Reserve Bank of Australia Annual Report 2011

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sovereign debt crisis in Europe and the earthquake in Japan, market conditions remained generally favourable. Volatility in the Australian dollar remained at an elevated level relative to pre-crisis years. Reserves Management The foreign currency assets and gold that are held on the balance sheet of the Reserve Bank comprise the major part of Australia’s official reserve assets. The Bank has responsibility for the management of these assets, which are held primarily to facilitate policy operations in the foreign exchange market. As these assets expose the Bank’s balance sheet to foreign currency risk, the level of reserves is managed to meet expected policy needs. Given the policy roles of the reserves portfolio, the investment mandate under which it is managed places a high priority on the liquidity and credit quality of the assets in which the funds are invested. While portfolio return is an input to the management process, it is subordinated to limiting liquidity, credit and reputation risk. Reflecting this, the Reserve Bank has adopted a cautious approach to the management of the reserves portfolio. Under this approach, the risk profile of the funds under management is defined largely by a benchmark. The benchmark is a hypothetical portfolio that represents the Reserve Bank’s estimate of the optimal strategic allocation to foreign currencies, and the assets in which they are invested, given the policy objectives of the portfolio. The composition of the benchmark is reviewed periodically to take into account updated performance and credit data, any structural changes in financial markets and changes in the Bank’s risk tolerance. The most recent review of the benchmark was completed in 2010. This exercise reviewed the implications of the financial crisis for the composition of the benchmark and the Reserve Bank’s investment framework more broadly. This process recommended a number of changes, which were implemented over 2010/11: •• The portfolio allocation to the Japanese yen was reduced from 10 to 5 per cent and an allocation of 5 per cent to the Canadian dollar was established. This change took into account updated performance data across a range of currencies as well as the results of portfolio tail-risk analysis. •• The benchmark duration target for the Japanese portfolio was reduced from 18 to 12 months. This decision followed a reassessment of the risk/return trade-off in the portfolio given the level of yields and the shape of the yield curve in Japan. •• The benchmark allocation to commercial bank deposits was removed and the Reserve Bank's use of such deposits was reduced to a minimum. This decision reflected a reassessment of unsecured credit exposures in the portfolio. This review took into account the contribution of such exposures to portfolio return, the availability of alternative secured-cash investments and the potential difficulties for central banks posed by exposures to commercial banks at times of market stress. The Benchmark Portfolio US Europe Japan Canada Asset allocation  (% of total) 45 45 5 5 Currency allocation (% of total) 45 45 5 5 Duration (months) 18 18 12 18 Source: RBA 20 Reserve bank of Australia
Over 2010/11, the return on foreign currency assets, measured in Special Drawing Rights, was 1.8 per cent, the lowest annual return since 2005/06. The low return was mainly due to the very low level of global bond yields; the net capital gain on holdings of securities was negligible. The higher average Australian dollar exchange rate over the year reduced the Australian dollar value of foreign earnings by 17 per cent. Rates of Return in Local Currency by Portfolio Per cent US Europe Japan Canada 2004/05 4.1 5.8 1.1 na 2005/06 1.2 0.1 –0.9 na 2006/07 5.6 2.2 1.1 na 2007/08 8.1 4.0 1.7 na 2008/09 5.2 8.1 1.8 na 2009/10 2.3 2.7 0.8 na 2010/11 1.1 0.4 0.2 1.0 Source: RBA The Reserve Bank also maintains a modest allocation of funds to two regional bond funds: Asian Bond Fund 1 and Asian Bond Fund 2. These funds are part of the Asian Bond Fund Initiative, which was established by the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP) to assist in the development of local currency bond markets in the region. The Bank has a total of $383 million invested in these funds. The return on these investments over 2010/11 was 8.8 per cent measured in US dollar terms. The two funds are passively managed by external managers. In addition to foreign currency assets, the Reserve Bank holds 80 tonnes of gold on its balance sheet. Over 2010/11, the price of gold rose by 21 per cent in US dollar terms but declined by 4 per cent in Australian dollar terms. As a result, the value of the Bank’s holdings of gold declined slightly to $3.6 billion at the end of June. The lack of activity in the gold lending market, noted in recent annual reports, continued in 2010/11. Reflecting this, income from gold lending fell to just $0.1 million for the year and, at the end of June 2011, there was only 1 tonne of gold on loan. ANNUAL REPORT 2011 | Operations in Financial Markets 21
Page 1: RESERVE BANK OF AUSTRALIA ANNUAL RE
Page 4 and 5: © Reserve Bank of Australia 2011.
Page 6 and 7: The banking and payments group cont
Page 8 and 9: 4 Reserve bank of Australia
Page 10 and 11: Audit Committee The objectives of t
Page 12 and 13: Roger Corbett AO Member since 2 Dec
Page 16 and 17: Committee’s questioning of the Ba
Page 18 and 19: The Reserve Bank hosts regular conf
Page 20 and 21: Reserve Bank Balance Sheet $ billio
Page 22 and 23: Days 120 100 80 60 40 20 0 Australi
Page 28 and 29: M 250 200 150 100 50 by other users
Page 30 and 31: about 10 per cent less than in 2007
Page 34 and 35: % Value of Banknotes on Issue Per c
Page 36 and 37: ppm 20 15 10 5 0 04/05 Source: RBA
Page 40 and 41: countries), the main international
Page 42 and 43: appropriate fee; the committed amou
Page 44 and 45: Economic activity in most EMEAP eco
Page 48 and 49: Staff in the State Offices also pla
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Page 54 and 55: No 50 40 30 20 10 counterfeit exami
Page 56 and 57: expected to reduce energy and water
Page 58 and 59: 4 3 2 1 0 and Securency Internation
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Balance Sheet - As at 30 June 2011
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Statement of Distribution - For the
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Cash Flow Statement - For the year
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Notes to and Forming Part of the Fi
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Interest on fixed coupon securities
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Sell repurchase agreements Securiti
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Balances of asset revaluation reser
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Note 2 - Net Profits Interest reven
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Note 4 - Interest Revenue and Inter
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Note 6 - Cash and Cash Equivalents
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Note 10 - Other Liabilities Provisi
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As at 30 June 2011 and 30 June 2010
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Accounting Valuation For financial
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Note 14 - Superannuation Funds (Con
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Market Risk Market risk is the risk
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Credit Risk Credit risk is the pote
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Liquidity Risk Liquidity risk is th
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Maturity Analysis - As at 30 June 2
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As at 30 June 2011 One $M Level Two
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Auditor-General for Australia Austr
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110 Reserve bank of Australia
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Organisational Chart August 2011 Re
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Banking and Payments Group Assistan
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Glossary ACC Asian Consultative Cou
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Reserve Bank of Australia Annual Report 2011

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