Academic journal article The Reserve Bank of New Zealand Bulletin

Banking Crises in New Zealand-An Historical Perspective

Academic journal article The Reserve Bank of New Zealand Bulletin

Banking Crises in New Zealand-An Historical Perspective

Article excerpt

1 Introduction

Triggered by rising credit losses on US residential mortgages over the period 2007-09, the global economy experienced its most significant financial shock since the Great Depression. The crisis first involved a 'run' by counterparties centred on the 'shadow banking system' (Geithner 2008; Gorton 2009; McCulley 2009). (2) Traditional banks could not absorb the subsequent withdrawal of liquidity from the financial system, in part because they had sponsored many of the off-balance sheet vehicles containing complex financial instruments that were part of the shadow banking system. In hindsight, the default risk inherent in these new financial products was not priced appropriately, nor was the correlation of default risk fully understood across the financial system. Banks therefore were ultimately exposed to the decline in the prices of these complex and opaque financial instruments that were backed by residential mortgages, and sustained heavy credit losses as a feedback loop emerged between disruptions to the financial system and the real economy. (3)

Ongoing balance sheet distress of major global financial institutions has resulted in unprecedented government intervention, firstly to stabilise illiquid institutions and markets, and ultimately to prevent failures of institutions at the centre of the financial intermediation process. Specific government intervention in the financial sector, together with fiscal and monetary policy support, appears to have stabilised current financial market conditions. The global economy has begun a tentative recovery as confidence returns and the worst of the asset price deflation is over.

Notwithstanding specific problems in the non-bank finance company sector, the New Zealand financial system has weathered this global shock remarkably well. While asset quality and profitability have declined--driven by the deterioration in broader economic conditions--New Zealand banks have not suffered the same erosion of capital buffers witnessed elsewhere. Banks in New Zealand were not generally exposed to the complex financial assets directly at the heart of the global crisis. Moreover, funding and liquidity risks--which were significant given the banking system's reliance on short-term wholesale funding--have been attenuated by: (i) the provision of crisis liquidity facilities by the Reserve Bank; (ii) the government guarantee of wholesale funding to enable banks to continue to issue debt; and (iii) ongoing support by the Australian parents of the big-four banks in New Zealand. Thus, while there have been important pressures and vulnerabilities exerted on the banks in New Zealand, the banking system avoided the deep systemic crises seen in other banking systems, which ultimately necessitated recapitalisation, or even nationalisation, of financial institutions in Europe and the US.

By 'systemic crisis' we refer to a major disruption in the process of financial intermediation that can result from both depositors and other creditors seeking to withdraw their funds from banks--the classic notion of a banking panic--or threats to insolvency from large declines in the loan portfolio. Both imply an erosion of a large proportion of banking sector capital (Bordo 2008, p. 11). (4) This definition distinguishes between failures of individual banks and a crisis that undermines the ability of the financial or banking system as a whole to function properly. However, in highly concentrated banking systems, problems that might be specific to any individual institution can take on systemic importance, if that institution constitutes a large enough weight in the financial system and there is the risk of contagion or spillover effects to other parts of the system.

With this definition in mind, this article examines systemic banking crises in New Zealand's past and identifies two such episodes. The first banking crisis occurred in the late 1880s to the mid-1890s and culminated in a bailout of the Bank of New Zealand (BNZ) in 1895 following a credit-fuelled rural land price boom in the 1870s and its subsequent collapse in the 1880s. …

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