Financial Stability Report snapshots
New Zealand’s financial system risks have eased, but remain high.
Slower mortgage lending growth and house price inflation have reduced risk. We are able to ease our mortgage lending restrictions and monitor banks’ behaviour.
High debt and asset prices mean the global economy remains vulnerable to shocks
Low interest rates have helped global debt levels and asset prices to build up. A sudden rise in global interest rates or a sharp slowdown in economic growth could lead to a sudden disruption in financial markets. These risks have increased since the previous Report.
New Zealand is exposed to global risks through both trade and our banking system’s need for foreign funding. However, banks have reduced their reliance on foreign funding over the past decade, improving their resilience to global risks.
High debt levels mean New Zealand households remain vulnerable to financial risk
In New Zealand, debt levels in the household sector are high. This is particularly true for households that have recently bought houses, and for property investors. An economic downturn or significant increase in interest rates could put some borrowers under stress.
House prices are high relative to incomes. This increases the chance that house prices could fall significantly in the future. Falling house prices could reduce household consumption by reducing households’ wealth and borrowing capacity, and make it harder for households to sell their houses to pay off their debts.
However, recent slower mortgage lending growth has reduced financial risk somewhat
Household lending growth has slowed, and fewer mortgages are being provided at high multiples of income or on interest-only terms. This is helping to gradually improve the financial resilience of the household sector.
House price growth has also slowed, particularly in Auckland. We think house price growth will remain low for some time, particularly as some Government initiatives are likely to weaken demand and support supply. The longer that house prices grow slowly, the less likely it is that they will fall sharply in the future.
Enabling us to reduce banks’ LVR restrictions for mortgage lending
We introduced loan-to-value ratio (LVR) restrictions in 2013 in response to rising housing lending risk. The restrictions have reduced the number of borrowers who would be forced to sell their houses or significantly reduce spending if they ran into financial problems.
With housing lending risks falling, we can relax the LVR restrictions. From the start of next year, banks will be able to provide 20 percent of new owner-occupier loans to owner-occupier borrowers with less than 20 percent deposits. And they will be able to provide 5 percent of new investor loans to investor borrowers with less than 30 percent deposits. We will continue to monitor changes in housing lending risk, and will further ease LVR restrictions if risks continue to diminish over the next few years.
However, banks need to better manage their conduct risk and lend responsibly
Strong culture and good conduct are important ingredients for a sound and efficient financial system. Weak governance and risk management can undermine decision-making, threatening the efficient allocation of savings and investment, and increasing the vulnerability of the financial system.
The Reserve Bank and Financial Markets Authority recently reviewed the culture and conduct of New Zealand’s banking system. While the review did not find widespread conduct and culture issues, it found weaknesses in the governance and management of conduct risks. Banks must produce plans for addressing shortcomings by March 2019, and report on progress implementing the plans.
And, longer term, financial firms need to manage risks from climate change
New Zealand’s financial system is exposed to climate risks through the sectors it lends to and insures. Rising sea levels and more frequent extreme weather events could affect coastal property values and lead to higher insurance claims. And banks have large exposures to the agriculture industry, which could be affected by both the physical risks of climate change and transition risks as the economy moves towards lower carbon intensity.
Managing the consequences of climate change will require coordinated action from a range of parties. Banks and insurance companies will need to ensure longer-term climate risks are adequately reflected in their lending and underwriting standards. Banks will also have a role in providing finance for mitigating actions.