RDP 2013-01: Currency Demand during the Global Financial Crisis: Evidence from Australia 3. Currency Demand Data

To analyse the surge in demand for Australian currency in late 2008 further, it is useful to understand how it is distributed and where it is held. Total currency on issue is made up of banknotes and coins and can be split into currency holdings of the non-bank sector and currency holdings of banks (Table 1).^[7] As an illustration, at the end of June 2012 there was $56.9 billion worth of currency in circulation, of which $51.0 billion was held by the non-bank sector and $5.9 billion was held by the bank sector.

3.1 Currency Holdings of the Non-bank Sector

Currency held by the non-bank sector has trended steadily upward through time, roughly in line with nominal GDP. However, demand for Australian currency by the non-bank sector increased dramatically in late 2008 as the global financial crisis intensified and policymakers responded (Figure 5). Currency holdings of the non-bank sector jumped by 5 per cent in October 2008 (a rise of just over $2 billion). In seasonally adjusted terms, that is 1¼ percentage points larger than the next biggest monthly increase in the history of the series going back to 1959.

The strong growth continued such that the increase in currency holdings over the three months to 31 December 2008 was 8 percentage points higher than the average increase over the same period in the previous four years. This is equivalent to an additional $3¼ billion and was 8 standard deviations above average, so cannot be considered a part of normal volatility. The increase in currency holdings of the non-bank sector was pronounced, but temporary. After a few months of very rapid growth, the currency stock stabilised and returned to trend by around mid 2010.

3.2 Currency Holdings of the Bank Sector

Bank holdings of currency are usually fairly stable as a ratio to nominal GDP, although there have been three periods since the early 1990s when this was not the case (Figure 5). Understanding these periods can tell us something about bank behaviour and aids in the econometric modelling of the total currency series (see Section 4).

The first occasion was in preparation for the year-date change at the end of the millennium (that is, ‘Y2K’). Commercial banks increased their currency holdings sharply in case they experienced an increase in currency demand from their customers. In the event, the date change was virtually incident free, and the stocks that were built up were not drawn upon (RBA 2000).

The second period began in August 2001, when the processing and storage of banknotes was outsourced from the RBA and banknote distribution arrangements were changed such that ownership of the RBA's Note and Coin Pools was transferred to the commercial banks (Carlin 2004). In lieu of the RBA's Note and Coin Pools, commercial banks are allowed to hold verified cash holdings (VCH), which attract interest payments from the RBA. VCH act as a buffer stock between the RBA's contingency holdings of banknotes and the day-to-day needs of commercial banks. The overall result of this change was a step increase in the level of bank holdings, as well as a transitory spike as banks became accustomed to the new arrangements.

The third period was during the global financial crisis in late 2008. This period was different to the previous two periods in that currency demand by the non-bank sector also increased sharply. During 2008/09 there was additional currency demand – that is, growth in excess of average growth in the previous four years – in both the non-bank and bank sectors (Figure 6). The peak in additional currency holdings came in November 2008, with the bank sector accounting for around $3 billion of the $5½ billion in total additional currency holdings.

In response to signs of increased demand for currency from the banking sector, the RBA changed operational arrangements on 10 October 2008 to allow interest to be paid on all VCH rather than only on a predetermined limit as had previously been the case. This facilitated banks building up buffers of currency beyond the increase in demand from the non-bank sector in order to be prepared for any further spikes in demand for currency.^[8] To some extent this experience echoes the build-up of cash in banks on the eve of Y2K, where banks built up a buffer of currency. However, unlike the Y2K episode, the public did demand additional currency. Such precautionary build-ups of currency by banks are a sensible risk management strategy given the potential for very adverse effects if they are unable to meet the demands of their depositors.

3.3 Banknote Distribution by the RBA

The rise in currency demand in late 2008 was not large enough to have any destabilising effects on the financial system, but it did raise some concerns about the physical provision of sufficient banknotes. The RBA was able to meet the additional demand from its existing contingency holdings of banknotes, and the 2008/09 production schedule was accelerated in case the increased demand for banknotes was sustained. The RBA also temporarily suspended the destruction of unfit banknotes, but these were never used and were subsequently destroyed.

This experience demonstrated that sharp rises in banknote demand have the potential to be disruptive to normal operations. As a result, the RBA has increased its contingency holdings to reduce the likelihood of shortages in the event of a future crisis and has improved banknote distribution to alleviate any logistical problems in periods of heightened demand.

3.4 Banknotes on Issue by Denomination

The daily banknotes-on-issue data are available by denomination. The surge in banknotes on issue in late 2008 was not evenly spread across all denominations, but was most pronounced for high-value denominations (Figure 7). The value of low-denomination banknotes on issue also increased, but the extent of the increase was substantially less.

The difference in growth between low-value and high-value denominations suggests that the rapid rise in banknote demand was driven by increases in the demand for currency as a store of value, rather than increases in demand for transactions. A strong rise in transactional demand would probably have resulted in stronger demand for low-denomination banknotes as merchants would have required them to make change (although it is possible that a brief increase in transactional demand associated with the fiscal stimulus may have resulted in a faster rate of turnover of these low-denomination banknotes).

In contrast, $50 and $100 banknotes are more likely to be held to store value, so their demand is likely to have been more sensitive to concerns about the stability of financial institutions.^[9] The sharp rise in $50 banknotes could be interpreted in either way as they are used in transactions as well as to store value. They are also the most common banknote withdrawn from ATMs, so the government stimulus payments probably contributed to some of the rise in $50 banknotes on issue. Ideally, we would like to consider non-bank currency demand by denomination but data limitations mean that we can only do this for total banknotes on issue.

3.5 Withdrawals

Another dimension to currency demand through this period is retail cash withdrawals – that is, withdrawals either in banks over the counter (OTC), from ATMs (automated teller machines) or as cash taken out as part of EFTPOS transactions (electronic funds transfer at point of sale). OTC withdrawals picked up noticeably in October 2008, and were $700 million higher than the level in adjacent months (Figure 8).^[10] The increase in the value of withdrawals in October was greater than the increase in the number of withdrawals, which is consistent with a small number of people making large precautionary withdrawals due to financial uncertainty. ATM withdrawals show an $850 million spike in December and another smaller spike in March 2009.^[11] These two spikes coincided with government stimulus payments.

Taken together, the three spikes in the withdrawals data can only account for just over half of the $3¼ billion in additional currency holdings of the non-bank sector. However, retail withdrawals are only one way that the total stock of non-bank currency holdings can change. A lower-than-usual flow of cash deposits into banks by households and businesses in late 2008 would also have caused currency holdings of the non-bank sector to rise, all else being equal. These retail withdrawals data do not include corporate or government withdrawals and can only give a partial view of currency flows.

3.6 Deposits

The rise in currency on issue in late 2008 was quite significant relative to the stock of currency. In light of international bank failures at the time, a natural question to ask is whether this additional currency demand in Australia was part of a shift away from bank deposits. Deposits data show this was not the case. Deposits rose over late 2008 (coinciding with the announcement of the Australian Government deposit guarantee on 12 October), suggesting that any concerns that some people may have had about the banking sector were not widely held. The rise in deposits was not as sharp as the rise in non-bank currency holdings at the time, resulting in an increase in the ratio of currency to deposits between September and December 2008 (Figure 9). But the increase in deposits suggests that confidence in Australian banks remained very strong. To the extent that the rise in currency demand suggests that a minority may not have shared in the broader public's confidence in the banking system, this is somewhat surprising given the introduction of the deposit guarantee.

While there is no evidence of any substantive lack of confidence in financial institutions across the community, there were some signs of nervousness among some depositors at this time, with the largest banks gaining market share in the period preceding the guarantee announcement at the expense of some smaller institutions (RBA 2009b). The introduction of the deposit guarantee system quickly quelled whatever depositor nervousness there had been, and deposits grew strongly thereafter.

Footnotes

We refer to ADIs as the bank sector and currency holdings outside ADIs as holdings of the non-bank sector. The non-bank sector includes household, corporate, government and foreign sectors. [7]

There is some anecdotal evidence of large withdrawals from banks at the time (e.g. Taylor and Uren 2010), although withdrawal data show only a moderate increase (see Section 3.5). [8]

Foreign demand for Australian currency, for example to satisfy retail foreign exchange demand, is mostly for $100 banknotes as they are the least costly to transport. Some of the increase in demand for $100 banknotes was likely to have been from offshore. [9]

The series is fairly volatile, so it is difficult to read much into this monthly movement. Nevertheless, growth in October was 5 standard deviations above average so represents some highly unusual behaviour. [10]

The series is multiplicatively seasonally adjusted and December has the highest value of withdrawals, so the spike in December 2008 could be understated by about 10 per cent. [11]