RBNZ liquidity measures: What do they mean?

This post is more of an open discussion post. I want to know what YOU think about the new Reserve Bank liquidity measures.

We know that BNZ, Goldman Sacs, the Press, and fellow bloggers such as the Hive and Mish believe that this (and yesterdays financial market review) illustrates a significant change in stance by the Bank. However the Bank itself believes that this illustrates no change in stance, but is simply mean’t to keep our monetary policy practice in-line with other countries – in the words of CPW, they wish to sit at the big boys table.

My knowledge of such things is decidedly limited – however, I’ll tell you what I think they mean, then you can correct me 😉

The main changes according to the Bank are:

  1. Extension of the range of securities eligible for acceptance in the Reserve Bank’s domestic liquidity operations to include: NZ-registered NZ dollar AAA rated securities, including Residential Mortgage-backed securities, and AA rated NZ government sector debt – including Government agencies, SOEs and Local Authorities.
  2. The discount margin applied in the Bank’s Overnight Reverse Repo Facility will be 50 basis points for all eligible securities.
  3. A graduated ‘haircut’ regime will replace the existing limit structure for all securities eligible for domestic liquidity operations.
  4. Extension of Overnight Reverse Repo Facility from 1 day to a maximum of 30 days.

My impression of what these mean is as follows (aided in large parts by this).

The first change is to extend the number of securities that the Reserve Bank will accept as collateral for loaning out funds through the ORRF (overnight reverse repurchase facility). This should increase liquidity by allowing institutions to borrowed based on these illiquid assets. However, at a rate of OCR+50 basis points, and given the fact that liquidity in New Zealand is still relatively healthy this should have no real impact on the economy.

The second change is to introduce the +50 basis points rate on these new securities. I think that the old style securities (such as government back AAA debt) is still priced at OCR+25 basis points, I would like to be corrected if I am wrong though (Update:  Supposedly they were lifting it to +50 anyways – so this is on all securities.  In a sense it is no change).

The third change is a “haircut regime“. A haircut implies that the bank will only accept proportion of the asset as collateral when making a loan – where the proportion depends on the risk associated with the asset. As a result, the riskier the instrument used as collateral, the less you will be able to borrow with it. This seems fine, as it simply assumes that the RBNZ is taking into account risk when making loans.

The final change is relatively significant. The ORRF can now be used for a 30 days, rather than one day transactions. There are two possible reasons for this that I can tell:

  1. It is being made into an instrument that can help groups with relatively longer term liquidity problems (where longer term is a month),
  2. The fact that the new securities have to be processed manually implies that it is expensive and difficult to work with them on a daily basis – so the loans are allowed to be out for 30 days to reduce transaction costs.

Ultimately, I think the Reserve Bank introduced these measure in order to be prudent (insofar as further liquidity problems could appear) and consistent with international best policy. I believe them when they say that this will have no impact on the monetary policy settings – and as a result, I feel people are reading too much into what has happened here.

We have gone through the changes, and they don’t appear to be terribly significant given the current level of liquidity in the economy. Hopefully it will remain that way.

If people would like to add some points and clean up the technical details here, I will add some updates to this during the day as (if) comments come in.

6 replies
  1. Fred
    Fred says:

    40% of banking funding is from non-residents (total 80bn) up from 30% 10 years ago and 40bn is due for maturity in 2 to 90 days (as at December 2007). When the OCR is reduced, and the exchange rate starts to fall and NZ is seen as riskier there is potential for a fair bit of this to be withdrawn. Therefore allowing residential mortgages (156bn) to be used as security would allow replacement of this funding (per financial stability report). If the RB accepts these as security does that mean that they can be traded and isn’t that what triggered the whole thing in the first place (except ours aren’t sub-prime!!)?

  2. Tim Selwyn
    Tim Selwyn says:

    Cullen has ben putting chunks of the surplus into the RBNZ for a few years now because they know how weak we are – as Fred mentioned there has been a dramatic rise in the last five years of overseas punters buying NZ dollar securities. The RBNZ was quite happy to create this extra value for off-shore investors and the Aussie banks that issued it.

    I think the RBNZ really likes the idea of having NZ as a big forex operation – but when you take the ego out of it what do we have? 11th or 12th most traded currency in the world and we are only 4 million people!? An unstable exchange rate and massive debt. It’s all backed by the over-hyped property market – created in part by the lending policies of the banks (and therefore also the RBNZ).

    I have argued a few years ago on my blog that the RBNZ has let the banks create this extra credit which has enabled them to effectively export domestic inflation to the finance sector (interest rates) and foreign investors (currency speculators) which has kept the economy bouyant and the higher exchange rate lets our massive trade imbalance remain less worse than it would be otherwise. Increase credit does not create domestic price inflation if the increase is held and operated outside of the domestic economy – that is my over-simplified understanding (which I conceed could be flawed). The problem is that all of these NZ dollar instruments held off-shore will want to be rolled over on favourable terms – and I don’t think we can give them that anymore. This will cause our exchange rate to plummet and make petrol esp. and inflation a lot higher than it is at present.

    And to fill the slack the government keeps pumping in 50,000+ migrants every year to boost all the raw figures like GDP. If immigration falls then a recession is assured too.

  3. Tim Selwyn
    Tim Selwyn says:

    And this just in:
    USA Today leads with an analysis that says the federal government’s “long-term financial obligations” increased by $2.5 trillion last year. In order to cover the benefits of everyone who is eligible for government programs, including Medicare and Social Security, “taxpayers are on the hook for a record $57.3 trillion,” a figure that translates into almost $500,000 per household. The number is much higher than the $162 billion the government reported as last year’s deficit because it doesn’t follow accounting standards that are the norm in the corporate world and fails to count future financial obligations.
    And we think we have problems…

  4. Matt Nolan
    Matt Nolan says:

    Hi Fred and Tim,

    Sorry for the delay replying – things have been exceptionally busy and so I haven’t had much of a chance (as you may have noticed with the dearth of interesting posts here lately 🙂 ).

    Fred, our exchange rate is risky because it is above what the market views as its “fundamental level”, as a result, a fall in the dollar will help to reduce risk and so will reinforce whatever this believed level is. There is risk in the very short-term that we will “over-shoot”. Such over-shooting is the result of uncertain information – something our Reserve Bank will be on notice to deal with.

    The trading of sub-prime mortgages turned into such a mess because the rating companies didn’t define the risk properly and so the market panicked in the face of uncertainty. I don’t think the trading of similar mortgages here would do anything. Furthermore, there is a difference between the mortgages being wrapped up in bond form and sold and what the RBNZ is offering – which is to make the assets more liquid by swapping the asset for cash (with the Bank taking a premium for risk).

    Tim, the creation of credit is one of the primary factors behind inflation – as you produce more money but there are no additional goods. In order for the RBNZ (and banks) to “create credit” they need to cut interest rates. Although it is true that strong global liquidity may have adversely impacted on the RBNZ’s ability to lift interest rates – it has still increased interest rates. As a result, the driver of inflation etc has fundamentally been money demand, which has stemmed from strong demand for credit from households.

    Now, the concern you hold about offshore liabilities stems from a justifiable concern that global liquidity is drying up – is that right. If that is the case then we will see domestic interest rates rise as a result of this – which in fact we have. However, the New Zealand economy is in a much better position than in was in 1990/91 when we faced similar headwinds from global investor concerns – a factor that global investors appreciate.

    In the medium term our current account deficit is concerning – however it is sustainable. Methods to improve our current account situation could make an interesting post – something I’ll keep in mind when I have a little more time 🙂

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