August 9

How safe is my bank? "It's as safe as houses." The answer to that question is particularly appropriate because the New Zealand financial system, which includes banks, finance companies and mortgage funds, is highly exposed to the residential property market.

The New Zealand financial system consists of three main divisions:
* Banks.
* Non-bank lending institutions, mainly finance companies, building societies, credit unions and the PSIS.
* The managed funds/insurance sectors.

The 17 registered banks dominate the country's financial system with assets of $329 billion, or 76 per cent of the country's total financial assets, at the end of last year.

By comparison, Australia has a far more diversified financial system with the banks accounting for just 52 per cent of the country's financial assets.

The New Zealand financial system is also relatively small, as its total assets are only 2.5 times GDP, whereas Australian financial assets represent 3.9 times GDP.

There are a number of other observations about the New Zealand and Australian financial systems:
* New Zealand banks have 44 per cent of their total assets in the form of residential mortgages, whereas the Australian banks have only 31 per cent of their assets in this area.
* Bank residential mortgages represent 34 per cent of New Zealand's total financial assets compared with 16 per cent in Australia.
* New Zealanders have far more mortgage debt than managed funds, whereas it is the other way around in Australia.
* New Zealand's non-bank lending institutions have well over 50 per cent of their assets in property and residential mortgages.
* Our troubled mortgage fund sector, which has assets of more than $3 billion, is included in the managed funds/insurance sector.
* New Zealand banks now source 39 per cent of their funding from overseas, compared with 30 per cent 10 years ago, whereas Australian banks have only 26 per cent of their funding from overseas.
* The four large Australian-owned banks account for 63 per cent of New Zealand's total financial assets, whereas the same four banks in Australia have only 32 per cent of that country's financial assets.

In summary, the New Zealand financial system is relatively small and is dominated by the banks, particularly the four large Australian-owned companies.

These banks have become increasingly reliant on overseas borrowing and 44 per cent of their assets are in residential mortgages, with an extra 8 per cent in the construction and commercial property/business services sectors.

But the biggest difference between the two countries is in terms of regulation, as the Australian financial system is highly regulated whereas we have a light-handed disclosure and self-discipline regime.

The Reserve Bank of Australia plays a role in maintaining financial stability with a focus on "the prevention of financial disturbances with potential systemic consequences".

In addition, the banks, building societies, credit unions, insurance companies and superannuation funds are regulated by the Australian Prudential Regulation Authority (APRA) while finance companies, merchant banks and unit trusts are regulated by the Australian Securities and Investment Commission (ASIC).

Australia introduced the "twin peaks" regulatory model involving APRA and ASIC in 1998 after the conclusion of the Financial System Inquiry. This was also known as the "Wallis Inquiry" after chairman Stan Wallis.

The Australian Government supports a strong regulatory regime because it promotes investor confidence, lowers the cost of capital and encourages honesty and fairness.

By contrast, there is effectively no regulation of the New Zealand financial system, although the Reserve Bank of New Zealand has a supervisory role over the banking sector.

According to a detailed International Monetary Fund (IMF) assessment of New Zealand's Financial System Stability, published in May 2004, the "New Zealand regulators do not carry any duty to protect individual depositors or policyholders, or to safeguard individual institutions, unlike many other jurisdictions".

The visiting IMF research team met a large number of investment sector professionals who expressed concern over the poor governance, lax lending standards and inadequate disclosure of the finance company sector.

The IMF report concluded that as far as finance companies were concerned "there is little timely quantitative information that is readily available to depositors and market participants".

The IMF recommended that the Ministry of Economic Development commit more resources to overseeing the non-bank sector "with a view towards enhancing public access to timely and comprehensive data".

These recommendations were not implemented.

Thus, New Zealand continues to have the "twin pillars" of inadequate disclosure and ineffective self-discipline, while Australia has the "twin peaks" of APRA and ASIC.

Meanwhile, the Reserve Bank of New Zealand monitors the stability of the financial system, including its ability to absorb "shocks" from various sources.

The Reserve Bank's assessment is published in May and November each year in its Financial Stability Report.

The May 2007 report stated that as far as finance companies were concerned risks persisted in the property and used car markets, although "latent property risks will take longer to play out given the current strong housing market conditions".

Last November's report noted that finance companies with a property lending focus had grown more quickly than their competitors, but the impact of the collapse of a number of companies on the wider economy would be contained because "the share of total household wealth held with finance companies is relatively small".

Finally in May this year the bank reported that there was considerable upheaval among finance companies but "failures in the sector are unlikely to have widespread negative effects on the financial system or broader economy".

This continued downplaying of the collapse of the finance company sector is difficult to understand because the IMF warned in 2004 that "the failure of any of the larger non-bank institutions could have a significant impact on market stability through negative reputational effects on other institutions".

The Reserve Bank also warned in an earlier Financial Stability Report that the failure of non-bank organisations could threaten the finance system through erosion of confidence or contagion.

The collapse of a large number of finance companies and problems in the mortgage fund sector has eroded confidence in the country's financial system and demonstrated that our market disclosure and self-discipline regime has been a failure.

This regulatory system has failed because financial literacy is poor, with few investors, or their advisers, having the skills or experience to assess risk and return.

There is a huge flight to the banks but a large percentage of investors have little financial confidence and are concerned that these organisations are also vulnerable.

Investors can be assured that the banks are safe even though they have a large exposure to the depressed property market and are too dependent on overseas funding.

Our banks are safe because they are large, have substantial shareholders and their funding and loan books are far more diversified than the non-bank lending sector.

Nevertheless, investor confidence in the country's financial system, as well as the capital markets, is far too low and there is a strong prospect of contagion when failure occurs in one part of the system.

Our financial system will remain small, dominated by the four main Australian-owned banks and limited in its ability to provide development funding for the productive sector until we introduce a modern best practice regulatory regime that enforces honesty and encourages widespread investor confidence.

Australasian Financial Systems: Australian regulation provides better results

(as at December 31, 2007)	Australia	New Zealand
Banks	(A$b)	(NZ$b)
- Housing mortgages	661	146
- Other personal lending	112	7
- Business lending	580	128
- Other assets	808	48
Total bank assets	2,161	329
Non-bank lending institutions	547	30
Managed funds/insurance	1,483	75
Total Financial System Assets	4,191	434
Gross Domestic Product	1,088	175
Financial assets/GDP	3.9x	2.5x