Reserve Bank says dairy debt, house price inflation still pose risks

Dairy farm debt and the risk of further house price inflation continue to pose risks to the nation’s financial stability, says the Reserve Bank in its latest bi-annual financial stability report.

Deputy governor Grant Spencer says the latest loan-to-valuation restrictions (LVRs) and the previous restrictions are increasing the resilience of bank balance sheets to a downturn in the housing market.

“However, the share of bank mortgage lending to customers with high debt-to-income (DTI) ratios has been increasing and this could increase the rate of loan defaults during a housing downturn,” Mr Spencer says.

The central bank has asked the minister of finance to approve the Reserve Bank using DTI restrictions on bank mortgage lending although the bank says it isn’t proposing to use such restrictions “at this time.”

Governor Graeme Wheeler says house price to income ratios remain among the highest in the world.

“House price inflation in Auckland has softened in recent months but it is uncertain whether this will be sustained …… and prices are continuing to rise rapidly in the rest of the country,” Mr Wheeler says.

“There is a significant risk of further upward pressure on house prices so long as the imbalance between housing demand and supply remains.”

Mr Spencer says the banking system has strong capital and funding buffers and profitability remains high.

“Despite being relatively concentrated, New Zealand’s banking system also appears to be operating efficiently from an international perspective based on metrics such as the cost-to-income ratio and the spread between lending and deposit rates,” he says.

“However, the banking system’s reliance on offshore wholesale funding is beginning to increase due to a widening gap between credit and deposit growth.

“Banks could become more susceptible to increased funding costs and reduced access to funding in the event of a heightened financial market volatility.”

Mr Wheeler says despite dairy prices recovering and that the average dairy farm is now expected to return to profitability this season, debt has increased because of the loss-making situation during the past two seasons, “leaving the sector vulnerable to future shocks. Some farms remain under pressure and problem loans are likely to continue to increase for a time.”

Mr Spencer says the Reserve Bank is still assessing the likely cost of the 7.8 Kaikoura earthquake to insurers but that the sector is “well positioned in terms of catastrophe reinsurance cover and capital buffers.”