Heads we win, tails you lose: as inflation bites, banks rake in $100m a week from obscure Covid stimulus

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When inflation hit a 32-year high, signaling an interest rate hike in February, bank stocks rose on the ASX. However, aside from the prospect of thicker profit margins, they coined $102 million a week from some obscure pandemic stimulus. Callum Foot investigates.

Inflation has just hit Australia’s highest annual rate in 32 years. “Extreme price pressures remain,” said treasurer Jim Chalmers, noting that there was cause for optimism as inflation was now likely to have peaked. Food and housing up almost 10%, very bad news. The good news is that the pace of rising prices is leveling off.

However, since inflation is about sellers raising prices, and bank stocks also rose today, it is reasonable to speculate that Chalmers may be having a quiet talk with the money sellers – the banks – about raising their prices.

Because in addition to the opportunity to fatten their profit margins as rates rise, they still have a big winner with gains from Covid stimulus. It’s called the TFF and it’s something that Jim Chalmers probably won’t explore in the public domain; nice little earner that it is for the banks – better make that big earner

A Reserve Bank response measure to the 2020 pandemic is now providing banks operating in Australia with $102 million a week in risk-free profits, with the Big Four banks claiming about 70% of the loot.

Covid stimulus

In March 2020, the Reserve Bank of Australia announced the Term Funding Facility (TFF) “as part of a comprehensive policy package to support the Australian economy in response to the COVID-19 pandemic,” according to the RBA’s August 2021 statement on monetary policy policy.

The TFF provided billions of dollars in cheap three-year loans to banks operating in Australia.

The aim of the TFF was to provide the banking sector with enough cash to continue lending to households and businesses at lower lending rates and to stimulate the economy through the Covid lockdowns.

Ultimately, $188 billion was borrowed by an unknown number of the 130 authorized depository institutions (ADIs) authorized to withdraw from the TFF.

Big Four dive in, big

As can be expected, the four big banks have taken the most money out of the TFF with about 70% of the total amount.

The CBA seized $51.14 billion, NAB $31.87, Westpac $29.78 and ANZ $20.09 billion. Together, the top 10 borrowers claimed 90% of the total amount provided under the incentive program.

The TFF was offered in two phases, the first offering loans at 0.25% interest and the second, after a fall in interest rates, offering loans at 0.1% interest.

The total interest rate per bank depended on how much the banks borrowed in each phase. CBA was the smartest of the big four, with an effective interest rate on their TFF loans of just 0.16%.

Print and then shred

These amounts are repayable in 2023 and 2024, with $3.6 billion due in April this year.

The money these banks lent through the TFF was essentially printed by the RBA for this purpose, it didn’t come from government revenue like taxes.

When the loans are paid back, the RBA will “shred” the money.

However, what will not be shredded is the interest that the banks earn on this money, this risk-free money.

How do we know this?

As previously reported here, as the banks took out loans from the TFF, the amount in each bank’s ESR accounts continued to grow.

The RBA’s bills of exchange were originally used and are still used to cover overnight interbank payments. In other words, these accounts are what Australian banks use to settle transfers between each other, with the RBA acting as a clearinghouse.

As such, banks have traditionally only needed a small amount of funds in their ESAs, about $2 billion before the pandemic.

The interest paid on the bills of exchange is also the vehicle the RBA uses to manage interest rates.

When the RBA raises the interest rate target to combat inflation, it also simultaneously raises the interest it will pay on money held in its ESAs.

Risk-free fun

The interest rate target is just that, a target, but the interest paid on money held in the ESAs is the real mechanism of interest rate change.

In his May 2021 Shann Memorial Lecture, ex-RBA Deputy Governor Guy Debelle pointed out that the amount payable on these accounts was, in effect, the risk-free interest rate.

By raising interest rates on these accounts, the RBA has raised the floor for borrowing across the economy, meaning higher interest rates will be passed on to ordinary Australians.

ESAs are starting to grow

However, in March 2020, banks’ ESAs began to grow even though no interest was paid on these accounts.

The cash stored in ESAs is considered high quality liquid assets. Under the Basel III Accord, financial institutions require a certain proportion of high-quality liquid assets to lower the risk of their lending. The more high-quality liquid assets a financial institution has, the more it can lend.

The bigger the ESAs got, the more freedom Australian banks got to borrow money.

The interest the RBA pays on the funds held in its ESAs is tied to the target cash interest rate and as such was 0% until the RBA decided to raise interest rates in May last year.

Since then, the interest rate target has risen steadily, including interest paid on funds held in the ESAs, which is now paid at 3%.

Currently there are $426 billion in the exchange settlement accounts of the RBAs, paying out about $13 billion a year in risk-free interest to banks operating in Australia.

TFF/ESA program: how the banks made money for free

When the banks took their $188 billion in cheap loans from the TFF, they almost immediately deposited it back into the RBA in their ESAs — instead of lending it out, as intended to stimulate the economy.

Initially, the lack of interest on these funds cost the banks a total of $6 million a week. altalthough, as discussed earlier, this was a fine trade-off for the banks for several reasons.

With interest rates rising, profits on the $188 billion borrowed run up to $102 million a week, about 70% of which goes to the big four. The interest that the RBA pays on the banks’ ESA deposits is approximately 2.84% higher than the interest on the initial TFF loans when we calculate the weighted average interest rate for the TFF loans.

The TFF loans are repayable between April 2023 and June 2024. Let’s see how those ESA balances dwindle after the TFF is repaid.

Is there something wrong with the TFF?

The TFF provided much-needed liquidity to the banking sector, mitigating the impact of the Covid recession.

What the RBA failed to predict was an increase in inflation due to the Russian invasion of Ukraine, the resulting rampant energy prices and the subsequent need, from the RBA’s point of view, to raise interest rates.

The mistake was to fix a borrowing rate of 0.16% on the funds lent in the TFF, fixed until 2024.

If the TFF were a variable rate tied to the spot rate, we wouldn’t be in a position where the RBA was printing the big four about $70 million a week for nothing.

Hindsight is everything.

Inflation figures seal case for rate hike


Callum Foot

Callum Foote is a journalist and revolving door editor for Michael West Media. He has studied the impact of undue corporate influence on Australian policy decisions and the impact it has on the interests of the people.

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