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NZ financial system withstands test, says Reserve Bank

New Zealand's financial system has so far withstood a severe test of global financial markets, but it would be prudent to ensure there is adequate liquidity in case disruptions intensify, Reserve Bank Governor Alan Bollard said today, when releasing the Bank's May 2008 Financial Stability Report.

Dr Bollard said the system has come through a period when many overseas financial institutions, including some of the world's largest banks, have incurred substantial losses related to the US sub-prime mortgage market.

"The IMF has described recent events as the largest financial shock since the Great Depression. Adjustment could be protracted, and further volatility in world equity markets, exchange rates and debt markets looks likely," he said. The New Zealand economy looks set for a period of slower growth, already evident in the housing sector.

The New Zealand financial system has very little exposure to offshore credit risk or the structured debt products that have damaged the balance sheets of many overseas banks. "Bank balance sheets remain solid, with appropriate capital buffers," he commented.

However, Dr Bollard said New Zealand banks have been affected by the global tightening in liquidity and availability of funds. "Banks in both New Zealand and Australia source a significant amount of their funding from global financial markets. They are facing a higher cost of funds and reduced liquidity in some markets and this has flowed through to higher borrowing costs for businesses and households.

"For its part, the Reserve Bank is undertaking some further changes to its liquidity management arrangements, designed to help ensure adequate liquidity for New Zealand financial institutions in the event that global market disruptions were to intensify. These measures include expanding the range of acceptable securities for domestic market operations to include Residential Mortgage-Backed Securities."

The Reserve Bank is also reviewing its prudential liquidity policy for banks. "Part of the review is likely to be focused on ensuring banks diversify their funding sources and lengthen the maturity structure of their debt."

Dr Bollard noted that banks appear to be tightening the availability of credit. "A more cautious approach to lending by banks appears prudent. However, there is a risk that if credit conditions are tightened too much, the slow-down in the economy will be exacerbated, putting additional pressure on households and businesses," he said.

Dr Bollard said the ongoing contraction in the finance company sector is being driven by domestic rather than international events and is unlikely to have widespread effects on the financial system, with effects being relatively contained.

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