Credit growth has declined and house price inflation has stabilised in New Zealand but the central bank wants more time before it eases the loan-to-value restrictions any further.
"Financial risk has lessened with both lending and house price growth slowing in the last 12 months – in part due to our imposition of loan-to-value (LVR) ratio restrictions," said Governor Adrian Orr in his first financial stability report since taking office.
However, "this more subdued lending growth needs to be further sustained before we gain sufficient confidence to again ease the LVR restrictions," he said. The LVRs have been in place for several years and were implemented to discourage banks from extending credit to riskier borrowers. It did ease them slightly at the beginning of this year as housing market pressures showed signs of abating.
According to the central bank, household sector indebtedness has increased since 2011, coinciding with significant growth in house prices, and debt is now at a record high. Indebtedness is particularly high for new homeowners and for property investors.
In 1988, the average household owed around $16,000 in debt and had an income of around $35,000 – a debt-to-income ratio of 46 percent. By the end of 2017, this ratio had risen to 168 percent, following a ten-fold increase in average household debt to nearly $160,000, while average incomes had only slightly less than tripled to $95,000, it said.
As a result, borrowers still remain particularly vulnerable to rising interest rates or a change in financial circumstances.
Overall, the central bank said the financial system remains sound but is still exposed to three key vulnerabilities: household sector indebtedness, dairy sector indebtedness, and the banking system’s exposure to international risks.
Regarding the dairy sector, it noted that most dairy farms are currently cash-flow positive, but remain vulnerable to any possible downturn in dairy prices and agriculture shocks. " Reducing this bank lending concentration risk requires more prudent lending practices," it said.
It also said the spread of Mycoplasma bovis is an "emerging risk to the sector," although the report was written before the government announced it would be attempting a phased eradication of the disease from New Zealand.
Orr said that New Zealand banks have reduced their exposure to international risks "due to strong growth in customer deposits and by raising funding at longer terms." However, "the most prominent international risk is disruption from a rapid increase in global interest rates, as central banks tighten monetary policy," he said.
While "monetary policy is not expected to tighten in New Zealand for some time" domestic interest rates could rise if higher global growth causes inflationary pressures to rise in New Zealand or if higher global risk premiums increased New Zealand banks’ funding costs.
On the insurance sector, it noted it also remains "sound, profitable and adequately capitalised but said "some insurers have relatively small capital buffers necessary to meet future events. We are discussing this directly with the insurers."
It also highlighted "challenges to efficiency in the insurance sector." According to the central bank, market share remains concentrated. "Life insurance commissions are particularly high, which inevitably flows through into higher premiums. We believe technology developments will be a key driver of competition in the future," it said.
The central bank also included a special focus on the "culture and conduct of financial institutions in New Zealand."
Banks have been in the regulatory spotlight, particularly since a Royal Commission inquiry in Australia started highlighting less than honourable practices from some banks’ Australian parents. The Reserve Bank and the Financial Markets Authority asked banks to demonstrate clearly why their customers should believe their business practices differ from their Australian parents.
"The Reserve Bank, along with other financial regulators, is taking a close interest in how the Australian parent banks are responding to these inquiries," it said. It also noted that the RBNZ and the FMA have called on New Zealand’s licensed life insurers to ask them to demonstrate how they identify and address conduct and culture issues.
Life insurers have been asked to provide written responses by June 22 that outline the actions they have taken or plan to take to identify and address culture and conduct risk, and their plans to address issues identified by the Australian Royal Commission.