Financial system sound, but risks remain
New Zealand's financial system remains sound, and well placed to support the expansion in the economy, Reserve Bank Governor Graeme Wheeler said today when releasing the Bank's May Financial Stability Report.
However, Mr Wheeler warned several risks to the financial system require continued focus.
"Debt in the household sector remains high relative to income, and house prices are overvalued on several measures. As a result, financial stability could deteriorate if there is a sharp correction in house prices, particularly if accompanied by a reduction in debt repayment capacity."
The Reserve Bank introduced loan-to-value restrictions in October last year to assist in reducing this risk, Mr Wheeler said.
"Debt is also elevated in the dairy sector, although incomes are currently strong. A reduction in dairy export prices, and any associated fall in land prices, could place pressure on the more highly leveraged borrowers in this sector."
Mr Wheeler said one source of risk to farm incomes is a disruption to China's economic growth, which could result from vulnerabilities in China's financial system. "Such a disruption could also affect international capital markets, and impair funding conditions for New Zealand banks."
"More broadly, New Zealand remains exposed to the international financial markets as a result of its high external debt and ongoing current account deficit. However, strong deposit growth in recent years has helped to reduce the reliance of the banking system on offshore funding."
Deputy Governor Grant Spencer said current prudential policy settings remain appropriate given the risks facing the financial system.
"The restriction of high-LVR mortgages appears to be having the desired effect of moderating house price pressures and reducing the risk of a severe market correction. House sales and mortgage credit growth have reduced and we estimate that house price inflation could have been 2.5 percent higher in the absence of the restriction."
Mr Spencer said the Reserve Bank expects the speed limits to remain in place until the housing market comes into better balance. This will be assisted by the upward movement in interest rates and an increasing supply of new houses.
"However, we will need to be confident that immigration pressures will not cause a resurgence of house price inflation. We consider that the earliest date for beginning to remove the LVR restrictions is likely to be late in the year."
Mr Spencer said that, over the coming year, the Reserve Bank will be undertaking a stocktake of its bank and non-bank regulations, with the aim of improving their efficiency, consistency and clarity. A further new initiative is the development of a comprehensive stress testing framework for the banking system. In the insurance sector, following the completion of licensing, the Bank is now developing a framework for ongoing insurance supervision.
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