Reserve Bank focuses on maintaining sound financial system

Release date
13 November 2013

New Zealand's financial system remains sound, Reserve Bank Governor Graeme Wheeler said today, when releasing the Bank's November 2013 Financial Stability Report. "Banks are well capitalised and have strengthened their funding base, while non-performing loans continue to decline.

"Nevertheless, there are risks to the financial system and the Reserve Bank has taken steps to address these," Mr Wheeler said.

"The main threat to the financial system is the risk associated with imbalances in the housing market The previously announced loan-to-value ratio (LVR) measures, starting from 1 October, are intended to reduce systemic risk by slowing housing credit and house price inflation, and by reducing risk on bank balance sheets.

"The household sector has high and rising levels of debt relative to both historical and international norms. Both households and banks are highly exposed to the housing market. Further, we have a situation where house prices are rising from already-overvalued levels, particularly in Auckland and Christchurch. This is increasing the risk of a future house price correction that could result in significant financial system stress.

Mr Wheeler said that several factors are contributing to the strength in house prices, including supply side constraints, a pick-up in net inward migration, relatively low interest rates, and relaxed credit conditions. "Dealing with the supply side issues is of primary importance. However, it is also important to avoid a prolonged build-up of excess demand while the supply issues are being addressed."

Mr Wheeler said that the Bank is closely watching the impact of the LVR policy. "The early evidence shows that banks have significantly reduced high LVR lending approvals, while increasing the cost of high LVR loans. However, it is too early to assess the impact of the measures on house price inflation."

Deputy Governor Grant Spencer said that other risks to financial stability were high levels of debt in the dairy sector, and New Zealand's high level of external indebtedness overall.

"While the dairy sector is currently enjoying record export prices, its high level of indebtedness makes it vulnerable to a fall in commodity prices or an increase in interest rates. A continuation of farmers' cautious approach of recent years will help to mitigate this risk," Mr Spencer said.

"New Zealand's high external debt levels reflect persistent balance of payments deficits over many years. While the post-GFC improvement in private savings has reduced the external deficit in recent years, this trend is likely to reverse as new investment expands. It is therefore important that the private savings improvement be maintained, and that the public sector deficit continues to reduce.

"New Zealand's external debt is mainly intermediated through the banking system, which is exposed to the volatility of world markets. Strong growth in retail deposits has allowed banks to reduce their reliance on offshore funding in recent years. Any sustained worsening of New Zealand's external position will cause the banks to become more reliant on the international markets, thereby increasing their exposure to funding risk. "

Mr Spencer said that over the last six months the Reserve Bank has continued to enhance the prudential framework so as to further strengthen the financial system.

The Bank's review of non-bank deposit takers was completed in September 2013 and several enhancements have been proposed. A review of the oversight regime for payment and settlement systems is in progress with the expectation that this regime will be strengthened. The licensing of insurance companies was completed on 9 September 2013. This has been a major effort by the industry with 99 companies now under licence.

Media Contact:
Mike Hannah, Head of Communications
Ph 04 471 3671, 021 497 418, mike.hannah@rbnz.govt.nz