Govt stock rise, inflation linked

Press, 2 May 1984, Page 7

Govt stock rise, inflation linked

PA Wellington The Government’s policy of raising the amounts of money that finance houses must hold in Government securities induces higher lending interest rates, says the Institute of Economic Research. In an independent report commissioned for the Finance Houses Association, released yesterday by the executive director of the association, Mr Ken Baker, the institute said that when the Government required finance houses to hold more Government securities, interest charges to other borrowers went up. It said that in the short- , term interest rates iKight go ' ’9

even higher as finance houses competed for funds to meet new Government requirements. “Later on, interest rates may fall from the peak, but they will remain higher than those which would have existed before the Government directed the finance houses to place more of their funds in Government securities.” The report, prepared by the director of the institute, Mr Brian Easton, and Ms Linda Kay, detailed likely consequences when a finance house faced a rise in its deposit ratio from 20 per cent to 30 per cent when its current investments were $lOO million. “Assuming that ify was

previously holding $2O million of Government stock, it needs $lO million of cash in order to purchase an additional $lO million of stock. “Some of this cash could be found by selling or running down some of its assets which are not defined as investments. Possibilities include selling commercial bills, trading bank Transferable Certificates of Deposit and reducing cash holdings ’ in banks. “A variation of the latter, which occurs on the liability side, would be to acquire the cash by increasing its bank overdraft (if market conditions permitted).” It was safe to assume that each of those actions

would involve some cost to the finance house, and typically would lead to a higher market rate. Selling commercial bills, for example, required greater discounting, the report said. It was unlikely that a finance house would find all the cash it required from those sources. “A second source would be.from advances being repaid. Instead of relending these funds they would be diverted for Government stock purchase. The equivalent on the liability side would be for the institution to divert any net deposits into stock purchase.

“Since there would be reduced potential on-lend-ing their effective interest

rate would rise. Note also that the margin between the cost of funds and return on all lending would be reduced again.” The report said that sometimes these two options would be insufficient

to provide the necessary cash, in which case additional funds would be sought from the market.

The relative urgency of the need for funds from the wholesale market was likely to push up the cost of raising them. The on-lending rate to customers might not be pushed up immediately but the higher cost of funds would eventually have to be recovered by an interest rate higher.