Housing and dairying debt remain at the forefront of Reserve Bank concerns, but a softening in house price growth has prompted the central bank to ease its loan to value ratio (LVR) restrictions on banks' lending criteria.
The changes mean a larger number of people with small deposits could now get bank financing, but for investors, the unchanged 5% cap on investor lending by banks' will likely overshadow the lower deposit criteria.
Household debt accounts for 60% of banks' lending, or $263 billion. Agriculture debt accounts for 14% of banks' lending, or $61.9 B. Dairy sector debt accounts for 9.3% of banks' lending, or $41.5 B.
The Reserve Bank's six-monthly economic stability report was expected by economists to ease the LVRs, which were also eased a year ago since being implemented in 2013, to rein in increasing bank exposure to rising household debt at the time.
Reserve Bank Governor Adrian Orr said risks to NZ's financial system had eased in the past six months, but vulnerabilities persist.
“In particular, households remain exposed to financial shocks due to their large mortgage debt burden,” he said.
ASB chief economist Nick Tuffley said the LVR easing could “at the margin” see more housing related inflation, but he noted after last year's LVR easing the inflationary impact appeared insignificant.
He noted house sales turnover and listings rose sharply in October, while mortgage rates had been falling for months, now below 4% to borrowers with a 20% deposit.
“Relaxation of the LVR restrictions is not without some risk, even though Auckland risks are slowly dissipating through a sustained period of flat prices.”
Adrian Orr said easing the LVR was done given both mortgage credit growth and house price inflation had eased to more sustainable rates, reducing riskiness of banks' new housing lending.
“If banks' lending standards are maintained we expect to further ease LVR restrictions over the next few years,” he said.
The Reserve Bank report said the dairy sector was now “highly indebted,” following a period of strong investment, rising land prices but then two significant milk price downturns in the past decade.
“Debt in the dairy sector is concentrated, with some farms carrying disproportionately large debts,” the report said.
Orr said the high dairy debt implied “ongoing financial vulnerability. Balance sheets need to be further strengthened. In the medium-term, an industry response to a variety of climate change-related challenges appears likely, requiring investment.”
Nick Tuffley said financial stress in the diary sector was falling, with banks tracking less dairy lending to farms which were showing signs of stress.
On the question of banks holding more regulatory capital, Westpac senior economist Michael Gordon said higher capital requirements would provide banks with a greater buffer against unexpected losses.
“But they tend to increase the average cost of funding; as equity is a more expensive form of funding than debt or deposits.”
That change would represent a tightening of financial conditions, to go with the easing via the LVR changes, he said.
Orr said NZ’s exposure to global risks has “reduced somewhat,” given the banks were now less reliant on short-term, and foreign, funding.
He said the Reserve Bank's preliminary view was that higher capital requirements were necessary, so the banking system would be sufficiently resilient while remaining efficient.
The Reserve Bank is to release a final consultation paper on bank capital requirements next month.
*Simon Hartley is senior business reporter and assistant chief reporter for the Otago Daily Times.