billion of foreign currency ($17.2 billion at 30 June 2015) and sell $34.5 billion of foreign currency ($28.8 billion at 30 June 2015). As of that date there was a net unrealised loss of $1,852 million on these swap positions included in net profit ($218 million unrealised gain at 30 June 2015).
The RBA has a credit exposure from foreign exchange swaps because of the risk that a counterparty might fail to deliver the second leg of a swap, a sum that would then have to be replaced in the market, potentially at a loss. To manage credit risk on swaps, the RBA exchanges collateral with counterparties under credit support annexes (CSAs), which cover the potential cost of replacing the swap position in the market if a counterparty fails to deliver. The RBA's CSAs specify that only Australian dollar cash is eligible as collateral. Under CSAs, either party to the agreement may be obliged to deliver collateral with interest paid or received on a monthly basis. At 30 June 2016, there was no cash collateral received ($673 million at 30 June 2015), while cash collateral provided was $2,329 million (nil at 30 June 2015).
- Interest rate futures – As at 30 June 2016, the amount of credit risk on margin accounts associated with interest rate futures contracts held by the RBA was approximately $0.4 million ($0.5 million at 30 June 2015). As at 30 June 2016, there was an unrealised loss of $0.2 million brought to account on those contracts ($0.2 million unrealised loss at 30 June 2015).
The RBA held no past due or impaired assets at 30 June 2016 or 30 June 2015.
Collateral held under reverse repurchase agreements
Cash invested under reverse repurchase agreements in overseas markets is secured against 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 Australian dollar reverse repurchase agreements is secured by securities issued by Australian governments, banks and various corporate and asset-backed securities. The RBA holds collateral equivalent to the amount invested plus a margin according to the risk profile of the collateral held. If the current value of collateral falls by more than a predetermined 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. The management of collateral and cash associated with tri-party repurchase agreements is conducted through a third party, in this case the Australian Securities Exchange. The terms and requirements of tri-party repurchase agreements are broadly consistent with bilateral agreements and the RBA manages the risk of holding them in a similar way.
The RBA does not sell or re-pledge securities held as collateral under reverse repurchase agreements.
Collateral provided under repurchase agreements
At 30 June 2016, the carrying amount of securities sold and contracted for purchase under repurchase agreements was $4,527 million ($1,781 million at 30 June 2015). Terms and conditions of repurchase agreements are consistent with those for reverse repurchase agreements disclosed above.
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.
| Risk rating of security/issuer(a) | Risk rating of counterparties(a) | Per cent of investments | ||
|---|---|---|---|---|
| 2016 | 2015 | |||
| Australian dollar investments | ||||
| Holdings of Australian Government Securities | Aaa | na | 1.6 | 3.8 |
| Holdings of semi-government securities | Aaa | na | 0.6 | 0.6 |
| Aa | na | 0.9 | 2.0 | |
| Securities purchased under reverse | Aaa | Aa | 26.4 | 27.4 |
| repurchase agreements | Aaa | A | 10.4 | 7.3 |
| Aaa | Other(b) | 1.1 | 1.6 | |
| Aa | Aa | 8.1 | 6.8 | |
| Aa | A | 1.5 | 3.1 | |
| Aa | Baa | 0.1 | 0.2 | |
| Aa | B | 0.0 | 0.1 | |
| Aa | Other(b) | 0.1 | 0.3 | |
| A | Aa | 1.4 | 1.2 | |
| A | A | 0.5 | 0.6 | |
| A | Baa | 0.1 | 0.0 | |
| Baa | Aa | 0.1 | 0.0 | |
| Foreign investments | ||||
| Holdings of securities | Aaa | na | 10.6 | 14.7 |
| Aa | na | 3.4 | 3.9 | |
| A | na | 15.3 | 18.0 | |
| Securities sold under repurchase agreements | Aaa | Aa | 1.1 | 0.9 |
| Aaa | A | 1.4 | 0.2 | |
| Securities purchased under reverse | Aaa | Aa | 1.4 | 1.1 |
| repurchase agreements | Aaa | A | 1.9 | 0.5 |
| Aaa | Baa | 0.0 | 0.2 | |
| Aa | A | 0.0 | 0.1 | |
| A | A | 0.2 | 0.8 | |
| Deposits | na | Aaa | 0.5 | 0.5 |
| na | Aa | 0.1 | 0.0 | |
| na | A | 4.3 | 0.0 | |
| Other | Aaa | A | 0.4 | 0.0 |
| Aaa | Other(b) | 0.1 | 0.0 | |
| A | A | 1.3 | 0.4 | |
| Other(b) | Aa | 0.7 | 0.1 | |
| Other(b) | A | 0.1 | 0.1 | |
| Other(b) | Other(b) | 0.6 | 0.0 | |
| Other assets | 3.7 | 3.5 | ||
| 100.0 | 100.0 | |||
|
(a) Average of the credit ratings of the three major rating agencies, where
available |
||||