I've written about this a lot in the past, and criticised the RBA for trying to create an artificial distinction between illiquidity and insolvency (a mistake many central bankers make), which does not exist under the law. The RBA Deputy Governor returned to the subject last week. The RBA's new "committed liquidity facility" is basically a taxpayer line of credit that prospectively (or counterfactually) insolvent banks can draw on to get immediate cash when they cannot meet their liabilities because of the underlying illiquidity of their assets. Dr Lowe describes it as thus (my emphasis added):
And I think kind of from a high level public policy point of view it’s entirely appropriate for the central bank to offer this type of facility to promise to liquefy certain securities in a stress environment. That’s what central banks are supposed to do. It’s also appropriate for the banks to pay a small fee – a small standing fee for doing that because if they were to hold government securities on their balance sheet rather than private sector securities they would earn a lower rate of return. So they’re earning a higher rate of return because the government securities on issue are not there, and part of that extra higher rate of return is reflected in this fee that is paid to the Reserve Bank. So I think that set of arrangements is perfectly
consistent with what an appropriate policy for a central bank is and it should not
lead to stresses in the government securities market.
