Risks to the financial system remain elevated and are largely unchanged in the past six months. Now is the time to improve financial system resilience and efficiency by increasing capital levels and addressing conduct challenges.
Some New Zealand households and dairy farms would face financial problems if their incomes fell or costs rose because they have high debt levels. Banks would face large losses if households and dairy farms defaulted on their loans at the same time as house prices and farm prices were falling. The risk of this happening is small but it is possible.
The risk has not changed much in the past six months.
The Reserve Bank imposes loan-to-value ratio (LVR) restrictions on banks’ mortgage lending to improve the resilience of households and banks. The LVR restrictions are reviewed every six months.
Slower growth in household debt and house prices, alongside safer lending by banks, have allowed the LVR restrictions to be eased in the past two years. The current LVR restrictions remain appropriate for now, as household risks have not changed much in the past six months.
Problems that develop overseas can harm New Zealand’s financial system. The most concerning international risks relate to high asset prices and debt levels in many large countries, particularly China. High government debt and already low interest rates limit the ability of governments and central banks to further support economic growth. These risks have not changed much in the past six months.
Longer term, climate change presents significant challenges for some industries and regions. The financial system must understand and adapt to climate change risks.
The Reserve Bank has proposed to gradually raise bank capital requirements to make the banking system safer. This reflects evidence that the costs of bank failures are higher than previously understood. We are now carefully reviewing public feedback on the proposals and expect to announce decisions by the end of November.
Separately, some insurers and non-bank deposit takers have capital buffers that would absorb only relatively small losses. These institutions should raise capital to reduce their risk of failure.
It is important that the financial system has a long-term customer focus to maintain public confidence and support financial system efficiency. Banks and insurers must respond to the challenges identified in the recent reviews of conduct and culture.
The Reserve Bank and Financial Markets Authority are working with banks and life insurers to ensure they have adequate plans to address the specific issues identified.
The price of home and contents insurance for properties perceived to be at high risk from earthquake damage is increasing. We are working with industry to understand the impacts this will have on insurance provision more broadly. Owners of more vulnerable properties should be aware that insurance may become less affordable in the future, which may reduce the value of their homes.
Looking forward, as climate change risks become more acute, insurance for properties susceptible to rising sea levels and coastal inundation may become more expensive and difficult to obtain.