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Thursday, May 20

Financial system outlook improved but fragile

The outlook for the financial system has improved over recent months, reflecting a recovery in the New Zealand economy driven by stronger trading partner activity and a sharp lift in the terms of trade,  Reserve Bank Governor Alan Bollard said today when releasing the Bank's May 2010 Financial Stability Report.

"However, the global financial markets remain fragile," Dr Bollard said.  "The sovereign debt concerns facing some European economies have weighed heavily on financial markets in recent weeks. European authorities and the IMF have recently announced initiatives to support sovereign debt markets and to begin dealing with the underlying problems.  But there is clearly a risk of further turbulence if adequate progress is not made.

"As an external debtor country, New Zealand could be vulnerable to any renewed deterioration in global debt markets. At the same time, the process of fiscal consolidation could dampen the global recovery, although our major trading partners in Asia and Australia should be less directly affected."

Dr Bollard noted that global imbalances have reduced over the past two years with higher savings helping to shrink current account deficits. New Zealand has also seen a marked narrowing of its current account deficit.  

"New Zealand households have increased their savings, which is positive for financial stability.  It will be important that households maintain a cautious approach to debt accumulation as the recovery continues." 

Commenting on the financial system, Deputy Governor Grant Spencer said that the New Zealand banks remain in good shape and will benefit from the economic recovery.  Non-performing loans appear to be plateauing out and, notwithstanding the recent market hiccups, banks have successfully been issuing term debt over the past year, lengthening their maturity structure and reducing liquidity risk. 

"Bank credit growth was restrained through the recession, reflecting weaker demand for credit by households and businesses and tighter lending standards," Mr Spencer said.  "We believe the banks have the capacity to meet an increase in demand for credit and doing so will be important to sustain the economic recovery."   

Mr Spencer noted that a gradual rationalisation of the finance company sector is continuing, with the new more stringent regulatory regime promoting further consolidation.

"A number of finance companies have joined the extended Retail Deposit Guarantee Scheme to give them more time to realign their balance sheets.  We do not expect the banks to enter the extended guarantee scheme given there is no need for them to do so," Mr Spencer said.

"Significant changes to financial sector regulation are occurring around the globe.  New Zealand will adopt measures that improve the soundness of the financial system while not undermining its efficiency.   A new Prudential Liquidity Policy for banks became effective in April and we expect to make further changes to the bank regulatory regime.

"The new non-bank regulatory regime should be largely in place by the end of the year.  And the Insurance Bill, giving the Reserve Bank oversight of the insurance industry, is currently progressing through Parliament."