KEY POINTS:
While the New Zealand banking system is escaping the worst of the overseas mayhem, short-term liquidity remains tight due to a combination of factors including heightened risk aversion related to the credit crunch.
The dramatic events overseas including a string of bank failures has seen the interest rates
banks and other financial institutions charge each other for loans spike to extreme levels.
The cost of borrowing in US dollars overnight in London rose the most on record after the US Congress rejected a US$700 billion ($1 trillion) bank bailout.
The seizure in the credit markets is tipping lenders toward insolvency, forcing governments to rescue five banks in the past few days.
In New Zealand yesterday Reserve Bank Governor Alan Bollard said central banks around the world had been keeping markets liquid. "We've been doing the same, so there's a lot of cash in the system. The banks are all very much cashed up," he said.
However, AMP Capital Investors fixed income portfolio manager Vicky Hyde Smith said banks were hoarding a greater proportion of that cash in deposits with the RBNZ and less of it was finding its way into the interbank market.
The RBNZ recently increased the amount of cash in the system to around $10 billion where a typical pre-crunch level would have been around $7 billion, Hyde Smith said. That figure is currently at about $8.5 billion.
The increase to $10 billion coincided with the beginning of the latest episode of international financial market turbulence but also occurred as banks were heading into their financial year end, at a time when they tend to raise additional short-term funds in order to look good at balance date, said Hyde Smith's colleague Grant Hassell, head of fixed interest at AMP Capital Investors.
Hyde Smith said the RBNZ was "very aware" of the liquidity issues and had taken a number of actions to address them including broadening the range of securities it accepts as collateral from banks.
Hassell emphasised the lack of liquidity in the interbank market was not likely to cause the banks here significant problems but it would not help the RBNZ's efforts to reduce lending rates for businesses and households.
That would require either a dramatic improvement in liquidity or further aggressive cuts to the OCR.
"I think it's going to take a bit of both", said Hassell, who expects the RBNZ to cut the OCR by 50 basis points again this month.