Unconventional monetary policy, bank deposits and household risk taking
Over the pandemic, unconventional monetary policy has substantially boosted bank reserves and deposits via the RBA undertaking quantitative easing (QE) and buying government bonds and making loans to banks via the Term Funding Facility (TFF). This boost should total around $0.55 trillion when QE concludes next year, turning to a drag when TFF loans are repaid and the RBA either lets its holdings of government bonds mature or sells them back to investors (this drag will be countered by deposits created when banks write more loans to households and businesses).
One way monetary policy works to boost the economy is to encourage people to rebalance their portfolios and take more risk. With the cash rate near zero, the exodus out of term deposits has accelerated for both households and businesses. Some households have bought equities, but the vast majority have stuck with traditional at-call deposit accounts that pay nothing. Risk-taking is more apparent on the other side of ledger, where low mortgage rates and generous government subsidies have seen a surge in home loans, reinforcing the view that the housing market remains a key channel for the transmission of monetary policy through the economy.
The process of money creation: money is normally created when a bank makes a loan, although unconventional monetary policy also adds to deposits.
In a modern economy, bank deposits are usually created when a bank writes a loan to either a business or a household, with deposits extinguished when a loan is repaid. The central bank is not directly involved the creation process, although the level of interest rates influences the bank’s decision to write a loan, along with the regulatory environment and the bank’s assessment of credit risk. (Less importantly, bank wholesale funding can also create and extinguish deposits, with deposits extinguished when a bank sells a bank bond to an investor and created when the bond is repaid.) Since the global financial crisis, the widespread adoption of unconventional monetary policy has also created deposits, driving strong growth in the money supply across the advanced economies. In particular, when a central bank buys a bond from an investor it creates bank reserves – termed exchange settlement balances in Australia – that allow a bank to simultaneously credit the bank account held by the investor.
By the same token, the unwinding of QE, via bond sales or the maturing of bond holdings, extinguishes deposits. In a similar vein, central bank loans to banks – such as those made in Australia via the TFF – also boost bank reserves and deposits, with the central bank acquiring collateral assets for the life of the loan via repurchase agreements in exchange for bank reserves (the haircut on the collateral is captured in other accounts payable). The repayment of these loans then extinguishes reserves and deposits.
Unconventional monetary policy has substantially boosted deposits in Australia over the past year and a half.
With the RBA cutting the cash rate to almost zero last year, it followed its peers in adopting unconventional monetary policy by buying government bonds and making cheap fixed-term loans to banks via the TFF (more unusually, it also undertook price-based QE, buying sufficient government bonds to support a target for the 3-year Commonwealth bond yield).
These steps have boosted bank reserves by about $0.4 trillion to date, making a major contribution to deposit growth. Deposits held by all authorised deposit-taking institutions (ADIs) grew by 11% over 2020, which was the fastest annual growth in almost a decade, and by a still-strong 6% over the year to Q2 2021. Excluding the contribution from unconventional policy, deposits grew by 5% over 2020 and fell by 7% over the year to Q2 2021. This suggests that had the RBA not implemented unconventional monetary policy, deposits would have fallen for the first time since the recession of the early 1990s.
The boost to deposits from unconventional monetary policy will peak in 2022 and eventually be unwound, but the drag will be countered by stronger loan growth adding to deposits.
From the start of the pandemic to now, unconventional monetary policy has boosted bank reserves and hence bank deposits by about $0.4 trillion (or 15% of ADI deposits in Q2 2021). Bond purchases have totaled about $0.2 trillion to date, while the RBA has made almost $0.2 trillion of 3-year loans to banks at an interest rate near zero.
Although the TFF has been closed to new applications for some time, the RBA has committed to buying $4bn of government bonds per week until at least February, where these additional bond purchases total about $0.15 trillion in a variety of plausible scenarios. This additional QE means the cumulative boost to bank reserves and deposits from unconventional monetary policy should peak at about $0.55 trillion in 2022 (or 20% of current ADI deposits). This boost will eventually be unwound when banks repay TFF loans and the RBA either allows the government bonds it has bought to mature or sells them back to investors (there will also be the roll-off of other government bonds the RBA bought to support the 3-year bond yield target and smooth market functioning early in the pandemic). This drag will be substantial, but will be countered by deposits created by a strong pick-up in bank lending.
Lending has accelerated very sharply on a booming housing market, where a surge in new loans suggest that annual growth in housing debt should reach around 10% by the end of 2021, which would be the fastest growth since the global financial crisis. Business lending remains weak, but the stock of corporate debt is growing, while housing debt is about twice as large as business debt.
Like other countries, near-zero interest rates have seen Australian households and corporates switch out of term deposits at a faster rate into at-call accounts.
With the cash rate near zero, banks have also cut term deposit rates to near zero (for example, the interest rate on a one-year term deposit of $10,000 has fallen from a pre-pandemic level of 1.2% to a record low of 0.3%). This has accelerated the ongoing shift out of term deposits into at-call accounts, most of which pay zero.
As at Q2 2021, term deposits have fallen to 40% of all household deposits, while term deposits account for 25% of corporate deposits, where these are the smallest shares since at least the late 1980s. The switch out of term deposits by households is similar to the experience of other advanced economies, where official interest rates have been near zero for much longer than Australia (note, though, that the share of term deposits has not fallen at a faster rate in countries with negative policy rates because some banks in those countries have discriminated between depositors, offering positive deposit rates to households and taxing businesses with negative deposit rates).
Easy monetary policy has encouraged some Australian households to take more risk and buy equities, but most have stuck with traditional at-call deposit accounts that earn nothing.
One way that unconventional monetary policy can influence the economy is via the portfolio balance channel. This is where central bank purchases replace bonds with bank deposits, causing investors to rebalance their portfolios by buying riskier financial assets, which boosts asset prices and reduces risk premiums and market interest rates.
In the case of households, the mix of near-zero interest rates and unconventional monetary policy has triggered only a modest increase in risk-taking in the mix of their financial assets. Expressing the net acquisition of financial assets over the past year and a half of the pandemic at an annual rate, households have increased their financial assets by an additional 12% of GDP relative to their pre-pandemic purchases in 2019. Nearly all this increase is accounted for by at-call deposits, where households are piling money up in traditional at-call accounts given the share of deposits accounted for by mortgage offset accounts – which are also classed as at-call accounts – has picked up only slightly from pre-pandemic levels. That said, some households have bought more domestic and foreign equities, totalling 3.5% of GDP, where Australian companies still pay relatively high dividends.
Unusually, households invested at a much slower rate in superannuation funds, where the acquisition of pension fund assets fell at an annual rate by 6% of GDP relative to 2019, although this was due to the government temporarily allowing financially-stressed households to withdraw money from their superannuation fund early in the pandemic.
Monetary policy has had a clearer effect on the liability side of the household balance sheet, where many households have taken advantage of very low mortgage rates and government subsidies to buy a home.
Easy monetary policy has had a more pronounced effect on financial liabilities as households have run up significantly more housing debt over the pandemic to date in response to the combination of the lowest mortgage rates since the 1950s and generous government subsidies for some home-buyers. Expressing the net increase in liabilities over the past year and a half of the pandemic at an annual rate, the 3% of GDP increase in total financial liabilities has been driven by a roughly 5% net increase in owner-occupier mortgages and a 1% net increase in investor home loans. Personal debt continues to contract in dollar terms, while small businesses and charities ran up debt relative to GDP at a slower rate than in 2019. This reinforces the view that the housing market remains a key channel for the transmission of monetary policy through the economy.
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