Guy Debelle: The Australian bond market in 2011 and beyond
Speech by Mr Guy Debelle, Assistant Governor of the Reserve Bank of Australia, at the
KangaNews Australian DCM Summit, Sydney, 15 March 2011.
* * *
Today I will discuss the current structure of the Australian bond market and talk about some
trends that might influence its evolution in the coming years. I will focus on the bank debt and
Kangaroo markets, given the theme of this conference. I will also address some of the issues
surrounding the implementation of the forthcoming Basel liquidity standard.
Overview
To set the scene, relative to the size of the Australian economy, the Australian bond market
is around the average for developed economies (Table 1). However, unlike in many countries
around the world today, the private debt market is significantly larger than the public market.
This reflects the prudent fiscal policy pursued by both sides of politics, at the federal and
state level, over an extended period of time (Graph 1).
Graph 1
Structure of the Australian non-government debt market
The non-government debt market in Australia consists of four categories of issuers: financial
institutions, other corporate issuers, asset-backed issuers and non-resident Kangaroo
issuers. As can be seen in Graph 2, while all four segments of the market have grown over
time, the development of the market has not been uniform:

Financial institutions have for some time had the largest share of issuance;
 asset-backed issuance grew rapidly during the early 2000s, but its growth was
severely affected by the financial crisis;
 corporate issuance has grown steadily over the past two decades;

more recently, strong demand for Australian-dollar assets has seen rapid issuance
of Australian-dollar debt by non-residents.
I'd like to touch briefly on the main drivers of developments in each of these markets and talk
about some of the potential factors affecting future issuance.
Graph 2
Financials
Over much of the past two decades, demand for credit outpaced the growth in deposits, so
that banks accessed wholesale funding markets to support growth in lending. This outcome
reflected a number of factors.
Australia's relatively high level of investment, and the sustained growth momentum of the
economy over the past two decades, underpinned the demand for credit. While the source of
the demand for credit shifted between household and business sectors, from the early 1990s
recovery until the financial crisis, aggregate credit growth was sustained at a rate of over
10 per cent per annum.
At the same time, on the supply side, the importance of superannuation in Australia has, for
much of the past few decades, constrained the growth in household deposits.
Superannuation funds have historically tended to invest in wholesale bank paper rather than
hold bank deposits. So, compared with other countries, more of the savings of the Australian
household sector has tended to end up in wholesale bank paper rather than in deposits, with
the superannuation sector as the intermediary.1
More recently, however, the demand for credit from households and businesses has slowed
in tandem. For businesses, the reduced appetite for debt was initially due to a desire to
strengthen balance sheets. More recently, strong profitability, most obviously in the mining
sector, is ensuring many segments of the business sector have sufficient internal funding to
meet their investment needs.
As has been discussed in much recent RBA commentary,2 for households the slowing in
demand for credit appears to be driven by a more cautious approach to debt. There are a
number of factors contributing to this. One is that the increase in household leverage that
occurred through the 1990s and first half of the 2000s in response to the downward shift in
the nominal structure of interest rates has run its natural course. The slower growth in
household wealth, and particularly the large negative shock to equity wealth at the height of
the crisis, has also contributed to the cautiousness, even though equity wealth has recovered
and household income growth has remained robust.
This growing caution of households in the past few years has seen the household saving rate
pick up substantially, and much of this saving has been in the form of deposits, given the
attractive yields on offer. The strong cash position of many businesses is also contributing to
stronger deposit growth. As a result of these factors, deposit growth has outpaced credit
growth for the past two years (Graph 3).
Graph 3
So banks have experienced a slowdown in asset growth and have funded the assets with a
greater share of deposits. A consequence of this is that wholesale debt issuance by financial
institutions has declined to its slowest pace since the mid 1990s. The most pronounced
slowing has been in the issuance of short-term debt as banks have sought to lengthen the
average maturity of their funding by increasing the share of long-term debt in total funding
(Graph 4).
Graph 4
There are reasonable grounds to expect these trends may be sustained for some period to
come. In particular, if one thinks about the composition of growth in Australia in the period
ahead, it is likely to be investment-intensive. But much of that investment is likely to be
funded by companies which are cash-rich or tap global capital markets directly. This means
that the growth in the economy in the period ahead may be associated with less growth in
business credit than has been the case in the past. It is also likely to boost deposit growth.
So banks may be seeing a prolonged period of faster deposit growth but slower asset
growth.
Asset-backed securities
During the period of expansion in household balance sheets, an increasingly significant
source of funding for financial institutions was the asset-backed securities market. The best
example of this was residential mortgage-backed securities (RMBS) which grew rapidly as a
share of the mortgage market. But as you all know, structured credit products were a major
casualty of the financial crisis, even in Australia where they continued to perform very well.
As a result, their share of the market has declined sharply over the past three years
(Graph 5).
Graph 5
I have spoken at length recently about the specific dynamics and challenges facing the
Australian securitisation market,3 so will simply reiterate some of the key points here:

Australian mortgage-backed securities have performed well throughout the crisis
with no investor losing any money in a rated tranche;

the fundamental quality of local collateral suggests that securitisation ought to be a
viable funding mechanism in Australia;

but securitisation will not return to the levels seen in the heady pre-crisis period,
given some of the purchasers of the paper pre-crisis are no longer around.
The recent issue by one of the major banks demonstrated demand is improving for the
product, at a price which was inside the recent AOFM supported deals. The Government
recently announced that it will permit the issuance of covered bonds. It will be interesting to
see where this product will fit with the existing RMBS. There may be different preferences
between the local buyers, who are more familiar with RMBS, and offshore buyers, most
obviously in Europe, who are more familiar with covered issuance.
Corporate issuers
In many respects, the corporate segment has been the quiet achiever of the Australian debt
market over the past few decades. The stock of bonds on issue from Australian entities grew
solidly from the mid 1990s until the financial crisis. Although the significance of market-based
funding as a share of total debt funding for Australian corporates has fluctuated somewhat,
over the long run, debt market funding has grown in line with the funding needs of the
corporate sector (Graph 6). As I just noted, the investment-intensive composition of growth
over the next few years is likely to see continued strong corporate issuance by Australian
names, particularly resources companies.
Graph 6
Non-resident issuers - Kangaroos and Australian dollar eurobonds
The fastest growing segment of the Australian capital market over much of the past decade,
and certainly in recent months, has been Australian-dollar issuance by non-residents - the
market of most interest to the audience here today. Initially, much of this issuance was
offshore in the Eurobond market, but increasingly issuance has moved to the onshore
"Kangaroo" market (Graph 7).
Graph 7
In addition to the shift in the location of market activity, an important compositional shift is
occurring with new issuance increasingly dominated by AAA-rated names (Graph 8). This
probably reflects the increased risk aversion of investors in the post-crisis environment.
Graph 8
Growth in the AAA-segment of the market has been underpinned by rapid growth in issuance
among the supranational and sovereign agencies (SSA) group. SSA issuance in all
currencies has grown rapidly in recent years, as these borrowers have responded to the
large fiscal demands stemming from the impact of the global recession on public budgets in
a range of jurisdictions. In addition, SSA issuers have displayed a growing tendency to issue
in Australian dollars over recent years. Last year, Australian dollar issuance accounted for
more than 8 per cent of SSA issuance in all currencies (Graph 9).
Graph 9
This greater tendency to issue in Australian dollars has been driven by both demand and
cost considerations for issuers. On the demand side, it is clear (although hard data are not
available) that global demand for high-yielding Australian-dollar assets has been growing in
recent years. An emergent group of international investors, along with the domestic investor
base, are interested in purchasing high-quality Australian-dollar assets, and, given the
relative scarcity of Australian government paper this has created a natural opportunity for the
SSA issuers.
Moreover, there has tended to be a cost advantage to issuing in Australian dollars, owing in
part to the elevated cross-currency basis swap that has encouraged issuance by supras and
agencies in Australian dollars. Equally as important as the cost of hedging is the large
amount of foreign issuance by Australian entities that ensures access to a deep swap market
for SSAs funding in Australian dollars.
APRA liquidity announcement
I would like to finish with a few remarks on the recent APRA announcement on eligible
assets for the forthcoming Basel liquidity standards.4 The APRA announcement stated that
CGS and semis are the only assets that currently qualify as Level 1 assets and that there are
currently no Level 2 assets on issue. This outcome reflected an assessment of the liquidity
characteristics of the various asset classes.
As outlined in the Basel documents, key considerations in determining which assets qualify
are assessments of the depth of local trading activity and the performance of assets in
stressed market conditions. Specifically, the observed performance of assets during the
crisis - a period indicative of a situation in which banks would need to rely on the liquidity in
these instruments - was taken as evidence of proven liquidity. The statement did not rule out
other assets qualifying as liquid assets at a later date, but there will need to be some history
to support an assessment that a particular market has genuine liquidity.
As is widely understood, in Australia, the amount of CGS and semis on issue falls well short
of the amount of liquid assets banks will need to hold to meet the liquidity standard.
Moreover, it would be counterproductive to require banks to hold such a large share of these
assets that it would impair the liquidity in these markets.
Hence, as announced in December,5 the RBA will offer the banks a committed liquidity
facility to meet the shortfall. The eligible assets that banks will need to hold to access this
facility are those which are currently eligible for repo with the RBA in its normal operations.
While a fee will be charged for this facility, I don't see that affecting the relative demand for
securities, other than CGS and semis, for the following reason. One can think of the current
situation as an arrangement where a flat rate of zero is charged. Banks currently hold a
range of assets to satisfy their liquidity requirements, with each asset having different credit,
maturity and market liquidity characteristics. Our view of how much we are willing to lend
against each asset under repo are based on these characteristics, and will continue to be so.
In the future, we are moving to a world where there will be a formalised liquidity facility where
a flat, positive fee is charged. So that should affect all asset classes equally and should not
affect their relative attractiveness. So I would not expect this to change bank balance sheet's
demand for the non-government assets they hold in their liquidity portfolios. For example, to
the extent they hold SSAs today, they should still hold them in the future.
Conclusions
In my talk I have described the configuration of the bond market as it stands in early 2011.
The structure of the market has changed noticeably after the events of recent years. Some of
the dynamics that have emerged from the crisis may continue to shape the bond market in
the future. I have highlighted three here today:
 First, the relative growth of deposits and credit may be quite different from that
observed over the previous fifteen years. This, together with regulatory and other
pressures, will have a material effect on the composition of bank liabilities.

Second, while asset-backed issuance was most disrupted by the crisis, there are
signs of a re-emergence.

Third, investors have a much stronger preference for high-quality assets than they
did in the pre-crisis period.