Financial Stability Report for May 2016

The New Zealand financial system remains resilient and continues to perform its functions effectively. Bank capital and liquidity buffers are strong relative to current regulatory minimums. Despite a modest increase in loan loss provisioning in recent quarters, bank profitability remains close to post-crisis highs. However, risks to the financial stability outlook have increased in the past six months.

The outlook for the global economy has deteriorated, causing an increase in financial market volatility earlier this year. Economic growth is slowing in a number of key trading partner economies and inflation is weak. Interest rates remain extraordinarily low as central banks maintain highly accommodative monetary policies, including in the US where the expected pace of policy tightening has slowed. The outlook for the Chinese economy remains particularly challenging given high levels of indebtedness and ongoing capital outflows. In Europe, low growth and inflation persist while legacy problem loans and negative interest rates weigh on bank profitability. Credit spreads have widened, placing upward pressure on the cost of funds for New Zealand banks.

Soft global growth and momentum in global commodity production have contributed to weak prices for New Zealand’s commodity exports. Dairy prices remain low with global dairy supply continuing to increase. Many farmers now face a third season of negative cash flow with heavy demand for working capital. Problem loan levels are expected to increase significantly over the coming year, although losses in the banking sector are likely to be absorbed mainly with profits.

Imbalances in the housing market continue to increase, contributing to financial stability risk. The Reserve Bank’s restrictions on loan-to-value ratios (LVRs) have reduced the share of risky lending on bank balance sheets. Along with government tax measures introduced in October, the recent investor LVR restrictions led to a cooling in the Auckland housing market in late 2015 and early 2016. However, Auckland prices remain stretched relative to incomes and recent data suggest that price pressures are re-emerging. House prices have also begun increasing strongly in a number of regions across New Zealand, although house price-to-income ratios are generally much lower than in Auckland.

The Reserve Bank is closely monitoring developments to assess whether further financial policy measures would be appropriate. Reducing the imbalance between housing demand and supply in the Auckland region remains essential if house price appreciation is to be contained over the longer term. Increasing housing supply is key and further efforts on a range of fronts should be considered to address the supply and demand imbalance. These include measures such as decreasing impediments to densification and greenfield development, and addressing infrastructure and other constraints to increased housing supply.

The Reserve Bank continues to make progress on key regulatory initiatives. Consultation papers on proposed changes to the outsourcing policy for banks and on changes to bank disclosure requirements will soon be released. A consultation paper has recently been released on crisis management powers for financial market infrastructures. The Reserve Bank, along with other government agencies, is preparing for the IMF’s Financial Sector Assessment Programme for New Zealand, which will take place later this year.

Graeme Wheeler
Governor