Is it time to bring back finance companies?
Is it time to bring back finance companies?
For anyone who had anything to do with the industry meltdown a decade ago that must seem like a crazy proposition.
In fact that headline alone probably has a few angry readers reaching for their keyboards.
New Zealand’s finance company sector famously collapsed between 2006 and 2010, destroying an estimated $3 billion of wealth and affecting between 150,000 and 200,000 depositors.
It also coincided with a global banking crisis, which meant failed companies got lumped in with a Government Bank Deposit Guarantee and tax payers were left carrying the can — to the tune of $1b when the nation’s largest finance company South Canterbury Finance collapsed in 2009.
But, despite all that, a US economic professor says we might need them again if we raise bank capital requirements.
Professor Ross Levine, chair of banking and finance at the Haas School of Business, University of California, was the most cautious of the independent experts in the Reserve Bank’s independent review of its bank capital proposals.
While Levine broadly endorses the RBNZ’s work, he argues it does not sufficiently consider the response of the financial system to increased capital requirements.
He says we need to be sure our financial sector is “dynamic” enough to fill any gaps left by the major banks if higher capital ratios see them pull back on lending in sectors that become less profitable.
In other words, if the banks are under regulatory pressure to take less risk then this can have negative impact on the economy by slowing growth.
At the front end of the business world we need legitimate pathways for financing activity that is high risk.
We need people to take a punt on tech start-ups, new export crops and new factories — the productive end of the economy.
“The overall impact [of the capital proposals] depends on the degree to which non-banks emerge and grow to provide financial services to households and firms,” Levine says.
“The RBNZ should consider the degree to which there are legal, regulatory and policy impediments to the emergence and operation of non-bank forms of household and firm finance in New Zealand.”
Levine isn’t only highlighting finance companies, he’s also pointing to the lack of depth in our capital markets. I won’t dwell on that, here.
We’ve just seen the release of the 2029 Capital Markets report.
There’s really no debate about the need to improve the opportunity for businesses to raise capital through equity markets.
But even if we build deeper and more accessible equity markets — we still a have gap.
What we lack — that many other countries still have — is a dynamic non-bank lending sector.
To put it bluntly, we used to have one — but we broke it.
New Zealanders have a bad habit of woefully under-regulating things until we have a crisis on our hands.
The building industry during the leaky homes era 20 year ago springs to mind.
We’re still litigating that one. There’s also a popular view that our relative lack of retail investors in the share market dates back to wildwest boom and bust period which ended with the 1987 crash.
An entire generation lost trust in the sector when they lost their money.
The same can be said of the finance companies.
We had plenty of functional nonbank deposit takers and second-tier lenders operating in this country for decades, before a property-fuelled bubble of greed blew up in the 2000s.
South Canterbury Finance, for example, operated as a highly successful but largely unremarkable farm lender for more than 80 years before it got sucked into a vortex of related party transactions including Auckland waterfront bars and Fijian holiday resorts.
The Reserve Bank has estimated that at the height of the boom prior to the GFC, non-bank lenders had assets of about $25 billion and made up 8 per cent of lending by financial institutions.
By late 2013 the size of the finance sector had halved and accounted for only 3 per cent of institutional lending.
The Reserve Bank’s register of Non-Bank Depositors provides a reminder of just how static the sector has become.
The list now mostly consists of Credit Unions and Building Society’s. There is a handful of finance company survivors but no new registrations in more than two years.
What’s left of the sector faces much tougher scrutiny.
The Financial Markets Conduct Act and Non-Bank Deposit Takers Bill mean the companies registers and participants are licensed.
And related party transactions are much more closely scrutinised.
Perhaps most importantly, there are much stricter requirements for disclosure of risk — it needs to be in plain language and well displayed. Which is great.
I don’t by any stretch think the sector is now over regulated.
The disaster of the past decade is all too fresh to suddenly remove rules that might look like “impediments” to an international observer.
But it might be time to look at the sector with fresh eyes and welcome it back into the financial fold.
What we lack — that many other countries still have — is a dynamic nonbank lending sector