Finance company fragility forced extension of guarantee

The wall of hot money building up in finance companies in New Zealand, and the likelihood of a flight of funds to Australian-owned banks, helped inform the decision to extend the guarantee of deposits and other liabilities to the end of 2011.

Two weeks ago the New Zealand government said it will extend the Retail Deposit Guarantee Scheme to December 2011.

The key change is a halving of the value of deposits covered, from NZ$1 million down to NZ$500,000 for banks, and NZ$250,000 in non-bank institutions.

Only institutions with a credit rating of BB or better can be covered after October 2010 while fees will also increase, especially for finance companies.

A regulatory impact statement from the New Zealand Treasury, published yesterday, shows a concentration of funding at finance companies at terms of between 90 days and year, and very little funding for these firms of more than one year.

Finance companies in New Zealand attracted an additional NZ$880 million into debentures and deposits following the introduction of the New Zealand government guarantee at the height of the financial crisis in October last year, the paper shows.

This was a rise of 19 per cent on their liabilities prior to the introduction of the scheme, and the books of finance companies were shrinking at the time (thanks to a three-year run of finance company failures that spread from tiny funders of second-hand cars in 2005 to affect substantial property finance firms).

In the paper Treasury noted that "the impending expiry of the current DGS has resulted in short-term 'hot money' seeking  higher returns, and a dramatic 'wall' of maturities is building up for many non-bank deposit takers as investors wait to see if the guarantee will be extended post October 2010.

"In general this wall of maturities is making it difficult for NBDTs (includes finance companies) to lend for term, and could result in liquidity problems for some NBDTs if they find it difficult to attract retail funding after the guarantee expires."

These issues may still exist once the guarantee schemes run out in Australia (in October 2011) and in New Zealand (at the end of 2011).

While investors won't have guaranteed bank deposits of Australian banks as the alternative, the perceived safety of many banks on their own merits may still suck plenty of funds away from the remnants of New Zealand's once vibrant finance company sector.