Is There Market Discipline for New Zealand Non-Bank Financial Institutions? - PowerPoint PPT Presentation

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Is There Market Discipline for New Zealand Non-Bank Financial Institutions?

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  1. Is There Market Discipline for New Zealand Non-Bank Financial Institutions? Slides prepared by Kurt Hess, University of Waikato Management SchoolHamilton, New Zealand

  2. Motivation Market Discipline with Basel II conceptual framework New Zealand Non-Bank Financial Institutions (NBFIs) Research Questions, Data & Methodology Interpretation / Conclusions Market Discipline NZ NBFIs Kurt Hess, WMS kurthess@waikato.ac.nz

  3. Motivation • Regulations / supervisory regimes struggle to keep pace with financial innovation in the market place. • Regulators / supervisors of financial systems (in particular banks) look at mechanism of market discipline to complement their supervisory system.(e.g. embodied in Basel II Accord) Kurt Hess, WMS kurthess@waikato.ac.nz

  4. Motivation • Sector of New Zealand NBFI provides an almost perfect “lab case” to study effects of market discipline because of the absence of impediments to the actions/effects of market discipline. • Such impediments in banking systems include moral hazard problems (too big to fail), implicit guarantees etc. Kurt Hess, WMS kurthess@waikato.ac.nz

  5. Market Discipline & Basel II Basel on the Rhine RiverRetrieved from http://www.basel.ch 21 September 2004 Kurt Hess, WMS kurthess@waikato.ac.nz

  6. Basel II Pillars • Pillar 1: • Minimum capital requirements • Pillar 2: • A supervisory review process • Pillar 3: • Market discipline (risk disclosure) Kurt Hess, WMS kurthess@waikato.ac.nz

  7. Market Discipline under Basel II • Part 4: The Third Pillar – Market Discipline, pgs. 175-190 • Section I:General considerations, p. 175-177 • Section II:The disclosure requirements, to p. 190 • contains 13 tables itemizing the detailed disclosure requirements Kurt Hess, WMS kurthess@waikato.ac.nz

  8. Market Discipline under Basel II • Pillar 3 under Basel does not represent a holistic view of market discipline • purely disclosure based focus • does not look at / include other measures to strengthen effects of market discipline in a comprehensive sense, e.g. observers must also be able to value the information / to impose a cost on the bank that releases negative information. Kurt Hess, WMS kurthess@waikato.ac.nz

  9. Market Discipline under Basel II Pages in New Basel Capital Accord (issued June 2004) Kurt Hess, WMS kurthess@waikato.ac.nz

  10. Pro Memoria: Calculation Capital Requirements under Basel II Unchanged Total Capital Credit Risk + Market Risk + Operational Risk  8% (Could be set higher under pillar 2) Significantly Refined Relatively Unchanged New Source: slide inspired by PWC presentation slide retrieved 27/7/2005 from http://asp.amcham.org.sg/downloads/Basel%20II%20Update%20-%20ACC.ppt , Kurt Hess, WMS kurthess@waikato.ac.nz

  11. Page Analysis Basel Accords (Analysis not to be taken too seriously) Page number of accord has increased by a factor of almost 8 (1988 vs. 2004).Where will we end up with future revisions? Kurt Hess, WMS kurthess@waikato.ac.nz

  12. Page Analysis Basel Accords (Analysis not to be taken too seriously) Kurt Hess, WMS kurthess@waikato.ac.nz

  13. Market DisciplineConceptual Framework Market discipline acts in two distinctive components: • Recognition / monitoring phase • Control / influencing phase The following simplified conceptual framework is inspired by Bliss & Flannery(2000), Flannery&Nikolova(2003), Hamalainen et al. (2005) Kurt Hess, WMS kurthess@waikato.ac.nz

  14. Market DisciplineConceptual Framework Kurt Hess, WMS kurthess@waikato.ac.nz

  15. Market DisciplineConceptual Framework Kurt Hess, WMS kurthess@waikato.ac.nz

  16. Overview NZ NBFI Sector • Identified approximately 400+ firms in this sector • Mostly smaller, privately held money lenders. • Public financial data available for a universe of about 100 firms who have issued securities and are thus subject to disclosure requirement of NZ securities regulations Kurt Hess, WMS kurthess@waikato.ac.nz

  17. Overview NZ NBFI Sector • Traditional view to distinguish between finance companies (general companies’ legislation) and special statutes companies (Building Societies, Credit Unions, Cooperatives) • … but distinction has become blurred. • SBS, PSIS provide near full banking services • Finance companies entering mortgage lending Kurt Hess, WMS kurthess@waikato.ac.nz

  18. Overview NZ NBFI Sector • While NZ registered banks are subject to strict a disclosure regime, comparably lenient rules for NBFI sector (Securities Act/Regulation 1978/1983) • Unique feature of the New Zealand regulatory regime: every company may offer (near) full banking services. • Can however not use “Bank” in name (but of course in advertising …) SBS ... Banking Like It Should Be ... Kurt Hess, WMS kurthess@waikato.ac.nz

  19. Overview NZ NBFI Sector Example advertising of some NBFIs Kurt Hess, WMS kurthess@waikato.ac.nz

  20. Overview NZ NBFI Sector • Regulatory review of sector is in progress both by • NZ government: review of general regulation / laws applicable to NBFIs • NZ Securities Commission: review of disclosure standards in sector Kurt Hess, WMS kurthess@waikato.ac.nz

  21. Overview NZ NBFI Sector New Zealand NBFIs by Asset Size (issued June 2004) Source: Data for end 2004 financial year from NBFI prospectuses Kurt Hess, WMS kurthess@waikato.ac.nz

  22. NBFI Sample Details • Narrowed sample down to 62 NBFIs issuing term deposit type products on an ongoing basis (excludes Credit Unions) Lending Categories of New Zealand NBFI Sample Kurt Hess, WMS kurthess@waikato.ac.nz

  23. Research Questions • Do investors exercise market discipline on NBFIs by asking for higher returns (wider spreads) for more risky NBFIs? • Expected effect under risk / return paradigm in finance • How does the disclosure quality impact above relationship? • Expect good disclosure to be rewarded with tighter spreads (controlling for risk) Kurt Hess, WMS kurthess@waikato.ac.nz

  24. Research Questions (cont’d) • How does disclosure quality affect risk choice of NBFI? • Expect NBFIs with good disclosure shift from price competition & high risk to competition on quality & lower risk profile(as predicted by Cordella & Yeyati, 1998 competition model) Kurt Hess, WMS kurthess@waikato.ac.nz

  25. Data & Methodology OLS analysis on cross-sectional data using the following proxies: • Interest spread compared to 3 year deposits with NZ banks. • Credit risk: SQP score, asset size, risk due to growth measure • Disclosure: developed disclosure quality index Kurt Hess, WMS kurthess@waikato.ac.nz

  26. Data & Methodology Credit Risk Proxies • No widespread, official credit ratings in NZ NBFI sector • Exception a few NBFIs rated by S&P (2) and Australian based Rapid Ratings (6) • SQP Relative financial strength ranking measure developed by JDJL Ltd published in its website www.interest.co.nz Kurt Hess, WMS kurthess@waikato.ac.nz

  27. Data & Methodology Credit Risk Proxies (continued) • SQP means • S – Balance Sheet Strength • Q – Asset Quality • P – Profitability • Strongest quartile on each criteria gets A through to D for weakest quartile. • JDJL Ltd does not disclose details as to which ratios / weightings are used. Kurt Hess, WMS kurthess@waikato.ac.nz

  28. Data & Methodology Credit Risk Proxies (continued) Two additional credit risk proxies: • Asset size to reflect capacity of NBFI to diversify credit risk • Divergence of growth from average in industry (squared difference to growth of NZ banks) • i.e. more risk for slow/negative growth and rapid expansion Kurt Hess, WMS kurthess@waikato.ac.nz

  29. Data & Methodology Disclosure Quality Index • Assesses quality of risk disclosure in NBFI’s prospectus along a total of 24 criteria, including …. • Qualitative components for depth of information in verbal text. • Quantitative amount of information, mainly as part of financial statements Kurt Hess, WMS kurthess@waikato.ac.nz

  30. Results Effect of Credit Risk on Spreads • Significant effect of all risk proxies on spread offered (sole factor regression) • Most dominant effect is • asset size (p-value 0.02%), … • SQP (p-value 0.29%) and .. • GowthDiff^2 (p-value 5.44%) • If combined, only asset size remains significant (p-value 1.07%) Kurt Hess, WMS kurthess@waikato.ac.nz

  31. Results Effect of Disclosure Quality on Spreads • No significance of disclosure quality as measured through prospectus based-based disclosure quality index, neither • As a sole regressor, nor .. • After controling for risk (joint regression with risk proxies) Kurt Hess, WMS kurthess@waikato.ac.nz

  32. Results Risk Choice of NBFI Given Disclosure • Positive SQP score coefficient (p-value 3.52% , i.e. companies with good disclosure are less risky (as predicted by Cordella & Yeyati,1998) • Similarly, lower disclosure quality for extreme growth companies (p-value 0.28%) Kurt Hess, WMS kurthess@waikato.ac.nz

  33. Results Risk Choice of NBFI Given Disclosure (2) • Not significant correlation asset size / disclosure (surprise?) though positive sign for coefficient (as predicted) Kurt Hess, WMS kurthess@waikato.ac.nz

  34. Interpretation / Conclusions Effect of Credit Risk on Spreads • Risk sensitivity of spreads as expected but are they adequate? • Further research required but default data in NZ NBFI sector (still) lacking. Kurt Hess, WMS kurthess@waikato.ac.nz

  35. Interpretation / Conclusions Effect of Disclosure Quality on Spreads • Lacking significance of disclosure quality most important result of this study. Potential interpretations of result: • Inadequate measurement of prospectus based disclosure quality (too narrow) Kurt Hess, WMS kurthess@waikato.ac.nz

  36. Interpretation / Conclusions Effect of Disclosure Quality on Spreads Potential interpretations of result (continued): • Information in prospectus & investment statement is not primary driver of trust into NBFI. Other factors? (brand recognition, history etc.) Kurt Hess, WMS kurthess@waikato.ac.nz

  37. Interpretation / Conclusions Effect of Disclosure Quality on Spreads Potential interpretations of result (continued): • NBFIs are inherently opaque and any level of disclosure will not change this. Accordingly investors will not reward good disclosure (in line with Morgan 2002).Policy implications: revise discl. rules? Kurt Hess, WMS kurthess@waikato.ac.nz

  38. Interpretation / Conclusions Potential Expansion of This Research • Use panel data and develop proprietary risk proxies based on information collected so far. • Improve understanding of spread dynamics (collect history) • Develop & evaluate methods of measuring disclosure quality (paper in progress) Kurt Hess, WMS kurthess@waikato.ac.nz

  39. Interpretation / Conclusions Outlook • Very topical area of research given great dynamics in NZ NBFI sector with strong growth over past 2-3 years • In a slowing economy, true credit risks of NBFIs might soon become apparent. • This will increase pressures on policy maker to speed up current review of regulatory/supervisory regime. Kurt Hess, WMS kurthess@waikato.ac.nz