KEY POINTS:
New Zealand's financial system has emerged from the global credit crunch and a string of finance company collapses largely unscathed, the Reserve Bank says.
Commenting on the central bank's twice-yearly Financial Stability Report, Governor Alan Bollard said the local financial system "remains sound and resilient despite a backdrop of quite wide international market volatility".
Rising default rates on sub-prime home loans in the US earlier this year triggered waves of panic on world financial markets and caused equity markets and higher risk currencies, such as the New Zealand dollar, to dive sharply.
While Bollard noted in the report that New Zealand was largely insulated from the ructions in global markets, there were some effects.
"We saw in New Zealand in August that the amount of liquidity in Kiwi foreign exchange markets had gone down, and interbank markets were being stretched as well at that time."
Spooked by uncertainty, banks and other institutions became more reluctant to lend to each other, and some interest rates rose as a result.
"Like a number of other central banks, we stepped in pretty promptly to take some steps to help re-normalise trading, and those have been broadly effective."
Bollard said fallout from the credit crunch was continuing. "We think we're through the worst of it, but it's not the end of the story quite yet.
"We've still to see some results reported through internationally, and you're still seeing some second-round effects from that."
However, this year's events contained important lessons for New Zealand.
"New Zealand is heavily reliant on foreign capital markets, given its large external debt. These markets may not be as secure and liquid as previously thought."
Deputy Governor Grant Spencer, who is in charge of the bank's financial stability functions, said that prior to the problems, risk premiums had reached "unsustainably low levels" as investors looked for places to park huge amounts of cash.
"We're now returning to a more normal level of credit spreads and risk aversion."
Spencer said the major local banks, which comprise about 90 per cent of New Zealand's financial system, "were given a little bit of a shock" by the global credit crunch, but remained in good shape.
"They have strong profitability, good capital and underlying good liquidity positions notwithstanding that shock."
The other big issue - the failure of 10 finance companies over the last 18 months - was "unrelated to the global liquidity crunch".
"They've been more a function of local credit issues and asset problems with some of the non-bank institutions, and that has had a liquidity effect on the broader non-bank sector."
Spencer also downplayed the impact of those failures.
"While these failures have clearly been an issue for individual debenture holders, we do not see these developments as systemic in nature, either in terms of their impact on the broader financial system or in terms of their impact on the New Zealand economy.
"We see other institutions stepping in to take over the activity of those failed institutions, both on the liability and on the asset side of the business."
In the property-development sector, regarded as one of the higher risk areas of activity for finance companies, Spencer said: "If there are profitable investments to be made, the money will come forward, potentially from equity investors."
He expected the strengthened regulatory framework for the industry, in which the Reserve Bank will play a vital role, would give investors a better basis on which to assess risk-return trade-offs.
