KEY POINTS:
New Zealand is more vulnerable to financial shocks than most developed countries because savings are too low and capital markets are not deep or broad enough, Reserve Bank Governor Alan Bollard warned yesterday.
Bollard has reflected in several past speeches on households' predilection for borrowing rather than saving, with two-thirds of national investment spending being financed from abroad.
In this year's annual speech to the Canterbury Chamber of Commerce he focused on the structure of the financial services industry
By international standards it is heavily concentrated in the banking sector, which is larger than the sharemarket and corporate and government debt markets combined.
The banks rely heavily on overseas funding, while their lending is concentrated on the household sector, mainly through mortgages.
Bollard was not beating up on the banks, however. There were well capitalised, comparatively efficient and their margins around the average for developed countries, he said.
Rather, he was worried by a lack of depth and sophistication in the capital markets.
A more developed corporate debt market, for example, would provide firms with an alternative form of funding and give investors more options.
"And the more means by which savings can be transformed into capital investment in a prudent manner, the more back-up there is if any single channel fails."
The corporate bond market had stagnated since the early 1990s, Bollard said. It was relatively illiquid, marked by a preference of private placements and low turnover in the secondary market.
"The situation could be summarised as too few willing institutional investors on one side and too few quality issuers on the other side."
The tax laws were one reason.
The approved issuer levy (AIL) - a 2 per cent tax on interest which approved large borrowers pay in lieu of the non-resident withholding tax their lenders would be liable for - had driven many corporates to borrow overseas, purely to lower their AIL commitments, Bollard said.
"Given the efforts New Zealand borrowers take to avoid the AIL and given that it collects only marginal revenue, it may be appropriate to reassess it."
Another problem was the illiquidity of the Government debt market, as operating surpluses reduced the Government's need to borrow. Bond markets use the Government debt yield curve as a benchmark for pricing private-sector bonds.
The development of a futures market in Government bonds would help, but faced a "chicken and egg" problem: "Market participants have been reluctant to trade futures until liquidity has improved but liquidity will not improve until more participants enter the market and trade."
About the sharemarket Bollard had little to say apart from noting that it was small by international standards.
Its total capitalisation was less than that of some individual corporations overseas, he said. Relative to the size of the economy, the sharemarket's capitalisation was smaller than those of Slovakia or Poland and about a third the size of those in other English-speaking economies.
Bollard suggested the big public sector investment vehicles - the Cullen fund, ACC and the Government Superannuation Fund - could play a role in developing markets as their requirements for investment products, including some outside the mainstream, evolved.
Innovation would also be stimulated by the necessary recovery in private savings.
"Some have argued that the pool of capital created by a rise in household financial savings in other countries, notably Australia in recent years, has provided an important impetus for capital market development, via increased demand for investment products."
