Effect on bank rates

RBA-ES-balancesEach time the RBA makes an announcement regarding the "target cash rate" - the media responds in a frenzied fashion as to what this means for home mortgage rates.

However - let's stop for a minute and summarise what we have learned about Exchange Settlement accounts from RBA documents:

  • They are used to make payments between banks.
  • The money in these accounts is "central bank money".
  • The average total balance is $1.25 billion (see graph).


broad-money-36-yearsWe know from RBA documents that the money in the Exchange Settlement accounts merely circulate between these accounts. Consequently, none of this "central bank money" actually gets deposited at commerial banks.

By monetising debt - commercial banks create the deposits that customers have in their accounts. The RBA provides the figures that make up "broad money" (i.e. notes, coins and all deposits) in their Money Aggregates spreadsheet - which is displayed adjacent. As of May 2012 - the figure for broad money is $1.46 trillion. Since $50 billion of this amount is "currency" - the balance of  $1.41 trillion can be considered to be deposits created from monetised debt.

At this point - you should be scratching your head and asking: How can setting an interest rate on $1.25 billion, which never actually gets deposited at commercial banks - affect $1.41 trillion of deposits which get created with book entries? It never cost the commercial banks anything to borrow the deposits - they merely monetised their client debt obligations.

If the RBA increases the target cash rate by 0.5% - it costs the commercial banks an additional $6.25 million. For the commercial banks to use this as the reason to adjust their interest rates on trillions of dollars of deposits and home mortgages just defies logic.

 Below is an explanation of how the Exchange Settlement Accounts operate at the RBA.