Opinion: D-day for NZ's financial industry

October 12, 2010, is a date that is already occupying a lot of people's minds in banks and finance companies. It is the day the Government's retail deposit guarantee scheme is set to expire. It is the new D-Day for New Zealand's financial industry and for many savers. There was an enormous sense of relief and surprise after the announcement that the Government would guarantee savings in bank accounts and finance companies for two years. Those finance companies still trading were given a new life. The reaction from savers was almost immediate. In the first few weeks, they filled their boots by investing in finance companies offering interest rates of more than 9 per cent while the banks were offering around 6 per cent. At least initially, many finance companies welcomed the influx of funds with open arms. Some announced special retail bond issues to take advantage of their new guaranteed status. Within a few weeks, most had filled their coffers and started to reduce interest rates closer to those offered by the banks. Most finance companies are now offering around 6.5 per cent to 7 per cent for their 18-month debentures while the banks are offering around 5 per cent. One reason the finance companies cut their rates was they simply ran out of quality lending opportunities, given the demise of the property development sector and the slowing of lending to small businesses and consumers. One of the great ironies of the flurry of activity after the deposit guarantee announcement was that finance companies took in hundreds of millions of dollars - at least some of which came from bank customers taking their money out of maturing term deposits - and promptly deposited it back in banks. The second reason was the dawning realisation that the D-Day potentially creates a massive moment of truth that could destroy them if they load up too much easy money. Many investors have been careful to invest in debentures or bonds that expire just before the October 12 cut-off. There is a danger that savers might pull all their money out at once, potentially pulling down those finance companies that survive until then. Executives in banks and finance companies have already started thinking about how to manage that moment of truth. Some are secretly hoping the Government will extend or phase out the guarantee but that is a risky strategy. Treasury and the Reserve Bank want to remove the obvious distortions created by the scheme as quickly as possible. Meanwhile, finance companies are trying to avoid building a wall of deposits that expire in the weeks leading up to the end of the guarantee. Many are trying to spread expiring debentures over a longer period around that deadline. The Reserve Bank is also moving to beef up its regulation of the sector and introduce a credit rating system. That should make it easier to assess the real risks of finance companies versus banks and avoid the sort of mismatches that saw unrated finance companies offering only 100-200 basis points more for a term deposit than a bank. In theory, all the banks and finance companies should be offering the same rates now, given they are all protected by the Government guarantee. But savers and institutions know this protection is only temporary and are demanding higher returns from finance companies than banks. * This piece first appeared in the Herald on Sunday, January 11, 2009.