While the financial system remains sound, developments in private sector credit and the housing market point to increasing risks to financial stability in New Zealand, Reserve Bank Governor Graeme Wheeler said today, when releasing the Bank’s May 2013 Financial Stability Report.
“Housing pressures are increasing risk in the financial system,” Mr Wheeler said. “House prices relative to disposable incomes are already high by international standards. Further price escalation will worsen the potential damage that could result from a housing downturn following an economic or financial shock.
“Our concerns are shared by the OECD and by the IMF in its recent review of the New Zealand economy. Housing risks have also been noted recently by all three of the major international credit rating agencies.
“Housing pressures, arising from pent-up demand, limited supply and the lowest interest rates in 50 years are being felt particularly in Auckland and Christchurch, where supply constraints are greatest. Demand is being underpinned by easier credit conditions, both in terms of lower mortgage rates and an increased willingness by banks to lend at high loan-to-value ratios (LVRs).”
Mr Wheeler said a strengthening of global financial market sentiment in recent months is contributing to the easier conditions by reducing bank funding costs and making offshore funding more readily available. “Global sentiment is also contributing to New Zealand’s overvalued exchange rate, which is continuing to hinder a rebalancing of activity towards the tradables sector that would assist in reducing external vulnerabilities.”
With the credit cycle now turning upwards, there are signs that the post-GFC recovery in household savings may be stalling. Household debt is rising from a level that is already high relative to incomes.
Leverage in parts of the agricultural sector also remains high, and borrowing by the sector is increasing at a time when recent drought conditions could expose financial vulnerabilities for some farmers.
“Reflecting our concerns around housing sector developments, the Reserve Bank has been developing a macro-prudential policy framework. We have recently consulted on this framework and will soon be signing a memorandum of understanding with the Minister of Finance to confirm the key elements of the policy, including governance arrangements,” Mr Wheeler said.
Deputy Governor Grant Spencer said that, while housing risks are growing, banks are performing well financially and have strong balance sheets. Their capital levels comfortably meet the new Basel III requirements that took effect in January.
“Looking forward, we want to ensure that bank capital requirements adequately reflect the risks around housing lending and accordingly we are undertaking a housing capital review. In the first stage of this review the Bank is increasing the risk weights applying to high LVR housing loans for the four major banks that use their own models as a basis for calculating minimum capital requirements.
“The increase in the risk weights, applying to all current and new high LVR loans for the major banks, will result in an average increase in capital held for housing of around 12 percent and will take effect from 30 September 2013.
“With regard to the new macro-prudential policy, the public consultation has provided useful feedback on the costs and benefits of the proposed framework and on the potential effectiveness of the various instruments. Overall, we do not envisage major changes to the framework proposed in the consultation documents. Over the next two months, we will be consulting further with the banks to establish the implementation details of the various instruments so that we are able to use them as necessary.”
Mr Spencer said that the Reserve Bank is also strengthening regulation in a number of other areas, including OBR pre-positioning, a review of the Bank’s oversight of the payments system and the implementation of a new prudential regime for the insurance sector.