RBA eyes risks as market transitions

  • By Zilla Efrat

The Reserve Bank of Australia would closely monitor risk premiums to assess whether asset prices were sensibly valued, Marion Kohler, head of the RBA’s domestic markets department, said yesterday.

Giving the keynote address to the online Australian Securitisation Forum, she outlined how markets for non-government securities had weathered the past 20 months as well as some areas the RBA would be watching over the coming months and years.

“One area of focus stems from the current historically very low interest rates,” said Kohler.

“Asset prices increase when risk-free rates are low, and this is part of the monetary transmission mechanism. However, as we've highlighted in recent Financial Stability Reviews, over time it also raises the prospect of ‘search for yield’ behaviour, where investors bid up the price of risky assets to the extent that risk may no longer be adequately priced.

“This, in turn, increases the risk of a sharp correction down the road. So, it's important to closely monitor risk premiums to judge whether asset prices appear to be sensibly valued. While bank bond spreads are around their lowest level in over a decade, it's difficult to know whether this is not aligned with fundamentals. Measures of equity risk premiums remain within their typical range.”

Kohler added that another area of the RBA’s focus would be possible changes in supply and demand in security markets as the Committed Liquidity Facility (CLF) was being phased out.

“Over the past two years, the stock of government debt has increased sharply, funding the fiscal response to the economic effects of the pandemic,” she said.

“This increase in high quality liquid assets (HQLA) has allowed the Australian Prudential Regulation Authority to phase out the use of the CLF over the coming year.

“The facility, which is provided by the RBA, allows banks to hold collateral other than HQLA, including bank bonds and RMBS, to fulfil their required liquidity coverage ratio.

“Given the changes in the CLF, banks might decrease their holdings of these securities. At the same time, banks are likely to increase their holdings of HQLA, which could be funded in part by increased bond issuance.”

Kohler said a third area of the RBA’s focus was the bank bond market and the refinancing of the Term Funding Facility (TFF), announced by the RBA in March 2020 to support the Australian economy in response to COVID-19.

“The facility closed to new drawdowns on 30 June 2021, at which time $188 billion of funding was outstanding,” she said. As the facility provides low-cost fixed-rate funding for three years it will continue to support low borrowing costs until mid 2024.”

Kohler said the TFF maturities were large and concentrated in the September 2023 and June 2024 quarters.

“Banks can meet this refinancing task in a number of ways, including sources of funding such as deposits,” she said.

“But it's likely that they will raise a sizeable amount of funds from bond markets to repay TFF funding

“If banks issue new debt to replace TFF drawdowns in the quarter of maturity, this would require quarterly issuance as a share of assets at levels not seen in over a decade.

“However, in liaison banks have indicated plans to issue bonds earlier than, or ‘pre-fund’, scheduled TFF maturities. Banks can also repay TFF funding early without any additional cost. These strategies would allow banks to spread the refinancing task over a period of time and would serve to reduce the effect of refinancing on market conditions.”