During the height of the COVID-19 pandemic, the RBA pumped billions into the financial system. Now we are in the middle of the big unwind as the RBA looks to tighten financial conditions further in response to high inflation.
The RBA stopped its yield curve targeting in November 2021 and its Bond Purchasing Program (BPP) in February 2022. However, the impact of these unwinds are dwarfed in size by the upcoming repayments for the Term Funding Facility (TFF) - see the chart below.
Drawdowns on the TFF ceased in June 2021, but banks did not have to pay back the outstanding $188 billion until now. The first deadline is on 30 September 2023 (for the initial allowance) with around $76 billion due. The final deadline is on 30 June 2024. The chart below suggests that these TFF repayments will be a shock to the Australia financial system - are we prepared?
What is the TFF and why was it introduced?
As COVID-19 developed into a pandemic, banks’ funding costs spiked and became volatile. The RBA became worried that the banks would pass on the higher costs to consumers through higher mortgage rates and would also reduce the amount of credit available to businesses. So, on 19 March 2020, the RBA announced the creation of the Term Funding Facility (TFF). The aim was to provide banks with cheaper funds to keep mortgage rates down and to encourage banks to keep lending to businesses.
Under the TFF, banks entered into repos (repurchase agreements) with the RBA. They provided specified collateral in return for money in their Exchange Settlement accounts at the RBA. The RBA initially charged 25 bps for the facility but later reduced this to 10 bps. The use of the TFF also had the secondary effect of decreasing the yield for banks’ bonds as banks did not need to issue as many bonds as before.
The chart below shows the spike in banks’ 3-year funding costs at the onset of the pandemic and the lower cost provided by the TFF.
The initial amount banks could borrow from the TFF was capped at 3 percent of their total credit outstanding. This equated to $84 billion or over 4 percent of GDP. The cap was expanded to 5 percent in September 2020. The major banks all used the maximum allowance as did the mid-sized banks like Bendigo, Macquarie, and Suncorp.
In addition to introducing the TFF, the RBA cut the cash rate to 0.1 percent, increased liquidity into the banking system through its normal Open Market Operations, introduced a yield target for 3-year government bonds, and introduced the Bond Purchasing Program (BPP), its version of QE. Stimulus cheques also helped push up the level of bank deposits, which at the time provided a cheaper source of funding for banks than bonds.
“In combination, these measures have caused interest rates across the economy to be lower than they would have been otherwise.” Christopher Kent, RBA Assistant Governor (Financial Markets), 9 June 2021.
The TFF should not be confused with the RBA’s CLF (Committed Liquidity Facility) which was set up to allow banks to use asset-backed securities (ABS) (including self-securitised) as collateral during periods of market stress so that they could meet their ARRA Liquidity Coverage Ratios (LCRs). The CLF has been discontinued because of the increase in government debt and semi-government securities means banks no longer need to rely on RMBS in a stress event. In the end, the CLF was never used in a stress event. The TFF used AAA ABS, government debt, and semi-government bonds as collateral - much broader than the CLF.
The impact of unwinding the TFF
The RBA has already unwound the $38 billion in bonds purchased under its yield targeting program. None of the $281 billion purchased under the BPP has currently been unwound, but unlike other central banks, the RBA is letting these bonds mature rather than actively selling them off. This should minimise the impact of their unwind as can be seen in the first chart of this article.
While the outstanding amount for the TPP (which is still close to $188 billion) is less than that for the BPP, it is being unwound over the next two years, a much more concentrated time frame, and will thus be a much bigger shock to the system.
Given that banks’ funding costs have increased since the end of 2021 (see chart below) and that rising interest rates have made deposits more expensive, it is no surprise that they have not paid much of their TFF liabilities early. By the same logic, the upcoming forced paybacks are going to hurt and may see increases in mortgage rates and interest rates for businesses.
Some banks will also have to scramble to buy new High Quality Liquid Assets (HQLA) to meet their LCR requirements with APRA as they pay back their TFF liabilities - Exchange Settlement funds are considered HQLA. Not all the collateral used for the TFF was HQLA so some banks will have to buy new sources of HQLA as they get non-HQLA collateral back from the RBA. This will reduce their available liquidity further and may force them to borrow more funds at higher rates, which will increase their overall funding costs.
However, this is exactly what the RBA wants, more tightening:
“This contraction of our balance sheet will contribute to some tightening of financial conditions in Australia and so assist with the return of inflation to target.” Philip Lowe, Governor of the RBA, Monetary Policy Decision, 3 May 2022.
It is unlikely that the repayment of the TFF liabilities will cause any sort of liquidity stress event. The RBA can easily step in with short and medium term Open Market Operations to smooth out any liquidity needs. They could also easily extend the TFF deadlines or restart the BPP. The repayment of the TPP will be painful but not deadly.
What does this mean for Private Debt in Australia?
Private debt funds are also experiencing the general increase in funding costs experienced by banks, but of course they are not exposed to the TFF like the banks. Further, they have the advantage of higher interest rate margins compared to the banks. They are also seeing increased demand for their services from businesses squeezed out by the banks. While the TFF may cause the banks some pain, it may be private debt’s gain.