Domestic Market Operations and Standing Facilities

Introduction

The Reserve Bank of Australia is responsible for the formulation and implementation of monetary policy. The Board's monetary policy decision is announced in a media release which is distributed through market data services and published on the Reserve Bank's website at 2.30 pm (AEST/AEDT) on the day of each Board meeting.

Conventionally, the stance of monetary policy is expressed in terms of a target for the ‘cash rate’ – the interest rate on unsecured overnight loans between banks. The Reserve Bank Board determines the target cash rate at its monetary policy meetings. Any change to the cash rate target takes effect from the day after the Board's monetary policy decision is announced. The Reserve Bank's domestic market operations are designed to ensure that the actual cash rate remains consistent with the target rate and that the financial system has appropriate liquidity. In addition to open market operations, where financial institutions compete with each other to transact with the Reserve Bank, the Reserve Bank operates standing facilities for liquidity provision to eligible counterparties on pre-specified terms.

During 2020, the Reserve Bank's comprehensive package of additional policy measures to address COVID-19-related pressures on the Australian economy has resulted in some important changes to domestic market operations:

  • Changes to practices in the cash market to facilitate the cash rate target moving to a very low level.
  • Purchases of government bonds in the secondary market to:
    • achieve a target for the yield on the 3-year Australian Government bond;
    • help lower government bond yields further out along the yield curve and so lower the whole structure of interest rates; and
    • address market dislocations.
  • A term funding facility for the banking system, through which authorised deposit taking institutions (ADIs) can access low-cost three-year funding. See Term Funding Facility.

The Reserve Bank also announced that it would continue to support liquidity in Australian financial markets by scaling the size and term of its open market operations as required in response to market conditions.

In May 2020, the Reserve Bank announced that it had broadened the range of corporate debt securities that are eligible as collateral for domestic market operations to investment grade, to assist with the smooth functioning of Australian capital markets.

Exchange Settlement Funds and the Cash Rate

On a day-to-day basis, the cash rate is determined by the supply and demand for exchange settlement (ES) funds (also known as the cash market). These funds are held in accounts at the Reserve Bank by banks (as well as a small number of other financial institutions) and are used by account holders to meet their payment obligations with each other and with the Reserve Bank. The Reserve Bank supplies sufficient ES funds to ensure that these payments can be met and that the cash rate remains consistent with the Board's target.

Under arrangements introduced in November 2013, some ADIs maintain a quantity of ES funds in their account as a buffer against intraday payments and payments they may need to settle after the time that the interbank cash market has officially closed. The size of these buffers is agreed in advance with the Reserve Bank and funds held for this purpose are paid interest at the rate on surplus ESA balances. Other account holders may also receive the rate on surplus ESA balances on a pre-agreed amount of funds in order to manage intraday payments. All balances held by ADIs under these arrangements are directly sourced through transactions (open-ended repurchase agreements or ‘open repos’) between the ADIs and the Reserve Bank, with the funding rate on these transactions also set at the rate on surplus ESA balances. This means that there is no net interest cost to institutions for facilitating the smooth settlement of payments in this way.

In the several years up until early 2020, the supply of ‘surplus’ ES funds beyond these agreed buffer amounts had typically been between $2 billion and $3 billion (Graph 1). However, the policy measures announced by the Reserve Bank in March 2020 have led to considerable change in the cash market. The combined effect of the Bank's enhanced liquidity operations, bond purchases and the term funding facility program have significantly increased balances held in ES accounts.

Graph 1

The Reserve Bank chooses to transact in the domestic market almost every day to maintain appropriate liquidity. This is because transactions between the Reserve Bank's customers and financial institutions (and their customers) change the supply of ES funds. As the Australian Government is a customer of the Reserve Bank, these gross flows can be very large. Expenditure and payments by the Government adds ES funds to the account of the recipient (or their financial institution), while receipts have the opposite effect.

The Reserve Bank's own transactions with financial institutions also alter the supply of ES funds. When ADIs purchase banknotes from the Reserve Bank, settlement is in ES funds. Similarly, when the Reserve Bank buys and sells debt securities (such as government bonds) from financial institutions, the aggregate supply of ES funds changes.

The Reserve Bank is the Administrator of the cash rate. It is calculated as the weighted average of the interest rate at which overnight unsecured funds are transacted in the domestic interbank market and has a robust waterfall of fallbacks to enable it to continue to be published, including in the absence of market transactions. In addition to being the Reserve Bank Board's operational target for monetary policy, the cash rate is also an important financial benchmark in the Australian financial markets. The cash rate is the (near) risk-free benchmark rate (RFR) for the Australian dollar. It is used as the reference rate for Australian dollar overnight indexed swaps (OIS) and the ASX's 30-day interbank cash rate futures contract. The Cash Rate is also known by the acronym AONIA in financial markets. For further information, see Cash Rate Methodology – Overview.

Open Market Operations

Each morning, the Reserve Bank announces its dealing intentions for its open market operations, inviting financial institutions to propose transactions. Counterparties are able to offer to sell highly rated debt securities to the Reserve Bank either under repurchase agreement (repo) or outright sale. Under a repo, the seller agrees to repurchase the security at a future time and at a pre-agreed price. The transaction is similar to a secured loan, with the difference between the purchase and repurchase prices representing the interest earned on the transaction.

Late each afternoon, the Reserve Bank may announce an additional round of open market operations, if required. Uncertainty in the timing of payments to, and from, clients that hold accounts with the Reserve Bank (mainly the Australian Government) can give rise to unforeseen fluctuations in ES funds during the day. The additional round gives participants the opportunity to either lend excess balances back to the Reserve Bank or borrow the shortfall on a secured basis. Notably, the Reserve Bank assesses the need for these additional rounds on a system-wide basis rather than on the position of individual institutions. The large increase in the size of ES balances since March 2020 has resulted in fewer operations being undertaken in the afternoon. Very occasionally, the Reserve Bank might announce further additional rounds of open market operations later in the evening. These are conducted prior to the close of the SWIFT End Session. For further information on additional rounds, see Technical Notes: Open Market Operations (Section 1.1.2).

One aspect of liquidity management through market operations is management of the effect of large maturities of Australian Government Securities (AGS) on system liquidity. The Reserve Bank acts to manage the volume of funds that are paid out of the Australian Government's account at the Reserve Bank into ES accounts (for the credit of the security holder) on the maturity date. In addition to using reverse repos and foreign exchange swaps to withdraw liquidity on the maturity date, the Reserve Bank makes purchases of the relevant near-to-maturity AGS ahead of the maturity date. These purchases are undertaken to manage near-term liquidity flows and have no implications for the Reserve Bank's monetary policy stance. As noted above, these purchases may occur as part of the Bank's open market operations. Interested parties can also approach the Reserve Bank's Domestic Markets Desk at any time with their offers, volume and rate, though approaches through open market operations are preferred. Data on all of the Reserve Bank’s outright holdings are published in Statistical Table A3.1 on the Reserve Bank website.

Standing Facilities

In addition to open market operations (where financial institutions compete with each other to transact with the Reserve Bank), the Reserve Bank also operates standing facilities that are available to eligible counterparties on pre-specified terms.

As mentioned above, the Reserve Bank has a standing facility that allows ESA holders to access a certain amount of funds at a pricing rate set equal to the rate on surplus ES balances. These funds are obtained through ‘open’ repos with the Reserve Bank (that is, repos contracted without a maturity date). To the extent that ESA holders retain matching funds against their open repo position, those ES balances earn the rate on surplus ES balances. An allowance is made for variations in ES balances arising from after-hours payments initiated through the direct entry (DE) system or New Payments Platform (NPP). Any remaining shortfall or surplus ES balances attract interest at the appropriate rate, either 25 basis points above the cash rate target in the case of a shortfall or, since November 2020, 10 basis points below the cash rate target in the case of surplus ES balances. These deposit and lending rates form the lower and upper bounds of the policy interest rate corridor. Banks have no incentive to borrow or lend ES balances outside this corridor.

The Reserve Bank offers a standing facility for intraday repos. These repos carry no interest charge and provide a means by which financial institutions can meet payments in advance of funds being received.

The Reserve Bank also has a standing facility where it agrees to extend overnight funding to an eligible counterparty at an interest charge set 25 basis points above the cash rate target. These ‘overnight’ repos are rarely used as the higher rate of interest attached to them creates the incentive to source funds in the interbank market.