THE PRESS FRIDAY, FEBRUARY 8, 1985. Lending to the Government

Press, 8 February 1985, Page 14

THE PRESS FRIDAY, FEBRUARY 8, 1985. Lending to the Government

The reserve assets ratio system, which will be abolished on Monday, has been a tool of monetary policy in New Zealand. The present form of the system has been used since 1973, though other ratio systems were in use long before that. The system has required the trading banks and a number of other financial institutions to hold a minimum percentage of. their deposits in Government or local authority stocks. The Reserve Bank, with the approval of the Minister of Finance, can vary the ratios from time to time. The effect of increasing the ratio means that a financial institution would have, less money to lend to the public or to businesses. The financial institutions would then have to attract more funds or tighten their lending policies. The reserve assets ratio system has also enabled the Government, through the Reserve Bank, to help decide priorities in lending. Farming and export businesses have received priority, as has housing, from time to time. To ensure that banks remain sound, they are required not to lend beyond a certain proportion of their deposits. The reserve assets ratio system, however, is separate from this requirement. Abolition of the reserve assets ratio system does not remove from financial institutions the requirement to continue sound banking practices. The abolition removes the compulsion about putting a certain proportion of a financial institution’s assets into Government securities. Equally, it removes the Government’s automatic claim to a proportion of savings for State purposes. The Government still needs to borrow — and borrow heavily — on the domestic market to finance the internal deficit. However, it is seeking Hie money at market rates. There is no lack of people willing to lend to the Government at present because the Government is offering attractive rates. One of the important reasons for having the ratio system has been overtaken by the fact that the Government is attracting the money that it wants on a purely commercial basis. One of the arguments against the system has been that it was unfair. While trading banks in January were required to put 28.5 per cent of their deposits in Government securities, private savings banks were required to put 54 per cent in Government securities, and trustee banks were required to put 38 per cent of their deposits in such securities. Against this, it must be remembered that the Government guarantees the trustee banks and the trading banks are credit-creating institutions working from a deposit base that is smaller in relation to lending. When Government interest rates were lower than commercial rates, the financial institutions were reluctant lenders to the Government. The banks and other institutions would j put up the interest rates to other borrowers to cover the lower interest rates earned by their money in Government securities. It may be argued that the other borrowers were subsidising the Government

borrowing. It is hard to determine on whom the burden fell most heavily. Nevertheless, the net result of the change on Monday will be that the Government has divested itself and local authoritiees of a privileged position, taken on behalf of taxpayers, that provided public funds at rates below market rates. The community as a whole will now have to compete with private demand, for investment funds. Another argument against the reserve assets ratio system is that it was rarely used for one purpose for which it was designed: that is, to provide a tool to adjust the money supply. • It was so used last year under the previous Government. At one point, the then Minister of Finance, Sir Robert Muldoon, concerned about the growth in credit, introduced a system of penalising banks for growth in credit. During the early months of 1984, the ratio system was applied probably as harshly as it has ever been for trading banks, finance companies, and building societies. The trouble is that the system applies to only certain lenders and people were able to borrow money from solicitors and others not affected by the controls. The fact that the system applied to some lenders and not to others is another argument used against its _ continuation. To try to answer this objection by -J embracing all lending sources would be impracticable. A Government has the opportunity to offer especially attractive terms to lenders — terms that may include tax concessions. These, too, are at the expense of all taxpayers in the end. Ultimately, if Government spending creates a deficit after tax revenue, the Government, like local authorities, must capture investment money. The present Government has resolved that this must be done at no less a rate than the market rate. In fact, since the rates of interest it has been offering have been the market rate, or near enough, there is little difference in the result for the time being. In the immediate future, the effect on interest rates of the abolition of the system is expected to be negligible. After all, the Government is aggressively looking for money and this will maintain interest rates. By about July, the reduction in the Government deficit may become apparent and the Government will be looking for less money. The amount of borrowing it seeks by tender may drop. Next week the tender for Government stock will be for $4OO million. It could drop by $lOO million or so in offerings towards the end of this year. Interest rates may then start to come down. A reduction in interest rates in the long term is one of the reasons given for the abolition of the ratio requirement. The abolition also conforms with the Government’s policy of removing controls over the economy, the over-all aim being to allow money to flow into areas of the economy in which growth can be expected. Clearly, the flow into public spending now depends on ability to pay rather than on regulation.