Why the Reserve Bank of Australia Restricts its Trading Transactions to the Government - Case Study Example

Banking and Finance Name Institution Banking and Finance The Reserve Bank of Australia came into existence in January 14 1960, as the central bank of Australia (Kent & Robson, 2010). It was established under the Reserve Bank Act 1959 when the central banking functions were removed from the common wealth bank. The Reserve Bank of Australia has a relationship with the Australian government that is set out by the section 11 of the Reserve Bank Act 1959 (Kent & Robson, 2010). The board is given substantial independence, and this is balanced by the obligation placed upon it by the Act, to inform the government of its policies on timely bases to get parliament accountability (Stevens, 2007). The Reserve Bank of Australia provides services to the government of Australia, other official institutions and other central banks. The members of the payment system and reserve bank board consists of the members from the treasury, leaders of other institutions regarded to be part of the economy, Australian government agencies and the bank itself (Kent & Robson, 2010). This paper reviews some of the roles of the Reserve Bank of Australia stated in the Reserve Bank Act 1959. The paper reviews the reasons why the Reserve Bank of Australia restricts its trading transactions to the government and semi government securities, mostly focusing on the intention of making sure its monetary and banking policy is meant to help the Australian citizens. The Reserve Bank of Australia is given the responsibilities of providing banking services to the Australian government, hence the reason why it restricts its trading transactions with the government and semi government securities (Kent & Robson, 2010). The boards of the bank, which include the payment systems board and the Reserve Bank board, consists of members of Australian government agencies, and other leaders of institutions in the economy of Australia (Coppel & Connolly, 2003). The bank is assigned with the role of making sure the currency of Australia is stable and there is full employment in Australia. According to the roles assigned to the Reserve Bank of Australia by the Reserve Bank Act 1959, the bank is supposed to maintain the economic prosperity of the Australian citizens (Coppel & Connolly, 2003). The bank also has the role of providing registry, banking and payment settlements to members of the Australian financial systems, international bodies, other central banks and the Australian government (Becker & Sinclair, 2004). Some of the services that Reserve Bank of Australia conducts that make it restrict its trading transactions to the government securities and semi government securities are the operation of the principle public accounts of the Australian government (Coppel & Connolly, 2003). The bank provides the government with term deposit facilities that are used for the purpose of depositing its excess cash reserves. The bank also provides the government with a short term overdraft facility, which caters for the times when the commonwealth cash balances, makes unexpected demands (Coppel & Connolly, 2003). The overdraft has, however, been used only few times. The transactional banking service the Reserve Bank of Australia provides to the Australian government includes services related to traditional banking and payments activities. An example of such a service is delivering direct payment entries from government agencies to recipient’s accounts. Furthermore, the Reverse Bank of Australia provides government agencies with access to services such as over the counter, BPAY, the internet phone and card based payment options that play an integral role in the collection of funds (Stevens, 2007). The Reserve Bank of Australia restricts its trading transactions with the government and semi government securities to maintain the supply of exchange settlement funds at the necessary level. Even when the demand for the Exchange settlement funds is stable, there is need for the bank to continue transacting in the domestic market daily (Coppel & Connolly, 2003). Daily trading in the domestic market is aimed at keeping the supply of the funds at the required level. When payments are completed between customers of the bank and financial institutions, the supply of the exchange settlement funds changes. The Australian government is a major client of the Reserve Bank of Australia, and therefore, any transactions between the bank and the government can lead to large payment flows (Coppel & Connolly, 2003). The transactions of the Reserve Bank of Australia and other financial institutions can also change the supply of the exchange settlement funds rates. The Reserve Bank of Australia, therefore, decides the amount to trade in the government and semi government securities every day, with the purpose of offsetting all its other settlement obligations and those of the government (Becker & Sinclair, 2004). This is very helpful in maintain the appropriate level of supply of the exchange settlement funds. The Reserve Bank of Australia transacts with the government mainly to make sure there are everyday flows of payments in the banking system. The flows happen when the customers of the bank, in this case the government, are active by making payments and collecting taxes (Kelly, 2000). The Reserve Bank of Australia, therefore, makes sure there are everyday trading transactions between itself and the government or other semi government securities, to enable sufficient supply of exchange settlement funds to meet the demand of the banks (Coppel & Connolly, 2003). The main reason of selling government and semi government securities is to remove excess funds from the banking system (Coppel & Connolly, 2003). One of the reasons why the Reserve Bank of Australia restricts most of its trading transactions to the government and semi government securities is to accomplish its task of formulating and implementing the monetary policy, through consulting with the government (Kent & Robson, 2010). The monetary policy is meant to control inflation in Australia. Managing the national foreign reserve assets and serving the government with banking services are the two other major reasons why the Reserve Bank of Australia ventures into financial markets (Kent & Robson, 2010). The cash rate is the Reserve Bank’s operational target for monetary policy, and therefore, it is its priority to set it. According to Kent and Robson (2010), the cash rate is the rate at which banks lend and borrow from each other, on unsecured bases in an overnight. Maintaining a cash rate helps in managing system liquidity. According to Kent & Robson (2010), the board of Reserve Bank of Australia has retained the cash rate target of twenty five percent. The Banks market operations in the domestic market are meant to make sure that the actual cash rates are almost close to the set target rate (Coppel & Connolly, 2003). The Reserve Bank of Australia uses Repos to act as a flexible instrument of managing the outstanding Exchange Settlement Account (ESA) balance in the system of banking with the purpose of stating as close to the set cash rate target as possible (Coppel & Connolly, 2003). The Reserve Bank of Australia restricts its trading transactions to the securities of the government and semi government to facilitate the Australian governments business in the foreign exchange market. One of the functions of the Reserve Bank of Australia is to conduct foreign exchange market transactions to its clients. The interventions of the Reserve Bank of Australia in the foreign exchange market increases the demand and supply rate of the Australian dollar, by buying Australian dollars against foreign currencies (Stevens, 2007). Furthermore, it is its obligation to manage the portfolio of foreign currency assets of its clients and its policy operations. The Australian government is the major client for foreign exchange services, which provide the biggest majority of client transactions (Kent & Robson, 2010). In its normal operations, the Reserve Bank of Australia purchases foreign currency in the market, with the purpose of covering its sales of foreign currency to the Australian government. During the periods of market stress, the bank draws its foreign currency store, with the purpose of meeting the demands of the Australian government (Kent & Robson, 2010). This action delays the negative flow of the impacts of the market stress to Australian market. For example, in the 2011 and 2012 financial year, a total of $ 7.3 billion were purchased by the Australian government from the Reserve bank of Australia (Coppel & Connolly, 2003). The transactions between the Reserve Bank of Australia and government of Australia were covered in the market. It can, therefore, be stated that the Reserve Bank of Australia makes transactions with and on behalf of the government of Australia to manage currency risk on foreign currency assets (Coppel & Connolly, 2003). The Reserve Bank of Australia plays the role of management of domestic assets and domestic liquidity through making higher government deposits and establishing positions of open repo (Stevens, 2007). The bank makes sure that the domestic assets are held under repo or purchased completely. Since most of the transactions in the domestic market by the Reserve Bank of Australia are contracted as repos, the bank makes purchases of debt securities related to the government and semi government debt securities (Stevens, 2007). Throughout the years, the bank has had to supplement its daily market operations presented as repos by swapping with foreign exchange. In conclusion, the Reserve Bank of Australia acts as the central bank of Australia after the central banking functions were removed from the common wealth bank. The relationship between the Reserve Bank of Australia and the Australian government is set out by the Reserve Bank Act 1959. The Reserve Bank of Australia restricts its trading transactions to the government and semi government securities because it is authorized by the Act to provide services to the government. Furthermore, the bank seeks to maintain the supply of the exchange settlement funds at the appropriate levels. Finally, the bank seeks to make sure there are everyday flows into the banking systems. References Becker, C., & Sinclair, M. (2004). Profitability of reserve bank foreign exchange operations: twenty years after the float. Reserve Bank of Australia. Berkelmans, L. (2005). Credit and monetary policy: An Australian SVAR. Reserve Bank of Australia. Coppel, J., & Connolly, E. (2003). What do financial market data tell us about monetary policy transparency?. Reserve Bank of Australia. Kelly, P. (2000). The Politics of Economic Change in Australia in the 1980s and 1990s. In RBA Annual Conference Volume. Reserve Bank of Australia. Kent, C., & Robson, M. (2010). Introduction to Reserve Bank of Australia 50th Anniversary Symposium. In RBA Annual Conference Volume. Reserve Bank of Australia. Stevens, G. (2007). Reserve Bank of Australia. Education, 9, 4-0. Read More