By Bernard Hickey
The Reserve Bank of New Zealand has given its half yearly tick of soundness to the financial system, but has again warned about the risks from an over-valued housing market and high household and dairy debt.
It also dwelled in its Financial Stability Report (FSR) on the risks to New Zealand from a potential slump in China's property prices and shadow financing system. The bank also announced it would develop a new comprehensive stress testing system for banking system.
Governor Graeme Wheeler said a disruption in China's economic growth was one source of risk for New Zealand farm incomes and international wholesale bank funding markets.
"Such a disruption could also affect international capital markets, and impair funding conditions for New Zealand banks," Wheeler said in the statement. He later told a news conference there was "quite a high liklihood that there will be some sort of correction."
“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," he said.
The bank said New Zealand’s financial system remained sound and well placed to support the expansion in the economy.
However, Wheeler warned several risks to the financial system required 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,” he said.
Wheeler later pointed to OECD research showing house price to disposable income multiples were 26% above the long term average in New Zealand, while house price to rent multiples were 66% over the long-term average.
“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."
High LVR speed limit
Deputy Governor Grant Spencer said current prudential policy settings remained appropriate given the risks facing the financial system.
He repeated comments made last Friday about the bank's speed limit on high Loan to Value Ratio Mortgages remaining in place until at least the end of the year.
“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," Spencer said.
The bank said in its FSR that the impact on house sales volumes (a drop of 11% versus the bank's expectations of a 3-8% initial drop) was greater than expected, but that moderation of house price inflation was in line with forecasts. It repeated comments from March that house price inflation would have been around 2.5% higher than the current annual rate of 8.4%.
"House sales and mortgage credit growth have reduced and we estimate that house price inflation could have been 2.5% higher in the absence of the restriction,” he said. Spencer said the Reserve Bank expected 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," he said.
“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.”
Spencer later said the high LVR speed limit could be phased out by lifting the limit on high LVR lending from the current 10% of new mortgage flow.
New stress testing
The Reserve Bank said it would be undertaking a stock-take of its bank and non-bank regulations over the coming year, "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," it said, adding the bank was now developing a framework for ongoing insurance supervision after the completion of its initial licensing process.
Spencer later said the Reserve Bank would not be following the practice in the United States of publicising the names of those who had failed stress tests, but would publish aggregated information across the banking system.
(Updated with more details and comments from news conference, RBNZ video of full news conference)
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