Guarantee scheme keeps risk return out of balance

The problem of finance companies paying interest rates unrelated to the risks of the investments will continue under the government’s deposit guarantee scheme, the Reserve Bank says.

Thursday, November 13th 2008, 7:08AM
The bank has, for some years, expressed concern that the interest rates offered by many finance companies were not commensurate with the risk that the firm would get into difficulties.

“The deposit guarantee scheme may temporarily prolong this situation, since the risk of failure of an institution accepted into the scheme over the next two years falls on the government,” the bank says in its Financial Stability Report released yesterday.

However, it says the regulatory changes underway for the non-bank sector, along with “heightened security on the part of investors” is expected to prompt further increases in differentiation between relatively secure versus relatively untested institutions.

Elsewhere in its report it suggests that consolidation in the finance company sector is something which may be pushed along by the guarantee scheme.

It says some of the finance companies in trouble, or their assets, may be bought by other firms covered by the guarantee.

This “might help to make the consolidation of the sector more orderly.”

It also acknowledges that the guarantee, although comprehensive, has some “inevitable downside” and will create distortions in the market.

“These distortions arise largely because it is not practically possible to guarantee the debt of all classes of institution.”

Examples include corporate or local government borrowers as their offerings will not be covered by the scheme.

To find out who has already been accepted into the scheme, click here.

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