Policy options

Until recently good fundamentals were seen as necessary and sufficient for optimal performance of the financial system

Until recently, policy orthodoxy in relation to financial system development largely entailed a focus on ensuring stable macroeconomic policy and sound tax and regulatory policies. In essence, good fundamentals were seen as necessary and sufficient for optimal performance of the financial system.

Our work does not lead us to challenge the importance of stable macro policy or good tax and regulatory policies for financial system development. However, it does begin to question whether these policies, by themselves, are sufficient to ensure the most effective operation of the financial system.

Pro-savings policies and other policies aimed at promoting financial market development may also be important.

While tax and regulatory policies and an environment conducive to the identification of sound investment opportunities are the dominant determinants of financial development, pro-savings policies and other policies aimed at promoting financial market development may also be important.

New Zealand’s financial regulations compare favourably against international best practice, although there is scope to enhance the regulatory framework in areas including: disclosure of information to savers, stronger supervision of non-bank deposit takers and collective investment schemes, and licensing of financial advisors. A review[21] of these areas is currently in progress. The government recently announced its decisions in some of these areas and will be taking legislative action.

KiwiSaver combined with recent tax changes has the potential to significantly increase household savings held in the form of financial assets

Similarly, the announcement by the Government of enhancements to KiwiSaver in Budget 2007 represents a significant development in savings policy. We believe that KiwiSaver has the potential to lead to a significant increase in household savings held in the form of financial assets. Some increase in national savings is also likely, although the extent will depend on how government funds its expenditure on KiwiSaver[22]. Another important measure is the recent set of changes that reduced the tax disadvantages to saving in the form of holding New Zealand and foreign equities through collective investment vehicles such as superannuation funds.

There could be a role for government to complement the market

Our work also suggests that there may be a role for government to promote financial system development more directly and set this as an explicit goal. Some government initiatives have already been taken relating to export finance and venture capital[23]. While the policy levers for further promoting financial system development are less clear, we believe that further investigation in this area is warranted.

It is important to take a dynamic view of the financial system because the market has considerable capacity to evolve and adapt

It should be recognised, however, that the market itself has developed over time to overcome inefficiencies within the financial system (e.g. through contractual arrangements and collateral requirements associated with debt financing). Because of this, we are cautious when it comes to considering policies to intervene in financial markets. Given the fundamental importance of the financial system in the allocation of resources within the economy, the risk of introducing distortions – including unintentionally - should be weighed very carefully. In doing this it is important to take a dynamic view of the financial system, in particular noting it has considerable capacity itself, to evolve and adapt to changing conditions.

As the financial system is a critical enabler of economic growth, we should continue to investigate its strengths and weaknesses

Nonetheless, the financial system is also susceptible to problems that may not be self-correcting. As the effective operation of the financial system is a critical enabler of economic growth, we should continue to investigate its strengths and weaknesses. In particular the work should focus on the performance of those parts of New Zealand’s capital markets that seem underdeveloped, and are important for growth such as the equity market. A key aim would be to better understand the importance of local capital markets for a number of aspects of firm performance including: firms’ access to finance; what the features of well functioning capital markets are from the perspective of firms; and how New Zealand’s markets compare with best practice in other small developed countries. The dimensions include:

• the regulatory settings around our capital markets and whether there is a role for government in further improving their development and function;
• further investigation of evidence on firms’ access to finance;
• the reasons behind firms’ location decisions;
• encouraging the entry of institutional funds in the venture capital market; and
• ensuring that tax and other barriers do not discourage the development of the corporate bond market.