Financial system well-placed to support economic recovery despite uncertainty and risks
The resilience of our financial system to the challenges presented by COVID-19 is reassuring given the uncharted waters ahead, Governor Adrian Orr says in releasing the November Financial Stability Report.
“Global economic activity continues to expand, albeit with significant challenges in large part due to the ongoing COVID-19 virus. With the risk of global inflation heightened, already stretched asset prices are facing headwinds from rising global interest rates,” Mr Orr says.
In New Zealand, economic activity was back above pre-pandemic levels. However, the more recent Delta outbreak is creating stresses for some industries and regions - particularly in Auckland. A transition towards living with COVID-19 in the community as a managed, endemic disease is changing consumer behaviour, affecting the viability of some businesses, while supply chain bottlenecks and inflation are adding to stresses in some sectors.
Strong demand for housing has pushed house prices above their sustainable level, increasing the chance of a correction. Recent buyers are borrowing more relative to their income, and may be vulnerable to higher mortgage rates or a fall in house prices.
While Loan-to-value ratio (LVR) restrictions have been the main tool we have used to address housing risks, we will soon consult on the merits of implementing debt servicing restrictions to lean against these risks. Meanwhile, we expect banks to be more cautious about high debt-to-income loans given the risks of rising interest rates and to the economic outlook.
“The unpredictable nature of future economic stresses reiterates the importance of resilience for our financial institutions so that they are in a strong position to keep supporting their customers and the economy,” Deputy Governor Geoff Bascand says.
Understanding and managing climate-related risks is necessary to support ongoing financial stability. Our 2021 stress test programme considers the impacts of droughts and other weather events on banks and insurers, including impacts on profitability and capital.
Our 2021 stress test of large banks to a severe but plausible economic downturn highlights growing resilience as capital levels have lifted. Capital requirements for banks will progressively increase from 1 July 2022 and it is encouraging to see them increasing ahead of these requirements.
We also intend to increase the minimum core funding ratio (CFR) requirement to its previous level of 75 percent on 1 January 2022, subject to no significant worsening in economic conditions.