THE PRESS SATURDAY, NOVEMBER 4, 1989. Japanese banks and DFC

Press, 4 November 1989, Page 24

THE PRESS SATURDAY, NOVEMBER 4, 1989. Japanese banks and DFC

A sense of broken trust has come to dominate relations between some Japanese banks and the New Zealand Government over the collapse of DFC, New Zealand’s largest merchant bank. The Japanese banks had large amounts invested in DFC and, like practically all creditors of DFC, their loans were not secured. They fear not simply a loss on an investment but the biggest bad debt ever sustained by Japanese lending to a foreign public institution.

The New Zealand Government will have to handle this whole affair with extreme care. Any sense of broken trust is as damaging for relations between countries as it is in personal relationships. The Japanese Government is not so far involved; but the closeness of the links in Japanese business, financial, and Government circles means that it will be difficult to confine any sense of betrayal to banking circles. The Japanese Government will have already observed that Japanese banks stymied the attempt by the New Zealand Government to raise money on the Japanese market. Other countries in which New Zealand raises capital will also be well aware of the action by. the Japanese banks and will examine the reasons the banks are giving. It is important to resolve the matter as quickly as possible, partly because New Zealand needs access both to the Japanese financial market and to other foreign markets for loans.

An account of the attitude of the Japanese banks appeared in the “Nihon Keizei Shimbun,” Japan’s leading financial daily newspaper. The core of the feeling seems to lie in the passage: “There is a unified feeling of ‘betrayal’ among banks here over the fact that a representative New Zealand Government institution could issue debt for so many years and then go bankrupt 11 months after going private.... If the New Zealand Government does not recognise debts of the DFC before its privatisation, it may be isolated from international capitalmarkets.”

Put another way, this is the argument that investments made before privatisation of DFC should be the responsibility of the Government and that the Government should honour them, presumably because the soundness of the bank was implicit in Government ownership. In strict legal terms this is not so, because the National Government, in 1976, withdrew a Government guarantee for the debts of DFC. Had the DFC failed while it was a Government institution the Government would still not have been liable for the debts. Investors’ funds were theoretically no safer then than they were after the merchant bank had been 1 sold. Legally, then, the burden of the complaint as recorded by the Japanese newspaper does not stand up. One should certainly hope that the implications about access to financial markets can be disregarded. Making the formal legal point may not, however, allay all sense of betrayal. The sequence of events under which the Government sold an apparently malfunctioning organisation which collapsed within a year is not a pretty sight; nor is the confusion over the intention of backing from the new owner, the National Provident Fund, and the quiet withdrawal of that intention. The legality of the position notwithstanding, the Japanese reaction can be respected even if, in commercial terms, the investors took their risks and lost.

The appointment of statutory managers under the Reserve Bank Act has been a move that seems to have puzzled and alarmed the Japanese banks. The normal method of procedure for a failed institution or company is the appointing of a receiver or a liquidator. The New Zealand alternative is unusual. However, the Australian Reserve Bank has the power to appoint a manager, from the Reserve Bank, for a financial institution in severe trouble. By the end of this year, legislation is expected to be passed in Australia which would make it possible for the Reserve Bank to appoint someone outside

of the bank to do the same job. In effect, there will then be little difference between the Australian and the New Zealand position. In Britain there has been a recent welter of regulations and other legislation to deal with unhealthy financial institutions. There, the Secretary of Trade and Industry has the power to appoint a trustee to look after the assets of a failing financial institution. That is not the same as appointing a statutory manager; but the idea is not wholly dissimilar.

The appointment of statutory managers effectively freezes all assets of DFC. The normal course of applying through the courts for payment of money owing is not available to creditors while the institution is under statutory management: The justifications given by the Reserve Bank for the appointment of statutory managers have been the need to maintain public confidence in the operation of the financial system, the need to avoid significant damage to the financial system and, subject to these requirements, the need to resolve as quickly as possible the difficulties of the institution and to preserve the position of creditors and maintain the ranking of claims of creditors.

Only in the last few years has New Zealand adopted the system of prudential supervision under which the Reserve Bank has the authority to examine the health of financial institutions. Britain and Australia already had that system. A Reserve Bank book published in 1983 discussed the possible establishment ,of prudential supervision. There it was argued that the special nature of financial institutions and the social costs to the community of large-scale default entailed more than just the costs of a failure to shareholders and depositors. The statutory management arrangement is an extension of the supervisory system.

The relative sizes and styles of the New Zealand and the Japanese economies may be of central importance to the understanding of what has happened. Because New Zealand has a small economy it often accounts for little of the time of international investors. Generally, the economy has been sound and has experienced few disasters which would rock the international boat. Until comparatively recently it was a highly protected economy so the opportunities for exposure by international banks were rare. The country has been politically stable. In these circumstances New Zealand must have seemed a safe place for investors, and also attractive when interest rates were high. The great size of the Japanese economy and the close co-operation among different sectors of the economy do not have close parallels in New Zealand. The potential for misunderstandings could easily turn into a sense of loss of trust.

The major question now is how to get out of the mess. The Minister of Finance, Mr Caygill, did not help matters when, in a frank if unwise way, he said that the Japanese banks were blackmailing New Zealand. His was a reasonable interpretation and one drawn also by this newspaper in an editorial article. Still, it might have been an observation better left unsaid by the Minister of Finance. He has since shown a better grasp of. the depth of feeling and the approach being taken by some Japanese banks. He is right to -raise the complications of what it would mean for the Government to bail out DFC. The Government will have to handle the issue delicately. No risks should be taken about endangering New Zealand’s capacity to borrow in foreign markets. The lesson for the Government should be to take more care in selling off its assets, especially those that may be shaky. The Government will win no respect for its dealings if it creates the impression that it is just tough luck when someone gets caught with a bad buy. In ordinary commerce, such attitudes may pass; when Governments are involved rather different rules apply. The Japanese are obviously sensitive to this difference.