New banks problem

Press, 28 July 1987, Page 26

New banks problem

PA Wellington Establishment of new banks may unsettle money markets and prompt a need to tighten liquidity management, says the Reserve Bank in its annual report. Developments during 1986-87, when lending rose in response to a spending boom before the introduction of the goods and services tax (GST), showed the need for authorities to constantly judge the stance of monetary policy, the report says. Shifting structures in the financial system mean unchanged settings of cash and primary liquidity marks are unlikely to represent a constant policy stance, it says. Of the stance taken last year, the bank says: “It appears that financial institutions became more comfortable with liquidity

under the new arrangements in the first few months of 1986-87 and this contributed to their willingness to accommodate the demand boom through an expansion in lending and deposit growth, in spite of continuing indications from Government that the stance of policy would remain firm.” That experience shows that monetary policy is not an effective instrument for closely controlling short-term fluctuations in either money and credit aggregates or in the level of economy activity, it says. The bank believes the pre-GST demand surge would have occurred "to a large extent” regardless

of the policy stance adopted during that period. But the authorities’ unwillingness to accom-

modate the rapid growth in financial institutions’ funding requirements that occurred during the surge did become "increasingly binding” through rising wholesale interest rates. That in turn could have been expected to have led to a slowdown in money and credit aggregate growth and economic activity, the report says. The bank believes the process of adjusting to the new environment produced by financial deregulation has not finished. Relationships on which existing marks are set could be unsettled by developments like the advent of new banks this year and the Reserve Bank will have to monitor them closely.

Continued modifications may be required to maintain a consistently firm policy stance, the report predicts.