Guy Debelle: Some effects of the new liquidity regime
Speech by Mr Guy Debelle, Assistant Governor (Financial Markets) of the Reserve Bank of
Australia, at the 28th Australasian Finance and Banking Conference, Sydney, 16 December
2015.
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Thanks to George Gardner, Tai Lam, David Wakeling and Kelsey Wilkins.
Today I would like to discuss a few aspects of the liquidity regime that has been in operation
in Australia for almost a year now, namely the application of one important aspect of the
Basel III standards, the liquidity coverage ratio (LCR). I will describe some of the features of
the LCR regime that have emerged over the past year and some of the market developments
that have taken place since its introduction. I will also summarise some of the information
that the Reserve Bank has gathered from a related development, the provision of detailed
information on asset-backed securities. This information has resulted from the Bank's
stipulation that for an asset-backed security to be repo-eligible in the Bank's operations, or to
be usable collateral for the Committed Liquidity Facility (CLF), an issuer needs to provide
loan-level data and detailed information on the security.
The LCR has been in full operation in Australia from the beginning of this year. In 2013,
banks had a trial run, so a number of the balance sheet and other changes had already
started to take place. Hence, by the time we got to the beginning of this year, all banks were
meeting their LCR requirement, generally with a reasonable buffer. To remind you, the LCR
requires that banks hold enough high quality liquid assets (HQLA) to cover their projected net
cash outflows (NCOs) in a 30-day stress scenario. Banks are required to calculate and
maintain an LCR of at least 100 per cent every day. In other words, absent severe market
disruption, the LCR is to be met all the time, not just at the end of a quarter (say).
While banks undertake extensive modelling to project their cash flows, there is some
inherent unpredictability and lumpiness in these flows, including around large deposits, as
well as some derivative positions. As a result, all banks have decided to maintain a buffer
above 100 per cent. To date, the average LCR for the industry has been around 120 per cent
with some banks maintaining large buffers.1
To meet the LCR, banks have made changes to both the asset and liability side of their
balance sheets. On the liability side, over the past couple of years, there has been little
change in the aggregate shares of deposits and wholesale funding, but beneath the surface
the changes have been much greater.
• Liabilities with high run-off rates under the LCR, such as deposits held by other
financial institutions, have been repriced to reflect the fact that they are not
particularly attractive forms of funding for a bank. The competition for this sort of
deposit has not been particularly intense, indeed the opposite has often been the
case, where banks have been happy to see these less sticky forms of funding leave.
• In contrast, the competition for deposits with low run-off rates has been particularly
intense. Such deposits include those where a customer has a number of different
products with the same institution, meaning their deposit is assessed to be stickier.
Banks have been willing to pay up for these more stable forms of funding which has
seen their relative rate rise.
• Term deposits are now actually "term" deposits and are, for the most part,
unbreakable ahead of the maturity date (without at least one month's notice). In the
past, such deposits were often broken ahead of the maturity date with little or no
penalty. Similarly, banks have made the pricing of notice-of-withdrawal accounts
more attractive to savers, where the investor is required to give the bank advance
notice of their intent to withdraw their funds.
• Banks have sought to increase the average maturity of their wholesale bond
funding. The average maturity of outstanding wholesale bond funding has increased
from 3 years to around 31⁄2 years since 2011.
There has been a marked decrease in the use of wholesale funding with a maturity
•
of less than 30 days. This is a particularly unattractive source of funding for the
banks, as they need to cover such funding with 100 per cent HQLA. Hence there is
little incentive to offer a yield any higher than the yield on HQLA. This is evident in
the yield on one-month bank bills. The spread between the one-month bank bill
swap rate (BBSW) and OIS declined markedly at the beginning of the year (as I
noted on an earlier occasion, this repricing was left to the last minute2) and has
generally been low and stable since. At the one month maturity, we see more
activity in banks buying back bills that have rolled down to a residual maturity of one
month than we do of new issuance.
On the asset side, there have also been a number of changes. However, unlike on the
liability side, many of these changes took place well ahead of the LCR coming into force at
the beginning of this year. We haven't seen too many changes take place over the past year.
The most notable change has been the increased holdings of HQLA by banks. To remind
you, securities eligible as high quality liquid assets in the Australian market are
Commonwealth and state government paper. Because of the relatively small pool of
government paper in Australia, the Reserve Bank provides, for a fee of 15 basis points per
annum, a committed liquidity facility (CLF) to address the shortfall in HQLA that can be
reasonably held by the banks.3 Assets which can be used to access this facility are assets
which are eligible collateral in the Bank's market operations, as well as selected securities
which the RBA has exempted from certain aspects of its related party guidelines.
Graph 1 shows the increased holdings by banks of Commonwealth and state paper. The
increased share since the end of 2012 is primarily a result of banks increasing their holdings
in preparation for the LCR. Currently banks hold just over a quarter of the stock on issue. It is
our assessment that if banks were to hold much more of the stock than this, liquidity in the
market would run the risk of being impaired. While it is impossible to be too exact in
determining where this (il)liquidity threshold is, we do not want to find out the hard way that
we have set the required holdings too high and market functioning is impaired.
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Within the overall share of government paper held by the banking system, the share held in
state government paper is much higher than it is in the Commonwealth's paper. APRA
maintains an ongoing discussion with banks about how they determine their asset allocation
between the various forms of HQLA.
Government paper comprises around 40 per cent of banks' Australian dollar liquidity
holdings. The CLF largely makes up the remainder of banks' available Australian dollar
liquidity for LCR purposes (Graph 2). The size of a bank's CLF is determined by APRA each
year as the difference between the banks' projected Australian dollar net cash outflows and
the amount of HQLA that they can reasonably hold. Hence a bank's annually determined
CLF will decline if either their projected net cash outflows decline and/or if the stock of HQLA
increases. Over the course of 2015 both these developments have occurred. For 2015, the
banking system's Australian dollar liquidity needs, in terms of their projected net cash
outflows plus an appropriate buffer to ensure the LCR remains comfortably above 100 per
cent, was assessed by APRA to be $450 billion, while we projected that the banks could
reasonably hold $175 billion of HQLA securities. For 2016, system liquidity needs have fallen
to $440 billion, even as banks' balance sheets have expanded. This is because banks have
sought to reduce their net cash outflows by the adjustments to their liabilities I described
earlier. At the same time, based on Commonwealth and state government budgets, we
project that the stock of HQLA securities that the banks can reasonably hold will rise by
$20 billion by end 2016. As a result the size of the 2016 CLF will decline from $275 billion to
$245 billion.
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Graph 3 shows the composition of the CLF collateral that the banking system holds.
Selfsecuritised assets comprise the bulk of the assets held. This is another area of ongoing
discussion between APRA and the banks. Other assets held are primarily bank-issued
paper. These assets are all held on the balance sheets of the relevant bank. They are not
"pre-positioned" or held on the balance sheet of the Reserve Bank, as is sometimes the case
in other jurisdictions.
Graph 3
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Moreover, the assets are subject to a haircut in terms of the amount of liquidity they can
potentially generate. For example, the haircut on a self-securitised mortgage-backed security
is typically more than 20 per cent, depending on various features of the security. That is $100
of such a security could potentially access no more than $80 of liquidity through the CLF. In
contrast, $100 of an Australian government bond can be sold for $100 of cash.
While such assets generally reside on the balance sheet of an individual bank, in stressed
circumstances, when the CLF is activated, the assets will be repoed to the Reserve Bank. To
manage this contingent risk, it is very important that we have detailed information about the
quality of such assets and are also able to price them accurately to determine the amount of
liquidity we would potentially provide against them.
To enhance the information available to us, since the middle of 2015, mandatory reporting
requirements came into effect for asset-backed securities to be repo eligible with the
Reserve Bank and also to be eligible collateral for the CLF.
The required information includes key transactional level data, detailed tranche information,
and the relationships between trusts and service providers including who is providing various
facilities such as a fixed to floating swap. At the loan level, required data for RMBS include:
62 loan fields such as loan balances, interest rates, arrears measures; 18 borrower fields
such as borrower income, employment type, whether they are an investor or owner-occupier,
whether they are a first home-buyer; and 13 collateral fields (that is, detail on the collateral
underpinning the mortgage) including postcode and property valuation.
These requirements include data that are commonly used by ratings agencies and RMBS
investors, but the data go beyond that to also include some useful information that has not
been commonly compiled before, such as offset balances and borrower income at
origination. This allows us, along with other investors in asset-backed securities, to
undertake a richer analysis of such securities and more accurately assess their risk and
pricing than may have been possible before. In our case, it allows us to undertake our own
risk assessment and not be dependent on rating agencies.
In addition to these data fields, issuers are also required to provide a working cash flow
waterfall model of the security which can provide useful information about structural aspects
of ABS in some cases only previously obtainable through a detailed reading of legal
documentation. This innovation has been very useful in standardising information across
securities, allowing us to verify structural features of deals and provide more granular
haircuts and pricing than was the case previously.
These reporting requirements are standardised for all repo-eligible asset-backed securities,
meaning that the same information is required for all securities. As a result, going forward, it
will be easier to compare securities. We see this as being of great benefit to the industry as a
whole, as does the industry itself, as evidenced by the support of the Australian
Securitisation Forum (ASF) through the whole process of introducing these new standards.
The repo-eligibility requirements also direct issuers to make the information available to
investors and other permitted users, not just to the Reserve Bank. By and large, the
information provided to these groups is the same as that provided to the Reserve Bank;
however, there have been some fields where the information provided posed a potential risk
to privacy. Hence issuers may redact some particular fields and provide aggregated
deindividualised data about these fields instead.
Since the middle of this year, we have received into our securitisation system around
1 600 submissions, covering around $400 billion in assets, including around two million
individual housing loans. The information is updated on a monthly frequency so we are
gaining not only a much richer view of the ABS market at any point in time, but also a rich
time series. With this very large panel data set we can examine how the market, and the
underlying collateral, evolves through time.
With the caveat that the data reporting is still in its infancy, it's already apparent that there are
many potential benefits of the data. Let me illustrate some of the summary information that we
can glean from the first few months of reporting. As noted earlier, these data cover around
2 million housing loans of the total of the approximately 6 million such loans on issue currently.
Graph 4 shows the loan to value ratio (LVR) at origination and currently. The largest share of
loans had an LVR at origination of between 70 and 80 per cent. While that is still the case in
terms of the current LVR, the share is noticeably lower. Similarly, there are almost no loans
with an LVR greater than 90 per cent, even though around nearly 10 per cent had an LVR
greater than 90 at origination. That said, it should be borne in mind that securitised loans
tend to be more seasoned than non-securitised loans and are therefore amortising more
quickly. The seasoning (time since loan origination) of the securitised loans is shown in
Graph 5. It shows that 95 per cent of the value of loans is more than one year old, and nearly
75 per cent is more than three years old.
Graph 4
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Graph 5
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One issue which is of some interest currently is the extent of the repayment buffer that has
been built up by borrowers. This is shown in Graph 6 which shows that two-thirds of
borrowing is covered by a repayment buffer of at least one month's worth of required
mortgage payments, and for half of this, that buffer is more than one year. As the time series
on this loan feature accumulates it has the potential to be useful information for monetary
policy as well as financial stability considerations. Graph 7 shows the level of documentation
for loans securitised by different types of lender. It shows that the major banks have a
minimal share of low doc loans in their pools, whereas for the non-bank issuers the share is
considerably larger.4
Graph 6
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Graph 7
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Finally, in terms of credit risks, Graph 8 shows arrears rates by states and shows that the
current distribution of arrears are consistent with the variation in economic conditions across
the states, though at the same time all arrears rates are relatively low.
Graph 8
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Of course, credit risk is not so much about the averages but the distributions. Having the loan
level data enables an insight into the characteristics of the loans in the various tails of the
distribution that warrant closer attention. It will also allow an assessment of the correlations
between the various drivers of risk that may lead to credit deterioration.
In sum, there is very rich potential in these data for many purposes for the RBA and other
market participants. From our point of view, the data provide us with a great deal of insight
into the contingent risk that might at some point reside on our balance sheet. But clearly, the
data are also very useful for financial stability and monetary policy considerations too.
Conclusion
To conclude, as we approach one year of the full implementation of the LCR in Australia, it is
worth looking at some of the changes that have occurred. There has been repricing of
liabilities to reflect the differences in their treatment under the LCR. On the asset side, there
have been increased holdings of government paper. The banking system's contingent use of
the CLF will decrease in 2016 from 2015 as banks have made adjustments to lower their net
cash outflows, which increases their resiliency to funding shocks. This has occurred even as
bank balance sheets have continued to expand.
While the LCR is now well established in the local market, the net stable funding ratio
(NFSR) is yet to be implemented and APRA will be consulting on this next year. This is also
likely to have an impact on the composition of bank balance sheets.
The enhanced reporting of information on asset-backed securities that commenced in the
middle of the year is providing the Bank and market participants with a wealth of
standardised information on this part of the market. It is allowing the Bank to enhance its risk
assessment of its contingent liability under the CLF, by providing us with a very granular
insight into the collateral that is held against the CLF. The data are beneficial not only for this
reason but also have the potential to inform assessments of financial stability and provide
insight into one important transmission channel of monetary policy.