1985 saw the free fall of the
Australian dollar against the Swiss franc in which the bulk of the CBA’s
foreign currency loans were written. What was the state of expertise
in the Bank? The Bank’s Investment and Economic Research Department
wrote a substantial report in June 1983 (Investment and Economic Research
Department, 1983):
Over the period from 1983 to 1986 the
Deutschemark (sic) is forecast to appreciate by more than 10% against the
US dollar. … (1)
Over the period to 1986 [the Australian
dollar] is expected to appreciate noticeably against a declining US dollar
and pound sterling, but to fall substantially against the yen and
Deutschemark. Exchange rates are expected to continue to exhibit a high
degree of volatility. (2)
This from the International Division (1984) in June
1984:
Strong economic fundamentals, a CHF6
billion current account surplus in 1984, and investor confidence in the
Swiss central bank’s anti-inflation stances augers well for appreciation
of CHF against the US Dollar. … The Swiss France traditionally tends to
track movements in the Deutschemark/US Dollar exchange rate and is
expected to strengthen in the second half of 1984 in tandem with the mark.
(1-2)
The Australian dollar has weakened since
April due to the rising trends in US interest rates, an easing in local
bill rates and resurgence of the US Dollar. … However, we expect the AUD
to recover from current low levels in the second half of 1984 … (2)
Relative movements of AUD and CHF against
the USD is expected to result in an overall moderate strengthening of the
Swiss franc against the Australian dollar over the next 12 months.
Historical and forecast trading levels of
Swiss Franc against the Australian Dollar are as follows: June 1983 1.8434
… June 1984 2.0100 … June 1985 1.93-1.95 [i.e. an estimate of 3-4%
depreciation of the Dollar against the Franc in twelve months to June
1985].
In summary, therefore, exchange rate
movements are likely to offset, to some extent, the interest rate benefit
of borrowing in Swiss Francs. However, an overall lower cost of funds
should still be provided by borrowing in Swiss Francs which also offers
the advantage of lower withholding tax cost than other foreign currency
alternatives. (3)
February 1985 witnesses the unexpected. This
from Edwards (1985), of Head Office International, to State offices:
The recent substantial depreciation of the
Australian dollar against overseas currencies, especially the US dollar,
raises the question of the increased AUD exposure that each F/C/L borrower
could have to CBA. … in view of the extent of the AUD depreciation which
has occurred – around 26% over 12 months for the USD and 6% over 12 months
for SFR – it is prudent that the position of each client be reviewed and,
if considered warranted, the client put “on notice” that the parity
adjustment will be sought at the time of next rollover if the AUD exchange
rate remains at its depreciative level or deprecates further. (1)
A hand-written annotation from a senior manager notes
that as ‘most if not all of our F/C/Ls are in CHFs’, then CBA borrowers
are ‘not too affected’.
Edwards’ memo was paralleled by a circular from
Treasury (Hulme, 1985a), the essential ambition of which was to hose down
concern:
The attached memoranda prepared for
internal use are circulated as a matter of information in view of the
confusing, conflicting and misleading commentary on this matter over the
past couple of weeks. (cover sheet)
All that can be said about attempts to
apply neat economic theories to rationalise the extraordinary decline in
the AUD over the past couple of weeks, is that they have been
entertaining. Most have also been ill-informed and misleading. … There was
not science in, or economic rationalisation for what followed over the
next couple of weeks … The level of uncertainty in the market was such
that it became a game of pass-the-parcel. No-one wanted to be caught
holding AUD when the music stopped. AUD had become a hot potato. Seeing
this strong downward trend in the AUD, a very interesting array of pure
speculators entered the arena looking for capital gain. Contrary to
economic theory, the speculators served only to exacerbate the situation.
… (2)
Finally, it is worth reiterating just two
points made by the bank during the height of the highly charged (and
mostly emotive) debate on FX licences in 1983:
(a) Because of the relatively small volume
of genuine commercial business and the uneven, often very lumpy, trade
flows in Australia, speculators would tend to be all on one side or all on
the other. Speculation would thus be inherently destabilising in the AUD
market. …
(b) Increasing the number of FX licencees
may bring artificial depth to the market but would add little, if any,
real depth. …
Market behaviour has attested to the
validity of these points. Much of the recent volatility has been the
result of dealers playing banks amongst themselves. … When the market does
settle down, at whatever price level, then this will provide the time
necessary (or rather essential) for rational assessment to be made so that
the price can move smoothly to a level determined on the basis of
fundamental economic factors such as balance of payments, internal
economic performance and relative inflation rates. … (2/3)
For the longer term outlook, it should be
noted that fundamental economic factors have changed little in the midst
of the events of the past three weeks. … By mid-1985 the domestic currency
market is expected to have readjusted to recent events and the Australian
dollar should trade with increased steadiness. However, it is difficult to
assess what will be the longer term damage on confidence in the AUD as a
result of the destabilising events of the recent weeks. Overall,
fundamental factors suggest the underlying trend of the AUD will remain
relatively weak over the remainder of 1985, unless the upward course of
the US dollar reverses. (second section, 2)
The Bank’s chief economist, R. H. Dixon, conceded
that what was needed to be known was perhaps in the realm of the
unknowable:
There is no simple answer to the reason
behind the fall in the value of the Australian dollar and behind movements
in foreign exchange values generally. … Because of the complexity of the
issues involved it is virtually impossible to forecast exchange rates. It
is fair to say though that the Australian dollar will remain volatile over
the next few months with a possibility that it may fall further. (13)
I think the lesson learnt over recent times
is not to dabble in foreign exchange speculation unless you have the
resources to back up a bad punt. Rather, every effort should be made to
insure risks which can be arranged through facilities such as forward
cover and hedging. (14)
Dixon then highlighted his detachment from the
peculiar state of his employer’s ‘dabbling’ in foreign exchange
speculation by concluding:
I conclude with the thoughts that
deregulation has been of benefit to all parties and we can look forward to
a shake-up in the finance industry. And in line with life in general, life
in the financial world, which has become more complex, will continue to do
so. (14)
F J Hulme, Group Treasury head, was not in a position
to join Dixon in his detachment. Hulme wrote to the Chief General
Manager of Corporate & International in October 1985 (Hulme, 1985b).
Hulme noted the recent creation of a Risk Management Advisory Service
within Treasury. ‘Because of the significant paper losses incurred
over the past year by borrowers of foreign currency … it was decided that
RMAS would extend its services from the outset to incorporate clients with
borrowings in foreign currency for purposes other than trade’.
From the types of questions being asked of
RMAS personnel by either existing borrowers or prospective borrowers with
approved but undrawn loans, it would appear that there could have been
deterioration in the quality of advice/information provided by CBA staff
generally regarding the risks associated with such loans and other related
matters. [A hand-written marginal annotation notes: ‘At grass roots levels
the quality of advice has probably never been sound!’] (3)
If an overall review of foreign currency
loan policy etc is to be undertaken, we strongly believe that the first
issue to be decided should be the degree of advice/information, etc, you
desire to be given to borrowers. …
Should [your leaning be to the view] to
provide advice and let clients deal through the Bank to manage exposure,
it would be necessary to set down some guidelines for our dealers …
Obviously the resources of RMAS would need to be increased substantially
to handle the business and may necessitate the recruitment of additional
expertise from the market. As we see the situation, the big danger with
this development would be that probably 80% of the clients with foreign
currency loans would not really understand what they were doing. While
this would not represent a problem if the client won, it is not difficult
to envisage the complaints if losses occurred. To proceed on this course,
the Bank would need to undertake a massive client education programme and
obtain water-tight and wide-ranging indemnities. (4/5)
The remaining course of action is to
provide professional management for a fee. … We have taken a policy
decision within Group Treasury not to pursue this course for the present.
As an aside, but very much related issue,
RMAS is in the process of establishing a computer-based profile on foreign
currency borrowers. … We would also stress that this RMAS programme is a
stop-gap rather than a final solution to existing reporting deficiencies
relating to foreign currency loan usage. … (7)
For what it is worth the Group Treasury
view is that the CBA should not be actively encouraging borrowers to take
open foreign exchange risks in situations where we know now that these
borrowers have no foreign exchange cash flows and are instead wholly
speculative in motive. There is a widespread lack of understanding of the
magnitude of risk, and the short-sighted attraction of lower foreign
currency interest rates has proven disastrous to many of our clients.
We would recommend that
any revised policy on foreign currency lending take particular account of
the term of the proposed advance. Also, you may wish to consider a system
wherein a client’s foreign currency borrowing ceiling would be established
by discounting his aggregate Australian dollar borrowing capacity … [A
marginal annotation notes: ‘We would surely only need to consider such
system if we waive parity adjustment requirements’.] (8)
L. G. Watson (1985), Corporate Administration, summed
up the state of play in October:
It is probably not putting it too strongly
to say that [point of controls] are approving F/C/L’s, S/L’s etc far too
freely in the present climate, particularly having regard to the outlook
for the Australian dollar. It seems reasonable to assume that there is not
a full appreciation of the risks involved. In the circumstances a complete
overhaul of the policy guidelines is seen to be necessary. (1)
While it is acknowledged that there is a
need to provide some exposure management advice on request to F/C/L
borrowers during the course of a loan, we would not at present wish to
advertise the availability of such a service.[
