If you’re a property owner or just anyone who’s glanced at the news over the past couple of years, you’ve almost certainly seen the Reserve Bank of Australia mentioned a few times. (Although ‘few’ might be an understatement given the fever pitch around interest rate rises.) Aside from making headlines nationwide, what does the Reserve Bank of Australia actually do? This article aims to find out.
What is the Reserve Bank of Australia?
The Reserve Bank of Australia (RBA) is Australia’s central bank. It’s owned by the Commonwealth Government and operates independently to oversee Australia’s financial system. Think of it as a sort of bank for banks. In the US, the central bank equivalent is the Federal Reserve, and in the UK, it’s the Bank of England.
We’ll explore the RBA's main roles a little further down, but in short, it’s responsible for:
- Setting Australia’s monetary policy
- Keeping Australia’s financial system stable
- Regulating banks and other financial institutions
- Overseeing the payments system, including cash and credit cards
- Issuing Australian currency
- Managing Australia’s gold and foreign exchange reserves
Now, while it’s called a "bank", it’s not a bank in the traditional sense like ANZ or Westpac. The RBA does provide select banking services to the federal government and a few government departments and commercial banks. But unfortunately for us common people, the general public isn’t able to open an RBA account.
A brief history of the Reserve Bank
The RBA is just over 100 years old, with origins stretching back all the way to the establishment of the Commonwealth Bank of Australia (CBA). (Yep, the exact same Commonwealth Bank that still operates today.)
The CBA opened in 1911 as a government-owned savings and trading bank. In the years that followed, it started doing more and more things a central bank would do. Following WWII, the CBA achieved official "central bank" status.
Eventually, the government realised that the CBA couldn’t act as a regulatory body as well as a commercial bank. So, the Reserve Bank Act of 1959 established two separate entities. The first was the newly named Commonwealth Banking Corporation, which would function as a traditional bank. The second was the Reserve Bank of Australia, which would take on the role of central bank.
The RBA officially started operating in 1960, and has been Australia's central bank ever since.
The Reserve Bank's role in Australia’s financial system
By now we’ve uncovered a bit about what the RBA does, but let’s dive into its role further.
Monetary policy
One of the RBA’s main concerns is the nation’s monetary policy, i.e. the management of interest rates and money supply. Overall, its aim is to provide sustainable growth to the Australian economy, maintain price stability, achieve full employment, and ensure the welfare of the Australian people.
Monetary policy largely revolves around the cash rate – the term given to the interest rate on overnight loans between banks. This is a big one, because the cash rate influences other interest rates (like mortgages and savings accounts), the Australian economy, and the inflation rate.
Whenever the RBA adjusts the cash rate, it can have a huge impact on economic activity. Lowering the cash rate typically stimulates economic growth because borrowing is cheaper (encouraging people to take out loans to invest) and people are more inclined to spend. On the other hand, raising it can help temper the economy if it’s overheating and if inflation is getting out of hand.
Inflation forms a big part of the RBA’s focus. The RBA’s goal is to keep inflation at a fairly steady rate of 2-3%, which allows the economy to remain relatively stable and ensures purchasing power is kept consistent. If inflation is at a rate beyond that, the RBA will adjust the cash rate accordingly.
This is obviously an area that’s been under intense scrutiny lately, given the recent inflation spikes and resulting interest rate rises issued by the RBA.
Financial stability and regulation
To keep Australia’s financial system running smoothly, the RBA plays a big role in regulating banks and other financial institutions.
It does this by working with other regulatory bodies, like the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC) and the Australian Treasury. Combined, they form a cooperative body known as the Council of Financial Regulators (CFR).
Each member of the CFR does different things. The RBA’s role is to deliver funds to banks and other institutions, oversee the payments system, and assess potential risks in the financial system that could trigger instability. These risks can be anything from economic downturns to financial market crises .
Payments system monitoring
On the topic of the payments system, another of the RBA’s functions is to ensure financial transactions are efficient and reliable. The payments system encompasses anything to do with money being passed from one party to another. Think everyday transactions like cash, cheques, debit cards, credit cards and online money transfers, to large-scale transactions between banks.
Efficiency is a key objective for the RBA. In fact, Australia was one of the first countries in the world to make payment efficiency a priority.
The RBA tries to maintain efficiency in the payments system by encouraging the development of innovative – and faster – payment technologies. Some of its past initiatives in the drive for efficiency include encouraging shorter cheque-clearing times and promoting direct debits for bill payments. It supported the development of the New Payments Platform (NPP) for instant payments, too.
The RBA also helps ensure security, reliability and anti-competitive behaviour in the payments system. Currently, it's looking to the future and examining the potential for mainstream adoption of digital currencies – especially as the use of cash is declining.
Currency oversight
The RBA is also responsible for overseeing Australia’s currency.
One of the more fascinating parts of the RBA’s job involves administering the production of Australia’s banknotes. Each banknote has to combine artistic creativity with stringent security features to help ensure they can’t be counterfeited, such as holograms and microprinting.
First, this brief is delivered to skilled designers, who are responsible for creating a visually appealing banknote that retains all of the crucial security features.
Next, the RBA has to formally approve the design and begin the process of turning it into a banknote. This is a fairly lengthy procedure that requires a great deal of consultation with all kinds of stakeholders.
Note that printing happens at a high-security, RBA-owned facility in Victoria. The notes are then issued to and distributed by banks so they can be circulated to the public.
Coins, on the other hand, fall under the jurisdiction of the Royal Australian Mint.
Gold and foreign exchange reserves
Interestingly, the RBA holds physical reserves of both gold and foreign currencies.
The RBA has about 80 tonnes of gold in storage, 99.9% of which is held in London. The reason it and other central banks hold gold is that it’s considered a stable and liquid investment. The RBA lends gold to different financial institutions and also buys and sells gold when necessary.
The RBA holds a number of foreign currencies, too, including US dollars, euros and yen. These are used to manage exchange rates, conduct foreign exchanges and support the stability of the Aussie dollar.
Government banking services
Lastly, another of the RBA’s functions is to act as the government’s bank. It handles government transactions and collects government revenue from taxes. It supports the issuing and managing of government securities like bonds and treasury notes. It also settles high-value payments and it provides foreign exchange services to the government.
How the Reserve Bank of Australia approaches decision making
The announcements of increased interest rates might seem relentless, but there’s a heck of a lot of work that goes into each and every RBA decision.
The RBA conducts incredibly thorough research and analysis to inform its decisions. It looks at all kinds of economic indicators, including the rate of inflation, employment figures, GDP growth, global economic trends and market figures. It then adjusts the cash rate accordingly.
Each decision is overseen by the RBA Board, which includes the Reserve Bank Governor, Deputy Governor, Secretary to the Treasury and several independent members. RBA Board members meet eight times a year to review all of the economic indicators mentioned above and to discuss monetary policy moving forward. They assess the current state of the economy, potential risks, and the effectiveness of different tools that could help meet their objectives.
There’s also a separate board known as the Payments System Board, which, as you might’ve guessed, specifically focuses on the payments system.
If you’re interested, you can actually read all of the RBA’s meeting minutes on its website . You can also check out the TL;DR versions of these minutes via the RBA’s meeting statements .
Why the Reserve Bank of Australia isn’t always predictable
While several factors could indicate the outcome of an RBA decision, no one can ever fully predict what the Board will decide. In that way, the process is a little like investing – it’s always subject to uncertainty.
A few historical decisions point to this. The first was in 2007 when the GFC was starting to ramp up. Many thought the RBA would hold off on increasing the cash rate because there were early, but clear, signs of financial instability. Doing so would potentially avoid further economic stress.
However, the RBA unexpectedly jacked up the cash rate by 25 basis points to 6.75%. This effectively meant that borrowing costs for consumers and businesses increased. The reason it decided to do so was due to the relatively strong economic conditions in Australia and the pressure of rising inflation.
Another example came in 2011, as the world was recovering from the GFC. At the time, there were strong concerns about the debt crisis in Europe, slower growth in the US and China, and general uncertainty in global markets.
Despite all this, Australia’s economy was doing pretty well and unemployment was stable. As such, analysts thought the RBA would hold off on doing anything to the cash rate, given it could possibly destabilise economic recovery.
Instead, the RBA decided to cut it by 25 basis points to 4.5%, citing global economic uncertainty and the overall aim of protecting Australia against international economic shocks.
Both examples illustrate exactly how complex monetary policy can be, and how the RBA considers multiple economic indicators before making a decision.
The Reserve Bank of Australia in a nutshell
The RBA holds a pretty crucial role here in Australia. From setting the cash rate to regulating currency, the RBA’s decisions have huge implications in affecting not only Australia’s financial stability but that of individual Australians too.
And while there are factors that could signify an RBA decision, one thing is absolutely certain: monetary policy is incredibly complex. Trying to predict a rate change, much like trying to predict the share market , can be a challenging and potentially futile exercise.
With that in mind, you can use your newfound understanding of the RBA to better interpret economic news and make more informed financial decisions.
Happy investing!
