Reserve Bank hits Govt. stock ratios

Press, 15 May 1985, Page 38

Reserve Bank hits Govt. stock ratios

PA Wellington Rather than perform a useful role in underpinning the soundness of financial institutions, the now-abol-ished Government stock ratios could have done the opposite, according to the Reserve Bank.

In its May bulletin the bank said a preferable response to concerns about the soundness of the financial system was that now being developed by the Reserve Bank. This emphasised the improved monitoring of financial institutions, but did not attempt to distort balance-sheets or dilute normal market disciplines on management.

The bank said financial institutions needed to hold a diversified range of financial instruments to ensure they had adequate liquidity to meet the range of contingencies their business faced. Liquid asset or prime asset ratios were used in a

number of countries. However, the compulsory holding of a substantial proportion of their portfolios in Government securities in the manner of the nowabolished New Zealand ratios was not an appropriate means of encouraging sound prudential management for a number of reasons.

“First, if a ratioed institution gets into difficulties, it may not be able to liquefy its stock holdings without a special exemption from its ratio requirements. Such an exemption might serve only to advertise its difficulties, and possibly compound them.

“Secondly, with Government stock issued in the past at below market rates,

the sale of stock holdings could involve the realisation of capital losses, causing further problems if the institution is already in difficulty. “Thirdly, the compulsory holding of low yielding assets reduces an institutions’s ability to adapt to changing market conditions and impairs its ability to compete for funds. “The implicit tax reduces an institution’s ability to realise reasonable profits and accumulate sufficient reserves to sustain it against future difficulties.” The bank concluded that, rather than performing a useful prudential role, it seemed more likelj' that the ratio system was counterproductive in this area.