Lurking beneath Australia's AAA economy...

Turning to derivatives, in November 2008 it was reported that the official Reserve Bank figures, from APRA, showed that Australian banks' off-balance sheet derivative exposures totalled $13.8 trillion (nearly ten times our Gross Domestic Product of 1.5 trillion USD, and probably understated). It was noted that 47.6% of the Big Four Banks' off balance sheet derivative exposure was to interest rate swaps ($8 trillion gross), with the remaining trillions in collateralised debt obligations (CDO), credit default swaps (CDS) and currency exposures.

According to reports, 'Banks could either deem derivative exposures to be "off-balance sheet" or use special-purpose entities to "house" the exposure in separate but related vehicles. In their absence, banks would be "forced" to increase the capital adequacy reserves required by prudential regulators.'

What remains a central issue is the fact that it was not made clear whether the Government's guarantee package extends to offshore borrowings by banks to cover off-balance sheet derivatives, bad bets and the impact such exposures would have if forced onto banks' balance sheets. Let's pray that Complexity Theory is flawed.

Since then we've learned that the National Australia Bank and Westpac borrowed money from the US Federal Reserve at the height of the financial crisis but we don't know if this has been paid back, whether it is included in our official gross foreign liabilities figures or the extent to which our gross foreign liabilities are written in Australian dollars; that Australia has a sub-prime debt market but we don't know the extent of it; that our banks say they have negligible (depends how you define it) direct exposures to the European sovereign debt crisis yet no one asks about their indirect exposure; that historical details of billions in government guaranteed loans have been taken off the Reserve Bank and Treasury websites, leaving us to speculate about whether or not this may be because the Government doesn't want Australians to know how much they've had to guarantee and/or they don't want the world to know the extent of the derivative exposures; and finally, despite Professor Garnaut's warnings, the Reserve Bank of Australia has set up a $380 billion bail-out fund called the Committed Liquidity Facility in the event that banks are insolvent or illiquid.

If the banks are hunky dory why is it necessary to set up a $380 billion emergency fund and, more importantly, is it enough in light of possible derivatives exposure?

Perhaps the Reserve Bank knows something that we don't?