Christian Hawkesby: So good afternoon. Welcome. Thank you for joining us. Thank you for joining us for this Financial Stability Report briefing. My name's Christian Hawkesby. I'm the Deputy Governor here and I'm joined on the stage in no particular order. Governor Adrian Orr at the far end. Kate Le Quesne, Director of Prudential Policy at the near end. And Charles Lilly, Acting Manager of Financial Stability Assessment and Strategy, I will call it. But overall guru is the more general job title. I just also want to acknowledge Kerry Watt, who's the Director of Financial Stability Assessment and Strategy, and there's a number of his team here who have been key contributors to the report as well. Also acknowledge our friends from Scots College who are here today as winners of New Zealand's Monetary Policy Challenge. So it's great to have you here today. Round of applause.
Keep the questions easy for us. Don't go too hard on us here in the press conference. We are here to talk about this, the Financial Stability Report. And it is packed with data, information, insights, boxes, special topics, a number of which have already been released ahead of the publication today. But I just wanted to briefly touch on a few high points before we open it up to questions. The first being that our assessment is that New Zealand's financial system is well-placed to manage the adjustment to higher interest rates that we are seeing. The full impact of previous increases in interest rates globally is yet to be fully felt, but what we are already seeing is a slowing in global demand, particularly out of China and that already affecting our commodity prices here in New Zealand. And we are also watching developments very closely in the Middle East from a financial stability perspective.
Here in Aotearoa, New Zealand households are adjusting to higher mortgage costs. So far the vast majority of households have been able to manage this adjustment, but we would acknowledge that some people are struggling and falling behind. For businesses, they continue to service their debt, although there are a few challenges, particularly in the dairy sector and the commercial property sector as well, partly due to high debt servicing and costs, but also a few other factors that we can talk about more on the panel. Overall, our view is that the New Zealand financial system is very well positioned not only to navigate this adjustment higher in interest rates, but also whether any other potential more severe economic scenarios that may play out and we can talk a bit more about our stress testing programme that talks to that.
Finally, and importantly what all of this means is that New Zealand financial institutions are well positioned to continue taking a long-term perspective and supporting their customers both households and businesses, through not only the current challenges that the system's facing at the moment, but also potential future challenges as well. Before I open it up to the panel for questions, I just wanted to do a couple of pieces of housekeeping. One is just to acknowledge that we are in an unusual environment constitutionally at the moment. A new government is yet to be formed, so we're not in a position to be talking about government policy or new government policy or any hypotheticals around that.
Here at Te Pūtea Matua, our mandate for protecting and promoting financial stability is very clear and the best thing we can do is just keep focused on that. Also, just a little reminder that the governor and a number of other colleagues will be here in just a few weeks' time to talk about the Monetary Policy Statement, which is our final set piece for the year, and you'll have plenty of opportunities to ask about all things official cash rate at that time. So without any further ado, I will open it up and if you could just direct your questions to me, then I can share that out as appropriate to the panel.
Thank you.
Media questions
Media: Hi there, Leighton Heikell from Newshub TV3. The unemployment rate has risen to 3.9%. Is that a good thing for the inflation battle?
Christian Hawkesby: So yes, the labour market number was out this morning. As I said earlier, we'll be talking at length about the labour market in just a few weeks' time. Here what we're talking about in terms of financial stability is whether the financial system can cope with the adjustment that's going on in the economy at the moment, which is a better balancing between supply and demand. And what our document's showing is that we're well positioned to do that. Not only the rise in unemployment that we're expecting to see as a central case, but also more severe scenarios that might be out there too.
Media: Hi, my name's Callie. I'm from 1News. Are there any sectors you expect to see hit hardest when it comes to job losses?
Christian Hawkesby: Well, the report does call out the dairy sector and the commercial property sector is those that have a few challenges in front of them. There's a host of different reasons there, partly in both cases with higher debt servicing costs. Also in the dairy sector, they're facing higher costs of their businesses and lower commodity prices for their goods as well. We do think the dairy sector's got itself in a better position having paid down a lot of debt through the period of the cycle and that should strengthen their ability to work through those harder times. We also call out the commercial property sector, which is a very diverse sector, but one where there are some differences across the different parts of that industry.
Media: Hi, Brent Edwards here from National Business Review. Just more on unemployment because you note in the report that a significant rise in unemployment could cause problems. So at what level of unemployment would you start to get worried that that was putting pressure, real pressure on households which would then flow through to financial stability?
Christian Hawkesby: Yeah. So last year we published a macroeconomic stress test and I might ask Charles in a moment to talk a bit more about our stress testing programme more generally. That was a test last year that had unemployment going up around the order of 9% as well as other things, lower asset prices, weaker economy more generally, and that was one that our assessment was that the financial system could weather that type of stress. It won't be comfortable, it's one that the financial system will be able to weather, but it won't be comfortable for all households and businesses and we acknowledge that everyone has a different situation. Charles, do you want to talk a bit about our stress testing more generally?
Charles Lilly: Yeah, sure. So in the report you'll see that they've got some projections of what the banks are expecting to see over the next year. So we went out and asked the banks what they think will happen with non-performing loans and what potential stresses will come through to households and businesses. So that's more of a central case, so what will happen based on the forecast that we see in the Monetary Policy Statement for example. In terms of the stress testing programme, we do look at much more severe scenarios than that. So for example, the Monetary Policy Statement in August had unemployment rising to just over 5%. We typically test, as Christian says, to rates of around 9% to 10% in those stress tests. And those are quite severe scenarios, but even then the banks do come through them without breaching their minimum capital requirements. So the stress testing programme is quite important and we continually test and assess the resilience of the banking system.
Media: Hi, Dan Brunskill from Interest. Can I just get you to elaborate on that point? Are you saying that unemployment rate up to 9%, financial stability is okay up until an unemployment rate of say 9%? Is that what you're saying there?
Christian Hawkesby: Yeah. I can take this one. In terms of our stress testing programme involves a number of different scenarios and it's very much a package of different things that we look at. From a solvency point of view, we think the financial system can cope with that type of stress. We look at stress tests that involve both macroeconomic challenges but challenges around climate, challenges around the environment. So that's really what underpins the amount of capital that we look to the financial system to hold, to weather those different shocks and the different variety that they could be.
We publish a lot of information which is often partial in terms of looking at different aspects of those challenges the financial system may face. The message from us in this report is that the financial system we think is well positioned to navigate those different scenarios and that's really important because it means that financial institutions can stick with their customers and continue to take that long term perspective. We're already seeing that in terms of our Credit Conditions report that was published recently, which showed that credit growth has slowed, but that's largely been around demand for all credit as opposed to the availability of credit.
Media: I also have an interest rates question, but from a financial stability perspective. How much room is there, I guess, for the economy to absorb higher interest rates? How much stress basically would that put on the financial system? Much room, how much higher can interest rates go, if needed, if inflation was more sticky before it starts to pose a financial stability risk? Do you have a view on that?
Christian Hawkesby: Charles, do you want to talk about the interest rate assumptions we make in the stress test? And then I might just answer the question more generally too.
Charles Lilly: Yeah, so the stress test that we did last year and repeated again this year for the banks was a stagflation scenario, so that is one of increasing interest rates and high inflation and rising unemployment. So those are quite severe scenarios that we test and even then the banks were able to come through those, not that it wouldn't be a very difficult scenario to go through.
Christian Hawkesby: And also just to be clear, another message that comes through in the report is that the biggest risk the financial system at the moment is that if central banks globally don't get on top of inflation. So the fact that interest rates have been lifted so far as they have, that's good news to the extent that it helps keep inflation down back onto central bank's targets and negates the need to push interest rates even higher in the future to really have another go at it. So that's a really important message that comes out.
Media: And just one quick final one, you note you were looking for the potential impacts of the Israel-Hamas conflict, watching for those impacts. What are those potential impacts?
Christian Hawkesby: Well, as always, there's always global risks, global developments out there and the framework we tend to think about is the trade channels, the financial channels, and then the general confidence channels. So in the case of this conflict in the Middle East at the moment, the trade channels are reasonably small, the confidence effects have been modest so far. What we are really looking at is if there's an escalation in that conflict and it creates challenges, particularly in global oil markets. That's going to have knock-on effects and if that creates a downdraft and financial markets and confidence more generally, that's what we're on the watch for.
Media: Thank you.
Media: Jenée Tibshraeny from the Herald. Just wondering if you could provide a comment on the extent to which banks have been lifting mortgage rates. They've been pointing to wholesale rates rising and swap rates and so on, but I'd also note that their net interest margin is at 2.38%, which is very high. So what do you make of the sorts of increases that we're seeing at the moment?
Christian Hawkesby: So mortgage interest rates in New Zealand are keyed off a number of variables, and even though the official cash rate has risen and stayed stable for a little while now, wholesale market rates have risen. So some of those factors that are influencing the cost of finances going up. Deposit rates are starting to rise now as well as banks are competing more for deposits. People are shifting out of call accounts into more term deposits. So there are some of the factors around the high mortgage rates that we've seen. We do notice and note in the report that interest rate margins are a bit wider than historic averages. That tends to be the case when interest rates are rising just cyclically that they tend to lead. What we point out in the report is that we think that those interest rate margins and profitability more generally are likely to come down in the period ahead as banks have to compete more for those deposits and some of these non-performing loans and provisions start coming through as we move into this more challenging period.
Media: I guess the question that we're often asked or I'm often asked is are those hikes justified? And because clearly the trends are moving in such a way that it makes sense for banks to be lifting these mortgage rates. But is the extent to which they're lifting them justified and how do we know that? Are you measuring that? How can we tell?
Christian Hawkesby: Yeah. We are not looking to give a running commentary and approval of every move in market interest rates. What we're pointing out in the report are some of these big key drivers and where they're likely to head in the future given those drivers, which are economic forces that will play out.
Media: Wages continue to increase, especially in the public sector. Are you worried about the impact that this might have on inflation?
Christian Hawkesby: We'll come back to that in a couple of weeks with the Monetary Policy Statement.
Media: How much is migration holding up the economy do you think at the moment?
Christian Hawkesby: We call out migration in the report in regards to its impact on the housing market and house prices. We note that house prices have stabilised more recently and risen slightly in recent months. We think there've been a couple of offsetting factors there. Increase in net migration being a positive one and offsetting that has been the lift in interest rates and the test rates that people need before they borrow to buy housing.
Media: Jenée again from the Herald. Does the Reserve Bank take some responsibility for the stress that pockets of mortgage holders are in at the moment, particularly recent first home buyers? Just given some of the decisions that have been made recently on the monetary policy side and also the financial stability side pumped up house prices and now interest rates are very high.
Christian Hawkesby: We absolutely acknowledge that some people are struggling. It is a tough environment. Some people have bought assets at high levels and entered markets with low interest rates and we're in a different environment now. So we do acknowledge that, that everyone's situation is different. We do feel that through the whole period we have been focused on achieving our inflation target, which is what we'll talk about in a couple of weeks, and supporting financial stability and doing that through taking a long-term perspective, as I talked about earlier. We think that the best thing that we can do right now is to keep inflation tracking back to its targets so that interest rates don't have to go higher and they don't have to create these types of financial stability challenges that may be out there.
Media: And just on debt to income ratio restrictions, can you provide any more commentary around when they might be implemented or if they'll be implemented next year after April?
Christian Hawkesby: Yeah, so I'll turn to Kate in a moment to talk about our DTI restrictions and that's part of our overall package and thinking around macroprudential tools, both loan to value restrictions and potentially DTIs.
Kate Le Quesne: Yeah, so with the DTIs, we published the framework earlier in the year and asked banks to be ready within one year to be ready to implement those. In the meantime, we've been doing a range of work internally readying for implementation and understanding that tool better. In particular, how the DTI tool works as complimentary to the LVR tool. One addresses probability of defaults and one loss given default, so some different dimensions of risk in that macroprudential sense. So we've been working internally on that. Ready to come out with public consultation on implementation and settings in the first quarter of next year.
Media: Sorry, just to be clear, the consultation will come out in the first quarter or will you look to implement? I guess it'll be after April. So...
Kate Le Quesne: Yeah, so first we need banks to be operationally ready and I think it was March 2024 is the readiness date. They needed times to get their systems ready basically. And then the consultation from us will come out in the first quarter of 2024.
Media: Hi. Just on following on that a bit, but on house prices. The level of a household debt actually, which has been driven a lot by the rapid rise we saw in house prices over the few years before and during COVID. Looking ahead, how worried would you be about a resurgence in house prices in terms of the impact it could then have later on financial stability?
Christian Hawkesby: Well, our assessment at the moment is that house prices are in that range of a sustainable level and that sustainable doesn't mean affordable sustainables around the economic fundamentals and core drivers of house prices. So it's been a good news story from our perspective over the last 18 months or two years as house prices have gone from very elevated levels to levels that are more sustainable and that's what was one of the motivators around easing some of our loan to value restrictions earlier in the year. And if that gap was to widen back out again, that would be something that would take our interest and be something that would prompt some actions from our part.
Media: Dan from Interest again. I've got a question on that. Is our sustainable house prices rising? Obviously house prices have come down making them more sustainable, but it seems like building costs and things have gone up. It seems to me that the sustainable house price must actually be going up. Is that something the bank tracks and is that correct?
Christian Hawkesby: So I'll turn to Charles in a second to talk about the different ways that we come at sustainable house prices, but at a high level you are right that the economic fundamentals are changing all of the time and therefore our assessment of sustainable house prices is changing as well.
Charles Lilly: Yeah, so some of the metrics that we look at are the cost of buying versus the cost of renting. We look at investment, so is investment in housing, how does that stack up against other assets? And then we also look at how affordable is it to service a mortgage compared to how it's been in the past. And so those are mainly financial variables and we look also at household incomes. So those do typically grow over time. They have grown quite strongly with inflation over the past few years as well. And so with higher household income, you do get a more sustainable level of house prices over time.
Media: Just back on DTIs, what conditions would you be expecting to see for those to be implemented?
Christian Hawkesby: Yeah. Do you want to take that, Kate?
Kate Le Quesne: Yeah. I mean, I guess generally our macroprudential tools are designed to reduce the risk that certain pockets of the financial sector amplify that boom bust cycle. So there the types of things would be considering around implementation. Does that systemic risk exist generally in the residential lending sector? We have the LVR tool, the DTI tool. We consider the different aspects of risk that they each address and then bring that together to consider how we'd implement those two tools together.
Media: Okay. So should people basically expect that there will be DTIs in place by mid next year?
Christian Hawkesby: It's not a decision that we've made. It's something that we're getting operationally ready to do in terms of having that in our toolkit, but also having the banks ready if they were to be deployed. Yeah.
Media: It's been suggested to me that the DTIs could affect first home buyers the most because they tend to be earlier in their careers and have a reasonable expectation of rising incomes. Would you agree with that?
Christian Hawkesby: Considerations for first time buyers is one of the things in our Financial Policy Remit. I'm going to call on Kate again. You're in high demand today on debt-to-income restrictions. Kate?
Kate Le Quesne: Yeah, sure. When we were considering borrower-based measures more generally, we did take into consideration in particular the impact on first home buyers. And when we chose the DTI framework as the tool to go with, it was in particular in consideration that that was less negatively impactful of those first home buyers relative to something like test rate floors. So that was the high-level consideration. Within the implementation, certainly we'd need to consider the range of impacts on the different types of cohorts that will be impacted by DTI and that's something that we'll definitely explore in the implementation space.
Media: One last question since you're here. You put out a special chapter about the dairy industry. Obviously, these things are always couched in fairly gentle language, but it seems like you're legitimately quite worried and the outlook for the dairy sector doesn't look great. And then I know you don't want to talk about government policy, but at some point, agricultural pricing emissions are going to come in as well. Could you just talk a little bit more about how worried you are about insolvency in the dairy sector and whether you think that's one of the biggest risks to New Zealand? Not just for the banking sector, but also thinking about our trade imbalance and export income and various challenges. Can you just elaborate on that a little bit more? How worried are you?
Christian Hawkesby: Well, it's enough of a focus for us to give it that prominence of in the report with its own chapter and to pre-release that information and do a lot of work around that. There are a number of factors at play as the report sets out in terms of what's happened to the costs for farming, the fall in dairy prices, and the challenges that that creates into the future. What's really important to us is to be able to call these things out early because the earlier you call these things out, the more it gives the sector a chance to adjust itself. We've been here before probably, what was it, 2015 or so? A very similar situation, very similar types of challenges.
And in the face of that, the dairy industry really took the message and worked down their debt level so that they could get in a better position for the next time around. We think we're seeing some of the benefits of that now with debt in the dairy sector much lower than that last time around. But the longer that the challenges are faced, the harder it will become too. So, there are many moving parts. We identify some of them in the report. There are other things that can happen as well if global production starts falling because of lower dairy prices now. That might be a catalyst to higher dairy prices with less supply around down the track. Adrian?
Adrian Orr: I'd just like to add, and really, it's a theme across the questions today. This document is really critical for raising awareness of potential risks and for investors, consumers, economic agents to have their eyes wide open. We had a question earlier about house prices. We've spoken a long time about the risk of high leveraged loan house prices. Likewise, we are talking about the risks of capital-intensive industries which operate on low margins based on global commodity price swings. It's always going to be at risk industries. And so go into these businesses suitably capitalised and with strong relationships with your lending institutions. That's critical to it. So, it's a raising awareness issue is the key to these documents, not forecasting the future. Almost everything we've talked about today are scenario stress testing analysis, severe but plausible. And so, it's about creating that awareness and having people think before they spend and invest. So that's the main challenge for us.
And probably my last bit is even DTIs, LVRs, et cetera, they can be in place, but they don't have to be binding initially. And I think people need to remind that the LVRs are in place, but they're not the constraining factor for people wanting to borrow into houses at the moment. It's more the interest rates. The LVRs aren't binding. The debt-to-income ratios can be put in place as well, but it doesn't mean they will be binding initially. But the fact they're in place is that when they do become binding, it means for the right reason. It means slowing excesses in the economy.
Media: Thanks. I appreciate we're in a state of flux in between governments here, but what impact, if any, would removing the employment target from the monetary policy side of things? What impact, if any, would that have?
Christian Hawkesby: We're not going to do hypotheticals on government policy. Yeah.
Adrian Orr: I think a really useful document is our recent review that is public. We had to do our five-year review of the Monetary Policy Remit and targets, and we stand by that review. So that's available for all to see.
Christian Hawkesby: Any more questions? Excellent. None from Scots College. Yeah.
Media: I'm from Scots College. My question's about global conflict. You've talked a lot about the Israel-Hamas conflict. Are similar considerations being given to conflict in Russia and Ukraine? Or is that being deemed less of a risk on financial stability?
Christian Hawkesby: Yeah, that's a great question and it's been a big focus for us here at the bank. The conflict between the Ukraine and Russia has had an even bigger effect on the global economy and affected both our monetary policy mandate and our financial stability mandate. It's been a big driver around why we've had persistent inflation pressure because of the impact of having a large food producer and a large energy producer at war with each other and how that's restricted supply globally and disrupted supply chain. So that's been a really big factor.
The more some of those imbalances and impacts start to moderate and normalise, that will help us on many fronts across our mandates. So yeah, great question. Best question left for last. So well done. Thank you very much. Thanks to the panel. Thanks to you all for joining us both here and online. Do read, do absorb the material here. We look forward to seeing you next time and you'll see the governor and a few others ahead of that in a couple of weeks. So, cheers.