Possibilities: Could New Zealand Have a Financial Crisis?

Listener 24 April 1999.

Keywords: Macroeconomics & Money;

If it were possible to predict the precise timing of a financial crisis, everyone would take precautions, and precipitate an earlier one. However the footnote has three lists of indicators. My scorecard for New Zealand gives 5 out 8 for macroeconomic performance factors and 5 out of 7 for macroeconomic policy factors (although some of our policy changes were more than a decade ago). But for microeconomic conditions (which the conventional wisdom says is the more important), I reckon it is 0 out of 8 (assuming reasonably competent bank management – who can tell until after the event?). Moreover, with one small exception all New Zealand banks are owned overseas. Megabank International will quickly and quietly bail out Megabank New Zealand if gets it into trouble, to protect its reputation elsewhere.

Non-banking financial institutions which take deposits have a higher (although still usually low) likelihood of difficulties. The rules of capitalism are that, under a liberalized financial system, the odd financial institution will occasionally go bust. That is why some pay higher interest rates – a premium for risk – and why prudent investors never put all their eggs in a single institution.

Other factors could damage the New Zealand financial system. Because the New Zealand dollar floats we wont get into the difficulties like those with a fixed currency regime. A currency collapse is unlikely to hit our banks directly, since they limit their foreign exchange exposure. But they lend to importers and non-bank financial institutions which may be more exposed. The same broadly applies if there was a sharemarket collapse. If a disruption is sufficiently great, who can be sure what will happen?

The New Zealand financial system cannot isolate itself from a systemic international financial collapse. The world has evolved a variety of institutions (such as the IMF, the Bank of International Settlements, and the G7) to prevent a repeat of the 1930s, but the international financial system has also got more complex. The recent performance of the IMF and others suggests they may not be able to cope with a full blow out.

Between the local and the global possibilities is that of “contagion” where financial disruption in one country spills over into others as investors “reassess risks” (i.e. panic). New Zealand seems to have benefited from the contagion effect of the East Asian crisis as some international investors treated us as a safe haven. (We are, of course, suffering from a loss of export markets.) But were Australia to get into financial trouble, so would New Zealand, despite the protestations (and fact) that we are different.

What to do? Many consider the Reserve Bank’s system of prudential supervision is the best available. Even so, it cannot guarantee every depositor’s dollar in every financial institution. Moreover until it is tested by a rip-roaring financial disturbance we cannot be sure how it will work. Improvements would be to limit speculative capital flows, without disrupting long term capital flows. But no one knows how to do so effectively. (Better macroeconomic performance would also help.)

What is the individual depositor to do? Putting money into an overseas bank exposes it to similar risks. You could invest in the sharemarket, but a sharemarket crash is much more likely than a financial one. Put the money under your bed? There is the danger of burglary, fire, or nuclear war.

It would be irresponsible of this column to conclude there was no chance of a financial meltdown in New Zealand. Life is about risk: true for one’s savings too. Even during the secure 1970s they were being systematically undermined by inflation. In today’s world there is a non-zero probability of one’s savings being slashed by a financial crash, instead of being eroded by creeping price rises.


1. Macroeconomic Performance
Low GDP growth
High real interest rates
High inflation
High stock of money relative to international currency reserves
High private credit relative to GDP
High credit growth
An external (current account of the balance of payments) deficit
Low GDP per capita

Financial opening (domestic financial market liberalisation)
Opening to external capital (freeing up international capital flows)
Currency appreciation
Trade liberalisation
Fiscal expansion (increase in internal, or government, deficit)
Domestic credit expansion

Deficient bank management: poor credit assessment & monitoring, poor internal risk management & risk controls, strained credit assessment skills
Connected lending: loans extended to banks’ owners, managers, and related businesses. (sometimes called “cronyism”)
Poor supervision or regulation (by the financial authorities)
Deficient market oversight
Political interference (which often involves cronyism)
Weak judiciary
Deposit insurance (which encourages poor bank management, and cronyism)