The biggest risks to New Zealand’s financial system have not changed materially in the past six months. The financial system is resilient, but the culture and conduct of financial firms must support public confidence.
Debt levels in the household sector are high, particularly for new homeowners and for property investors. These borrowers are vulnerable to rising interest rates or a change in financial circumstances. If borrowers default on their loans, it could cause significant loan losses for the banking system.
Over the past year credit growth has declined and house price inflation has stabilised. Continued slow growth would reduce the chance of large house price falls. Bank lending standards have tightened, with banks reducing the amount they are willing to lend relative to incomes and reducing the availability of interest-only lending.
Loan-to-value ratio (LVR) restrictions control the share of mortgage loans that banks can grant to customers with low deposits. Only 15 percent of new loans to owner-occupiers can have deposits of less than 20 percent. And, only 5 percent of loans to property investors can have deposits of less than 35 percent. The LVR rules reduce the likelihood that a significant share of borrowers would become financially stressed if house prices fell.
With some households still financially vulnerable, the Reserve Bank is keeping the policy unchanged for now. The rules will be eased in the future if housing market risks decline and banks maintain prudent mortgage lending standards.
The dairy farming sector remains highly indebted, and vulnerable to a future downturn in dairy prices. Dairy farms also face a number of longer-term challenges, including the impact of the response to environmental concerns.
Global dairy prices have been stable over the past year and most dairy farms are currently profitable. This has allowed some farms to pay back some of their debt. Farms should continue to carefully manage their borrowing and banks should continue to lend prudently. It will likely take time for the most indebted farms to manage down their debt.
The spread of the M. bovis disease is an emerging risk for the dairy sector. M. bovis has potential to negatively impact the productivity and profitability of the sector, and could lead to losses for banks.
New Zealand banks rely on funding from overseas so they can provide loans to New Zealand households and businesses. There is a risk that if global financial markets are disrupted, New Zealand banks could face higher funding costs. Those costs could then be passed on to New Zealand consumers and businesses in the form of higher interest rates on loans, or fewer loans being made available.
Banks have reduced their reliance on international funding markets over time by growing customer deposits and seeking funding at longer terms. But financial markets could become disrupted if global interest rates increase rapidly as central banks start tightening monetary policy.
Public trust in banks, insurers and other financial institutions is essential to maintain stability in the New Zealand financial system. The importance of firms’ culture has been illustrated by the series of ongoing inquiries into financial services conduct in Australia. The Reserve Bank, with other regulators, has asked the boards of New Zealand banks and chief executives of life insurers to show that there are no system-wide misconduct issues in the New Zealand banking and life insurance sectors.
The Reserve Bank promotes the financial stability of the banking system by imposing minimum standards, such as how much shareholder funding banks require and how much liquidity they should have in order to meet customer demands.
Financial stability is also enhanced by bank customers monitoring the strength of their bank. The Reserve Bank has just launched the Bank Financial Strength Dashboard to make it easier for customers to monitor banks. The innovative design is the first of its kind, and allows financial information to be compared across banks. The Dashboard will improve incentives for banks to act appropriately and make it easier for banks to benchmark themselves against each other.