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SMELLIE SNIFFS THE BREEZE: 'Reserve Bank Unstable'

SMELLIE SNIFFS THE BREEZE: 'Reserve Bank Unstable'

By Pattrick Smellie

Nov 13 (BusinessWire) - As a cub reporter on the Manukau Courier back in 1983, it was my duty to report the monthly deliberations of the Papatoetoe City Council.

It was election time and, to be frank, there was bugger all happening. A report of mine quoted a mayoral candidate as saying "there are no serious issues." To deal with this absence of news and liven things up, a sub-editor dropped the "no" in that sentence and made the piece much racier.

Something similar happened to the headline on my searing investigation into instability on the slopes above one of the area's many well-appointed and uncontroversial sportsgrounds.

"Reserve Bank Unstable", the headline squawked.

Thankfully, this was before the kiwi dollar was floated. Had a forex dealer been reading the Manukau Courier that day, there wasn't much they could have done about this advice from an unexpected source of weakness at the country's central bank.

That headline sprang to mind this week at the briefing for the Reserve Bank's six-monthly Financial Stability Report, if only because one of the surprises about New Zealand's emergence from the global credit crunch is the new-respect for Australasia's relatively sound financial system.

This despite the fact that both Australia and New Zealand continue to live shamelessly on the savings of others, running current account deficits between 7 and 9% of gross domestic product, with little sign of sustained improvement.

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While nowhere near Icelandic levels of imminent danger, this part of the world remains seriously indebted. But it finds itself sheltered by a combination of a good name and the fact that, by and large, Australian banks didn't participate in the risk proliferation that took down some of the biggest names in U.S., European and Japanese banking over the past year.

As a result, the kiwi dollar - insignificant in world terms otherwise - is consistently one of the top 10 traded global currencies, attracting liquidity whenever the U.S. economy looks even slightly better. When that happens, hot money starts looking for higher returns offshore.

Ignore, for the moment, the oddity that the currency of the worst-indebted developed nation, the U.S., becomes a magnet for funds whenever its economy looks worse. You know the incentives are screwed up when you flee to the source of your woes. If it was a marriage, it would be seeking counselling.

The impact, for New Zealand particularly, of a floating currency is a wildly gyrating, fundamental impediment to understanding a business trying to grow in the world market which, by the way, is the only place to grow to any real size.

Forget for a moment that we should rejoice in this liquidity as a global currency. The NZX would kill for that kind of volume. Trading today at around $43 million is desultory stuff, especially as Kathmandu began trading today, and was celebrated at NZX's HQ.

The electricity market, too, looks in vain for liquidity, but appears unlikely ever to achieve it, raising the question of whether it's possible to create a true "market" on New Zealand's weak, and stringy, renewables-dominated national electricity system.

To return to the currency, the RBNZ's problem is that its tools for reacting to the huge forces at play in global money are so limited. That's why some of the new language coming out of the RBNZ this week is so interesting. The search is on here, and everywhere that's smart about it, for new tools.

With the dust clearing on the global financial meltdown, we began to get glimpses of the much more restricted world in which banks will be operating in the future. A world in which the central bank not only monitors banks, but starts telling them how to behave.

There are different risks in this, like what if the central banks of the world are wrong and we have a different sort of credit crunch because the world economy stops growing so fast?

But there is no doubt that we are moving back to a world where banking will be more regulated.

How will that play out here?

For a start, monetary policy will get some new "mates", as National's most purist of finance ministers, Ruth Richardson, used to say.

The RBNZ's governor and deputy governor, Alan Bollard and Grant Spencer, outlined more new thinking in their report and in testimony to the finance expenditure select committee this week than for many a long year.

For a start, the RBNZ will force more prudent lending practice from trading banks over the course of economic cycles. When times are good, they will have to put more aside for when things turn bad, as they generally do at some stage.

And when times are tough, the banks shouldn't be so inclined to stamp so hard on the brakes.
Ironically, if these rules had been in place before now, there would have been more conservative lending to the dairy sector mid-decade, when prices rocketed on historic high Fonterra payouts. And in current circumstances, the banks would have been better prepared for a sudden deterioration in credit conditions.

In particular, what the RBNZ is describing should take some of the weight off the Official Cash Rate as the sole tool for setting monetary conditions.

The identification of stricter liquidity ratio rules as an automatic economic stabilisation tool marks a significant shift in central bank activism to force more prudent behaviour from the banking sector in the wake of the global credit crunch.

In practical terms, the new approach will skew banks to back their lending with longer term funding arrangements.

“There is potential to use liquidity ratios as an economic stabiliser. The idea of dynamic provisioning through the cycle could potentially support the OCR,” said deputy governor Spencer. “Our main lesson from the crisis was to produce a policy in that area of weakness.”

However, the OCR would remain “the only way we have to change (monetary) conditions,” Bollard told the select committee. “The background is that liquidity ratio policies could have beneficial impacts over the cycle. It’s new territory and it’s something a number of countries are looking at,” he said.

“We mustn’t over-promise on this,” Bollard said, “but we are keen to look at core funding’s capacity to contribute to monetary policy.” Bollard says the moves are “not welcomed” by trading banks, but they are feeling the same pressure internationally. The financial stability report says such intervention should “reduce the cyclicality of the overall financial system.”

“In the New Zealand context, with a large proportion of imported capital, the Reserve Bank believes the fluctuating attitude of international lenders has contributed to excessive exchange rate cyclicality.

“The new liquidity rules restrict the proportion of loans that can be funded through short term wholesale borrowing. This will force future rapid increases in demand to be funded mostly through long term wholesale debt, raising funding costs and likely moderating credit growth.

“In the downturn, this pre-existing long term funding helps maintain investor confidence and reduces the extent to which the bank will need to access (potentially troubled wholesale funding markets, reducing any funding squeeze.”

It's true that the foreign/Australian-owned trading banks operating in New Zealand played jiggery pokery with the tax system and are one by one being found to be tax avoiders.

And they were flayed this week by an Opposition inquiry for pocketing millions in fattened margins last year, despite being found by the RBNZ in its report the next day to have suffered margin reduction in recent months owing in large part to heavy competition for longer-dated retail deposits. And perhaps owing a little to the politics of being seen to compete.


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