David Taylor* discusses how the banks may profit from the taxpayer as COVID quantitative easing winds down.
There really is no such thing as a free lunch.
I’ll explain why.
In March of 2020, the federal government announced Australia was facing health and economic crises.
Both have cost the country dearly.
But one aspect of the economic response seemed too good to be true.
As the crisis unfolded, the Reserve Bank announced it was engaging in a money-printing program, also known as quantitative easing.
It’s an unconventional policy, with a country’s central bank creating new money to buy government bonds from commercial banks.
The process boosts the money supply, drives down interest rates and incentivises the commercial banks to increase their lending.
I wonder though, did you ever stop to think about who would end up having to pay for this program?
Everything has a price eventually, it’s only a matter of time.
The RBA and the economic bailout
The Reserve Bank has a critical role in helping to manage the economy at any time, let alone during a once-in-a-generation pandemic.
Its suite of policies over the past two years have been comprehensive, but there are two aspects of that policy tool kit which affect you directly.
The first is that it’s kept its cash rate target at the record low of 0.1 per cent since the economic crisis began.
The second is that it’s literally punched in extra zeros on its computer terminals at its headquarters in Sydney’s Martin Place in order to create money with which it’s bought billions of dollars of government bonds every week from the commercial banks — now totalling over $320 billion.
This is quantitative easing.
It results in the commercial banks having fewer bonds on their books and more cash to lend out (cash received by the RBA) — and an incentive to do so since they’re only earning 0.01 per cent on it at the Reserve Bank.
But what’s the cost?
Here’s the thing.
Tens of billions of dollars worth of bonds are still sitting with the Reserve Bank and the cash used to pay for them with the commercial banks’ accounts with the RBA.
So what if, just what if, the interest rate on the commercial bank’s deposit account with the RBA (exchange settlement account) rises?
Of course, the Reserve Bank would need to pay the extra interest to the commercial banks.
As of Wednesday, December 29, the exchange settlement balances totalled $428.7 billion.
Independent economist Saul Eslake has been studying the Reserve Bank’s financial accounts in detail.
“Prior to COVID, the Reserve Bank was paying about $1 billion in interest, mostly to the banks, on their exchange settlement (ES) balances.
“[Those] balances were typically less than $30 billion at any point in time.
“It was receiving around $2 billion a year in [coupon payments] on its bond holdings.
“[But now] the interest the bank pays on its much-enlarged ES accounts have fallen close to zero.
“[The RBA] will still probably be earning more in interest on its large bond holdings, at least for a while, than it has to pay the banks interest on their ES balances but clearly the Reserve Bank’s ongoing profits from that interest rate spread will decline [as interest rates rise].”
That means, as interest rates on those deposits rise high enough, the Reserve Bank would start paying billions in interest to the banks — just like a bank pays you interest on your deposit account.
“It’s conceivable that the Reserve Bank could start recording losses as a result of the narrowing in the spread between what it receives and what it pays,” he says.
What Mr Eslake is saying is that the Reserve Bank is right now making money from its bond-buying program, but once interest rates start to climb higher, the bank could start to bleed money with more going out to commercial banks than it receives from the government in terms of income from its bond holdings.
What happens if RBA starts bleeding money?
The Reserve Bank, like any bank, is a business.
When it incurs losses, it seeks to “re-capitalise” or seek debt and equity (more money) to keep its position stable.
An “investor” the RBA leans on is the government, former Treasury economist Warren Hogan says.
“If [the RBA’s] losses are large enough, they wipe out their profits and also their reserves, they will need to be recapitalised,” he says.
“That’s funds from the government.
“It’ll be an appropriation of general revenues from the government.”
Under a scenario of rising interest rates where the RBA suffers enough losses under its bond-buying program, the government would have to use taxpayers’ funds to recapitalise the bank.
You, the taxpayer, would begin paying for the fallout of the RBA’s money-printing program.
This isn’t happening yet.
But 2022 is shaping up to be another difficult year globally and the RBA has a lot to juggle.
What’s the possible damage?
Short answer? Billions.
“The exposure of the Reserve Bank to the underlying financial system is much bigger than it has ever been before in its history,” Professor Hogan says.
“If interest rates change, then the Reserve Bank’s exposure to that would be measured easily in the billions, if not in the tens of billions.”
The Reserve Bank helped sandbag the economy with its money-printing program but as Professor Hogan says, “quantitative easing does not mean that the debt is eradicated, it just means that you don’t have to call on the private sector immediately for those funds”.
“The debt will have to be repaid.
“It will either be repaid by taxes or be repaid by the Reserve Bank.”
This isn’t to say quantitative easing wasn’t worth it, it most certainly prevented an economic catastrophe.
It’s just that it doesn’t happen in a vacuum.
Debt has been created and it will need to be managed and paid back.
When might all this happen?
We know banks’ fixed rates are on the rise, but a crucial question of course is whether the cash rate will rise this year, which would affect the rates on the commercial banks’ ES deposits.
That’s up to the RBA itself.
It’s indicated it will be patient and wants to see a significant lift in wages first.
However, the pandemic and supply chain problems are already lifting inflation, which could force the Reserve Bank’s hand to raise the cash rate targeted earlier than expected.
And in the US, which is ahead of us in seeing inflation rises, the Federal Reserve said this week that interest rate rises there could be as early as March.
Based on the RBA’s 2021 annual report, it does not believe it will need to call on the government for more funds.
When we asked Treasury for a response, it indicated that the RBA’s capital can be replenished over time by retaining future earnings, rather than via a capital injection (money from government revenue).
The multi-billion-dollar question though is, what if interest rates are forced materially higher this year?
If they do, the taxpayer will be on the hook for billions.
Free lunch? Not a chance.
*David Taylor is a business reporter for the ABC’s Audio Current Affairs programs.
This article first appeared at abc.net.au.
