Tony Boyd
Future Fund in the clear
Is the Future Fund propping up the Big Four banks?
That question arose today after ABN Amro published a report declaring that the major banks were heavily reliant for their balance sheet funding on deposits from the Future Fund and Reserve Bank open market operations.
The authors claimed this was unsustainable and that the major banks would have to look elsewhere once those short term funding options dried up.
Firstly, it is worth looking at the Future Fund's own disclosures and others made by the RBA to check what the country's largest single investor has been doing with its cash.
Portfolio updates published on the Future Fund website in January and April showed “cash” holdings of $37 billion and $35 billion respectively.
The Future Fund revealed in Senate Committee hearings in February and May that this cash was “materially” invested in bank bills with a short duration of 50 to 60 days.
Although the Future Fund website says its cash is managed by Colonial First State, QIC and the Reserve Bank it is now clear from a speech given late last month by RBA assistant governor Guy Debelle that the Future Fund cash at the RBA peaked last year and had virtually gone by the end of 2007.
When the Future Fund was first established, all flows from the government were immediately deposited with the RBA before being available to the fund's chief investment officer.
Moving $35 billion in cash from the RBA into bank bills was smart and contained an element of public good.
The move was smart because the RBA pays the cash rate while bank bills pay a rate about 50 basis points higher than that. Over the past six months, the Future Fund has been able to earn about $87.5 million more from bank bills than it would have earned on deposit at the RBA.
There is an element of public good in investing bank bills because, as the ABN Amro paper pointed out, interest rates on home loans would probably be higher if Australia's major banks had been forced to obtain more expensive funding offshore.
The Future Fund took higher risks shifting its deposits from the risk free RBA into bank bills. But in doing so it acted within the parameters of its directions from the parliament to take an acceptable but not excessive level of risk.
Australia's big four banks are among only 20 AA rated commercial banks in the world. According to Standard & Poor's there are less than five commercial banks in the world with higher ratings. So the Future Fund is investing in paper issued by banks it knows in a market it knows.
Investing in bank bills is in keeping with the status of the Future Fund portfolio which is still in transition from a start up phase to being fully invested. Bank bills provide liquidity and flexibility while helping the fund achieve its long term target of at least the CPI plus 4.5 to 5.5 per cent per annum.
The latest asset allocation of the Future Fund is being finalised as part of the audit component of the 2008 annual report. The report will be released to the federal government before being publicly released in September.
Meanwhile, there is no indication that the Reserve Bank will end its extraordinarily generous support for the Big Four banks any time soon.
One sign of the RBA's generosity toward the banks is its tolerance of a 'round robin' arrangement that allows the banks to turn mortgage securities on their own books into third party collateral allowed to be used in repo arrangements.
The RBA will not allow mortgage backed securities issued by an institution or a related party to participate in repo exchanges. But it is understood that major banks have swapped equal amounts of their own securities with other banks and then used those to participate in repo arrangements.
Another sign of the RBA's lifeline for the major banks is the fact that a bank could go into the open market and buy RMBS assets at up to 150 basis points above bank bills and then repo them back to the RBA at 20 to 30 basis points under the bank bill rate. Now, that is a nice turn.
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