The RBA’s balance sheet
Dispelling the accounting confusion Steven Hail
If Megacorp A owns Business B, then it is sound accounting practice to include the assets and liabilities of B in the consolidated balance sheet of A, and not to treat the entities as if they are entirely independent of each other. How strange then that when the entity A is a federal government and B is its (generally) wholly owned central bank, this is overlooked.
In the last couple of years, this feature of central bank accounting has led to confusion and angst relating to the impact on the Reserve Bank’s balance sheet of the series of increases in the target cash rate which of course the RBA itself sets, and the associated increases in yields on Commonwealth Government bonds.
During the two years after the pandemic struck, the RBA purchased about $330bn of government bonds, with the aim for a while of holding the yield on 3-year treasury bonds at the target cash rate and of imposing downward pressure on long term interest rates. While these purchases were secondhand, from the private sector, rather than directly from the Treasury, the fact that the Government’s deficit spending closely matched the scale of bond purchases led some to claim that the RBA was ‘printing money’ to fund government deficits. In addition, the RBA supported private banks by offering them low-cost funding for three years. If one includes the bonds with this funding, the assets on the RBA’s balance sheet have expanded since March 2020 by well-over $400bn, with most of this being accounted for on the liability size by a very large increase in private bank exchange settlement account balances. These balances of course were created at no cost using nothing more than a computer keyboard.
It won’t come as a surprise to learn that central banking is usually rather profitable. In normal times, these profitable. In normal times, these profits accumulate as reserves on the RBA balance sheet, and later are credited to the Government’s account as a dividend, subject to leaving the RBA’s capital position at a small and conventionally determined positive balance.
This is how the central banks nearly always operate. I was once told by a politician that he asked a former governor why the RBA’s capital balance was important, and the answer given was that it isn’t really – people just like to see it there.
The pandemic led to the RBA buying large quantities of treasury bonds at premium prices (since higher bond prices go along with lower yields) and at the same time lending extensively to private banks at a very low interest rate until 2024. The subsequent economic recovery, mainly driven by government deficit spending but supported by the RBA’s measures, along with a global spike in inflation driven by war and other factors, has seen the central bank raise its target cash rate from virtually zero to 4%, with bond yields moving in the same direction. This means bond prices have fallen sharply, causing a large capital loss on the portfolio the RBA purchased in 2020 and 2021, and that the RBA is now paying private banks a higher interest rate on exchange settlement balances than it is (still) charging them on the funds they borrowed under its term funding facility.
The RBA has been making losses
All in all, the capital and reserves position of our Reserve Bank has gone from about +$35 billion just prior to the pandemic, to -$15 billion today.
Does this matter? No. In fact it is a sign of success. It is a consequence of the economy recovering from what was a very perilous position indeed in mid-2020.
One way of explaining that it doesn’t matter is to remind ourselves that the RBA is the currency-issuer. When private entities have a negative capital position, it means that they could not sell off their assets and by doing so cover their debts. It means they are at risk of insolvency. This is not true for the currency issuer. There is no insolvency risk.
If you don’t like that argument, here is another one. The Commonwealth Government’s net debt is officially currently close to $550 billion. Given an RBA capital position of -$15 billion, you might choose to say the net debt is more like $565 billion. If the RBA had a capital position of +$15 billion instead, you could fairly argue the debt should have been $535 billion.
The capital position of our central bank should be regarded as not much more than a rounding error in our public accounts. It has no greater significance than that, and none taken out of context of the government’s consolidated balance sheet. This is what lay behind Governor Philip Lowe explaining that if the central bank was to write off treasury bonds held in its portfolio it would not change the net financial liabilities of the public sector, correctly defined. The Treasury would have fewer liabilities, but its central bank would have fewer assets, and the two entries would just cancel out.
It is fair to say that confusion about the above has been widespread. You may have read the following suggestions:
- The RBA might need to sell off its bonds before maturity, to avoid the risk of further losses, if interest rates and bond yields go higher still.
- The RBA might want to avoid bond purchases in future economic downturns due to the resulting losses.
- The RBA’s future decisions on the target cash rate might be influenced by losses on its bond portfolio and related losses on Term Funding Facility lending to banks.
- The RBA cannot afford to pay a dividend to the Commonwealth Government for some years, because it is required to get its money back.
- The Commonwealth Government should budget to recapitalise the RBA as soon as possible.
- The RBA’s independence is compromised by having a negative equity capital position.
The first of these would risk dislocating financial markets. The second would be a ridiculous reason for eliminating a policy option. The third might make further rate rises less likely – a good thing in the opinion of this author – but for a nonsensical reason. The fourth is not significant, but simply means the RBA not crediting the Commonwealth Government’s account (with what is usually a small amount) due to an accounting convention. The fifth has the potential to distort fiscal policy decisions, because the restoration of a clearly positive capital decision would involve a deletion from the public account at least as large as the proposed Housing Australia Future Fund, again for purely accounting ends. However, given the current windfall surplus the Government has, it would probably not matter very much. The sixth has no logical justification at all.
The Reserve Bank of Australia is wholly owned by the Commonwealth Government. While conventionally it has been excluded from the general government sector when discussing its balance sheet, this is a source of confusion, and has the potential to distort both monetary and fiscal policy decisions.
The accounting practices of the central bank, however we choose to organise them, should never be allowed to influence either the public discourse on economics or economic policy decisions in practice.
Dr Steven Hail is Adj. Associate Professor at Modern Money Lab, Torrens University, and is an ERA member.Know someone interested? Please share