Assessment of the New Zealand financial system

New Zealand’s banking sector is sound, efficient and well-developed. Many other parts of the financial system (with the exception of the foreign exchange market[6]) are relatively under-developed[7] i.e. are small and lacking in depth and liquidity.

Firm financing is largely in the form of debt finance with equity finance playing a much lesser role

In the New Zealand financial system firm financing is largely intermediated by banks which are the single largest provider of debt finance, with equity finance playing a much lesser role (SNZ, 2004). Existing owners are the single largest source of new equity followed by other informal sources (e.g. family, friends and angel investors). This is reflected in a small and relatively illiquid stock market, an extremely small domestic corporate bond market and a venture capital market that is growing but remains relatively immature. Figures 2 to 4 illustrate this by looking at the relative sizes of New Zealand’s banking sector, stock market and venture capital investment.

Because of this firms are unlikely to experience a comprehensive menu of financial services through all stages of their development. Possible reasons for under-development of the New Zealand financial system include:

• New Zealand’s low national saving rate with private saving tilted towards housing.
• Heavy reliance on foreign lenders and owners.
• The lack of very large firms that support the local equity market.
• Co-operatives and state-owned enterprises that don’t raise capital on the local equity market.
• The lack of growth ambition within New Zealand firms and potential lack of profitable opportunities that could be restricting the demand for capital.
• The small scale of the New Zealand economy which is reflected in high costs relative to other countries of undertaking “due diligence” and investment analysis.

Figure 2 – Size of banking sector: selected countries

Source: OECD Factbook 2007, Denmark National Bank, Reserve Bank of Australia, Reserve Bank of New Zealand, Federal Reserve Board

Figure 3 – Stock market capitalisation: selected countries

Source: World Federation of Stock Exchanges, OECD Factbook 2007

Availability of capital

A key question is whether under-development of the financial sector is affecting the availability and cost of capital (particularly equity capital), thereby constraining the investment and expansion of New Zealand firms.

There are few New Zealand studies that look for evidence of firm capital constraints - such problems are difficult to observe

There are few empirical studies in New Zealand that look for evidence of firm capital constraints and, in any case, such problems are inherently difficult to observe. The Business Finance Survey (Statistics New Zealand, 2004) suggests there are few problems with firms obtaining finance, but such surveys are not in themselves direct tests of finance constraints and are subject to survival bias[8]. A report by Buckle et al (2000) found that firms’ investment intentions are influenced in part by the strength of their balance sheets and small firms are more affected by changes in their financial position. This result suggests that financing constraints may affect firm expansion, although the study has some limitations due to weaknesses in the data. In contrast, a more recent MED study (Fabling & Grimes, 2004) finds little or no evidence that perceived finance constraints cause poor firm performance and concludes instead that poorly performing (relatively unprofitable) firms find access to capital difficult. It is to be expected that a good financial system would deny weak firms access to capital. Overall however, it may be that the likelihood of finding significant problems is low during the expansion phase of the business cycle, when capital is more readily available. To draw firm conclusions, further investigation would be required.

Certain firms are more likely to have difficulty accessing capital e.g. new and young firms lacking collateral

Certain firms are more likely to have difficulty accessing capital (e.g. young firms with limited cash-flow, those with intellectual property or highly specific assets that can’t be used as collateral and highly geared companies). For these firms, equity finance (including venture capital) is a more appropriate and likely option than debt finance (Statistics New Zealand, 2004; LECG, 2005). However, access to risk capital could potentially be a problem given that the early-stage equity market is still young and relatively underdeveloped by international standards. An assessment of the Venture Investment Fund suggests that this government initiative is having a positive impact on development of the market in New Zealand, but that significant development of the industry is expected to take time (LEGC, 2005).