Financial system sound, but vulnerabilities remain

While New Zealand has so far come through the COVID-19 pandemic better than initially feared, vulnerabilities in the financial system remain, Reserve Bank Governor Adrian Orr says in releasing the May Financial Stability Report.

“Successful public health measures along with substantial monetary and fiscal policy support, helped to prevent many business failures and a larger rise in unemployment. Key New Zealand export prices have also been resilient, with dairy prices at their highest level in several years.

“Yet, despite doing better than feared, border restrictions, supply chain disruptions, and social distancing have reduced activity in affected sectors, and some businesses remain vulnerable.”

We are also seeing the impact of low global interest rates resulting in increased risk taking and higher asset prices. This is an international phenomenon, with the New Zealand impact most visible in higher house prices.

A high proportion of new lending has had high debt-to-income and loan-to-value ratios (LVR). This makes recent borrowers more vulnerable to a rise in mortgage rates, and exposes households and the financial system to a decline in house prices, Deputy Governor Geoff Bascand says. The recent tightening in LVR requirements, particularly for investor lending, will help to mitigate some of these housing risks and support more sustainable house prices.

“We will be watching how market conditions respond to the Government’s recent policy changes. If required, we are prepared to further tighten lending conditions for housing using LVR requirements or additional tools that we are assessing,” Mr Bascand says.

Government support and strong capital and liquidity buffers have meant that the pandemic has had a limited impact on financial system soundness, but further resilience is needed.

Most insurers have maintained or improved their capital positions over the past year. Solid profitability and dividend restrictions have allowed banks to build their capital levels, providing a buffer to absorb any future losses, and overall banks are in a strong position to keep supporting their customers and the economy. New capital rules will start being implemented from 1 October 2021, with increases in minimum requirements starting in July 2022 to support resilience in the future.

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