Banks need to think about broader economic imbalances
The Reserve Bank today released its Financial Stability Report, a twice-yearly report that assesses the health of the New Zealand financial system. The report covers developments in financial institutions, foreign exchange and debt markets, and payments systems. It also comments on recent financial policy developments.
The Reserve Bank Governor, Dr Alan Bollard, commented that New Zealand's financial system has continued to be stable. Financial markets are performing well and the banks continue to be well capitalised and strongly profitable.
"However, there are significant economic imbalances which present risks for the financial system. The ongoing housing boom and large savings deficit in the household sector are being funded by international borrowing via the domestic banking system."
"While global markets are currently very liquid, we should be mindful that this will not always be the case. And the longer imbalances run, the more likely we are to see a sharp correction".
"The banks are highly competitive, but while competition is to be encouraged, the low level of lending margins has contributed to ever increasing levels of household debt and upward pressure on house prices," said Dr Bollard.
Reserve Bank Deputy Governor, Grant Spencer, said that financial indicators suggest that banks are managing the risks associated with their individual portfolios adequately. "However, it is not clear that banks are taking appropriate account of the systemic risks associated with the rapid growth in their aggregate lending."
Dr Bollard said this financial stability risk raises the question of whether
a regulatory response is needed to better manage the risks to a sound and
efficient financial system.
"The increased focus on risk sensitivity in Basel II will introduce a better alignment of risk and regulatory capital – for instance, loans on higher loan-to-value ratios will command higher regulatory capital holdings. The Bank has also been considering whether the current framework should be modified in this direction ahead of the introduction of Basel II," said Dr Bollard.
Dr Bollard concluded by noting that the best contribution to continued financial stability would be a moderation and gradual adjustment in the housing market. The banks should be mindful of this and be careful not to exacerbate the risks inherent in already-stretched household balance sheets.
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