International credit rating agency S&P Global Ratings has warned of the increasing risks facing New Zealand banks as a result of the continuing rise in house prices.
In a new report, S&P has downgraded its Banking Industry Country Risk Assessment (BICRA) for NZ's banks by a notch, dropping it from 3 to 4, on a scale where 1 is the lowest risk and 10 is the highest risk.
However it has not changed the individual credit ratings of any New Zealand banks.
"In our opinion, economic risks facing financial institutions operating in New Zealand have heightened as a result of continued strong growth in residential property prices nationally," S&P said in its commentary accompanying the report.
"Reflecting the increased risks, we now apply higher risk weights in our capital analysis of the financial institutions we rate in New Zealand, and consequently, we expect forecast risk-adjusted capital ratios for all of them to be lower than would have been the case otherwise.
"Nevertheless, our ratings on all the financial institutions operating in New Zealand remain unchanged.
"This reflects our expectation that despite some weakening in the capital levels of all these financial institutions, their stand alone credit profiles (SACPs) would remain unchanged.
However S&P did downgrade the SACPs of ASB and Rabobank by one notch each, although it did not downgrade the two banks' credit ratings, "... reflecting our assessment of timely financial support from their respective parents, if needed," S&P said.
S&P said the increased risks to this country's banking sector had been driven by "...continued strong growth in residential property prices nationally, coupled with an increase in private sector credit growth."
"We believe the risk of a sharp correction in property prices has further increased and, if it were to occur - with about 56% of registered banks' lending assets secured by residential home loans - the impact on financial institutions would be amplified by the New Zealand economy's external weaknesses, in particular its persistent current account deficit and high level of external debt."
S&P said it had factored into its assessments recent changes introduced by the Reserve Bank to try and moderate the housing market, such as introducing new loan-to-value ratio lending restrictions on residential investment properties.
"We consider that these tools have been only partly successful in limiting the pace of buildup of risks facing financial institutions in New Zealand," the report said.
"In our view, structural constraints such as supply and demand imbalances and continued high migration levels will pose significant challenges to the effectiveness of macro-prudential tools."
S&P said it had lowered ASB's SACP to bbb+ from a-, and Rabobank's SACP to bbb- from bbb, "...reflecting its view that their forecast capital levels will moderate.
"The revisions of the SACPs of ASB and Rabobank NZ stem from our view of increased risks across the banking system in New Zealand.
"We consider that no new significant bank-specific risk, such as any asset quality concerns, have emerged that drive these revisions."
S&P added that the New Zealand banking sector's funding profile remains a weakness despite a modest strengthening of banks' customer deposits and a slight reduction in banks' dependence on external borrowings.
"Net external debt still funds about 32% of domestic customer loans and support from core customer deposits remains limited, at about 52% of domestic customer loans. Partly offsetting these weaknesses is our expectation of funding support for the banking system from the New Zealand government and central bank if needed in a stress scenario. We also consider the country's conservative banking regulation, stable industry structure, and banks' restrained risk appetite remain supportive of the banking industry," S&P said.
"It is worth pointing out countries such as Spain and Ireland as reminders of the impact that rising economic imbalances [such as particular persistent current account deficits and a high level of external debt] can have on a country's banking system."