Ethnic variations in firm financing

This note uses linked administrative data to investigate the extent to which the financial conditions faced by firms – measured through the implied interest rate from annual tax filings – vary with the ethnic composition of the firm’s owners and shareholders. Access to capital has been highlighted as a barrier and constraint for MÄ ori firms (New Zealand Productivity Commission 2021, and the references within), owing to a combination of legislative challenges specific to MÄ ori land-based businesses, systemic bias in the financial system, low financial literacy rates and existing disparities in income, home-ownership and business experience. This research is part of a wider work programme at the Reserve Bank investigating the financial system landscape faced by MÄ ori entities. This note builds on previous work looking at specific dimensions of our analysis, specifically the work of Te Puni KÅ kiri and Nicholson Consulting (2020) for defining MÄ ori firms and Fabling (2021) for building firm balance-sheet measures using administrative tax data. This work brings together MÄ ori firms, the firm balance-sheet measures and the characteristics of the owners and shareholders to investigate the financial conditions faced by MÄ ori firms, and how these compare to New Zealand firms more generally. While the note measures variations in firm financing for each of the major ethnic groups in New Zealand, the presentation of the results throughout the rest of the note focuses on MÄ ori firms given the observed disparities in outcomes. The key insights from this note are as follows. First, MÄ ori firms are, on average, paying higher implied interest rates on debt compared to non-MÄ ori firms. This stage of the analysis does not adjust for the characteristics of firms or their owners, but this finding for the average interest rates is robust to a range of definitions for a MÄ ori firm, and for each of the broad industry groups considered in this analysis. Second, after adjusting for the available characteristics of firms and their owners, this analysis finds no statistically significant difference in the implied interest rates paid by MÄ ori and non-MÄ ori firms. The analysis is complicated by the fact that around half of owners who identify as MÄ ori also identify as European. To put this another way, our analysis does not find evidence that systemic ethnic bias plays a role in determining the interest rates paid by firms. It shows that the difference in interest rates paid by MÄ ori and non-MÄ ori firms can be explained by the characteristics of the firms receiving the loans. However, it addresses only one dimension of firms’ access to finance. Bias may be present across other dimensions. Data limitations prevent us from exploring whether there is systemic bias at the loan application stage, for example. Finally, this analysis highlights a number of data gaps, particularly the lack of loan level application data for firms. A more comprehensive investigation of ethnic variation in firm financing would need to address these data gaps. Key findings of Analytical Note: - This note uses annual tax filings from firms – consisting of companies, working proprietors and sole traders – to calculate an implied interest rate on debt. These firm data can be linked to the owners and shareholders to investigate the effect of ethnicity on firm financing. - MÄ ori firms, defined using the ethnicity of the owners, are paying higher implied interest rates on average than non-MÄ ori firms, by about 50 basis points. - This analysis does not find evidence of systemic ethnic bias in the financial sector contributing to the interest rates paid by firms. It shows that the difference in interest rates paid by MÄ ori and non-MÄ ori firms can be explained by the characteristics of the firms receiving the loans. However, it addresses only one dimension of firms’ access to finance. Bias may be present across other dimensions. Further research is required to determine why MÄ ori firms tend to have firm characteristics that raise financing costs - the role of home ownership and socioeconomic disparities would be interesting areas of future research. - This analysis highlights a number of data gaps, particularly the lack of data linked to loan applications. A more comprehensive investigation of ethnic variation in firm financing would need to address these data gaps.