Martin Hawes: Banking on a guarantee

The government guarantee of the deposits of banks and some finance companies lasts until October 12 next year. Mascot's demise this week brings an important question into focus: what will happen when the guarantee period ends?

Many have invested with banks and finance companies so that their funds mature before the guarantee ends. This is a good idea, because it means their money is as safe as the Government - as safe as you can get.

However, the banks and finance companies' need for funds will not disappear in October next year. If a lot of investors withdraw their money in the lead-up to the guarantee's expiry, these institutions will be starved of capital and in trouble. So will there be a rush to the exit doors?

I have a theory that the Government expects to continue the guarantee for banks after October next year. This would be reasonable: banks are the most important part of our financial system and the Government cannot allow widespread failure. To continue the guarantee for banks permanently would bring New Zealand into line with the rest of the world.

The Government no doubt expects that the guarantee for banks is unlikely to cost the taxpayer anything - our banking system is sound and people have confidence in it. In a nice twist, that confidence increases with the guarantee.

This is not the case with finance companies. The guarantee for them is already costing the taxpayer and may cost more. Mascot's failure will dent investor confidence even further in this sector and that does not bode well for other finance companies.

Although the Government is likely to extend the guarantee for banks permanently, I do not think this is justified for finance companies. They are not critical to the financial system and, as Mascot has shown, there will be a cost to the taxpayer.

I congratulate Treasury for swiftly meeting its Mascot guarantee obligations. Clearly some thought had gone into this as a contingency and information for Mascot depositors was posted on the Treasury website within hours of news of the receivership being released. Such efficiency will give a little confidence to investors but when it comes to the non-bank tier of deposit takers, we now understand there is a cost.

How can the Government cease to guarantee this sector without causing widespread failure? This is not an area which I think should be permanently guaranteed, but, clearly, there will be difficulties of transition.

Investors in guaranteed finance companies should be relaxed as long as their deposits mature before October 12, next year. However, they should pay close attention in the lead-up to that date if they are considering extending the term.

Each week financial author Martin Hawes shares strategies to help you grow your wealth. You can email finance questions to info@wealthcoaches.net or andrea.milner@heraldon sunday.co.nz On the web: www.wealthcoaches.net