KEY POINTS:
Last Sunday, at the height of the global financial crisis, the New Zealand Government and the Reserve Bank followed the lead of other Governments and central banks to shore up confidence in the banking system by guaranteeing retail deposits held by banks, building societies, credit unions and finance companies.
The broad policy initiative was necessary but, like most policy made on the run, contains some serious downside risk, particularly to the taxpayer, and needs to be reworked.
The major areas of concern are:
* The potential inclusion of all finance companies. From a taxpayer perspective this is unacceptable and will ultimately result in low-quality property developments, car and personal loans and other such assets being moved on to the Government balance sheet.
It beggars belief that a Government that has been reluctant to insist on sensible regulation of this sector can expose the taxpayer to the downside risk still apparent in many of these companies.
A sensible revamp would be to make the Guarantee Scheme available only to those finance companies with an S&P or Moodys credit rating of Investment Grade or better (not just new companies, as has been proposed in the latest amendment).
This would force much needed consolidation among the weaker players and, let's face it, if you're not investment grade, you have no business taking people's deposits in the first place.
Giving some of these businesses a Government Guarantee effectively rewards the reckless or highly speculative related party lending activities they have historically engaged in. Also, in a practical sense, the proposed close monitoring of these businesses will be very difficult.
* The pricing structure of the package provides exactly the wrong incentives. Under the proposal the most secure financial institutions, who have the best credit ratings and who have been more prudently managed (that is, the banks) have to pay 0.1 per cent for the guarantee but the lower quality organisations get a free ride.
Almost all overseas schemes will have the opposite pricing arrangements - the more risky you are the more you pay. To do otherwise is bad for the taxpayer and ultimately will result in major distortions in the market. The hastily announced adjustment made on Wednesday that there will be an extra cost on just the growth in the books of unrated finance companies does not ease this concern.
* The scheme does not include guarantees over wholesale deposits. Given that some 40 per cent of bank funding comes in this form and that the Australian Government is providing this guarantee facility to their financial institutions, New Zealand will have to provide it. Otherwise wholesale funding will be available to Australian financial institutions but not NZ institutions, or only available at higher prices.
* The scheme will need to be changed to offer a guarantee window of three years to match the Australian scheme, because when our scheme finishes after two years all funding will flow to Australia.
* The proposed scheme creates an artificial boundary between financial companies and other businesses which will distort the real economy. For instance, lower quality finance companies may become Government guaranteed and be able to borrow plenty, while higher-quality corporations will struggle to borrow other than from banks (who wants to lend to even a good quality credit when you can lend to someone else with a Government guarantee?).
Effectively this kills the Corporate Paper market in New Zealand and needs to be resolved.
The best advice for the Reserve Bank and Treasury is to sit back and either wait for full details on the Australian scheme to be released or, better yet, work with the Reserve Bank of Australia as, ultimately, our scheme will need to broadly match it. To do otherwise, given the close integration of our financial systems and economies, will result in serious distortions.
The aim of the final form of the Guarantee Scheme should be to secure the financial system without creating further distortions and at minimum risk to taxpayers. Remember that the taxpayer is already facing a forecast decade of deficits before factoring in any impact of a Guarantee Scheme. If the scheme is not well devised taxes may well have to go up.
* Paul Glass is a fund manager with Brook Asset Management.
