ric battellino : central bank market operations address by mr ric battellino, deputy governor of the reserve bank of australia, to the retail financial services forum, sydney, 28 august 2007. * * * central bank market operations around the world have been in the news in recent weeks, so i thought it might be useful to take this opportunity to run through those developments. while this topic may seem somewhat distant from retail financial services, there is in fact a strong relevance to today ’ s conference, because much of what central banks do in financial markets eventually flows through the whole financial system, including retail services. background the reserve bank has been using market operations to implement monetary policy since the 1980s. 1 essentially, this involves dealing in markets to influence the interest rate on overnight funds in the money market – also known as the cash rate. central banks are able to closely control the overnight interest rate because they have unlimited ability to inject funds into, or withdraw funds from, the money market. this model for implementing monetary policy is now fairly standard across the developed world. the reserve bank board sets the stance of monetary policy in terms of a target for the cash rate because this rate ultimately influences the broad spectrum of interest rates in the money and capital markets and the interest rates that intermediaries charge on loans, including those in the retail market. in effect, all interest rates in the financial system are determined in one way or another relative to the cash rate. by targeting the cash rate, central banks are therefore able to exert broad influence over the overall cost of credit in the economy and, in turn, economic activity and inflation. after the reserve bank board has decided the target for the cash rate each month, the domestic markets department of the bank is responsible for keeping the actual cash rate in the market as close as possible to the target over the ensuing inter - meeting period. a major determinant of the cash rate is the aggregate level of balances held by commercial banks in their exchange settlement accounts at the reserve bank. these are the funds that banks rely on to meet their daily settlement obligations to each other and to the reserve bank. if banks do not have enough of these funds, they risk failing in their payments, so a shortage of funds causes banks to bid more aggressively in the money market to try to restore their holdings. on the other hand, because these funds earn an interest rate that is below the rate that could be earned in the market ( 25 points below the cash rate ),

as 450 basis points. while the secondary market spread remained this wide, there was likely to be little new primary issuance. investors could satisfy their demand much more cheaply in the secondary market. it is well understood that as a consequence of the demise of sivs, the investor base for asset - backed securities is substantially narrower than prior to the crisis. this is particularly the case in offshore markets. as some of these investors relied on various forms of excessive leverage to be profitable, they are not likely to return. but there are still natural investors, both domestic and offshore, that ought to be attracted to the high quality of the australian rmbs. recent developments rmbs issuance this year has been around $ 18 billion, higher than the $ 14 billion issued last year but well below the $ 50 billion plus annual issuance prior to the crisis ( graph 4 ). however, this comparison exaggerates the situation. the underlying pace of housing credit growth has also slowed from around 15 per cent per annum to around 7 per cent. so given this slowing in system credit growth, comparisons of gross issuance with the pre - crisis period are not very informative. an alternative benchmark is the amount of issuance required for securitisation to hold its own as a share of total housing lending. a rough calculation suggests that annual gross issuance of around $ 25 to $ 30 billion would be required to see securitisation maintain its current share of housing credit. graph 4 all of the issuance this year, with the exception of one tranche in early 2010, has been in the domestic market. the issuance has been mostly by the smaller lenders, regional banks, credit unions and originators, who have limited access to alternative funding sources. these issues have involved some degree of support from the aofm. in total, only $ 3. 2 billion of the rmbs issued have not had aofm support. in thinking about the aofm support for the rmbs market, i believe the aofm program has a number of advantages relative to alternative means of support : it can be easily tailored to help specific types of institutions ; it can be phased out easily ; the likelihood that the government loses money on its investment is very small ; and there is no ongoing contingent liability to the government from providing the support. if instead a government guarantee of rmbs were provided, it would be difficult to phase out, creating a commitment that could generate a large contingent liability for the government. at