Rising house prices and debt threaten NZ banking system

House price growth and “record household debt” in New Zealand amid a period of “subdued” wage growth is “raising the risks to the banking system's financial stability”, a new report by international ratings agency Standard & Poor’s has warned.

According to Round Three: As Housing Imbalances Resurface, New Zealand's Banks Ready Themselves For Further Macroprudential Limits, the Reserve Bank of New Zealand (RBNZ) is preparing for a third round of macroprudential limits in an attempt to again curtail growing housing imbalances.

Standard & Poor’s (S&P) warned that while some indicators of financial stability have improved since RBNZ embarked on macroprudential intervention in 2013, “their effect has been narrow as housing-related imbalances continue to build [including the increasing use of interest-only loans], highlighting the challenge facing the regulator as numerous cyclical and structural impediments, most outside of its control [i.e. strong net migration], remain unaddressed”.

The report reads: “In our opinion, for New Zealand's four major banks … whose housing-related loans account for 57 per cent of total loans, the resurgence of rising household imbalances increases the vulnerability to a sharp correction in house prices.

“We note the increasing risk at the system level comes at a time when other micro indicators of stress at an individual bank level, particularly in the housing portfolio, remain in good health.

“This procyclical strength at the entity level is unsurprising given the backdrop of falling interest rates and otherwise relative strength in many parts of the New Zealand economy,” it adds.

Touching on the fact that RBNZ has proposed significant lending cuts in recent months in a bid to “further mitigate risks” to financial stability arising from a current housing boom, S&P said it believed the proposed restrictions would have a greater impact on lending volumes and house price growth outside of Auckland, and would “partly address two of the increasing imbalances that have so far remained relatively untouched by current restrictions.”

These are: investor lending demand, which now accounts for 38 per cent of flow (from a low of 29 per cent in October 2015); and housing credit growth, which is now running at an annualised rate of nearly 9 per cent (against annualised wage growth of less than 2 per cent).

New restrictions not enough to support a reversal in risk weights

However, the ratings agency said that the new restrictions will only have a “modest impact”.

It argued that although RBNZ expects the changes to lead to a 2-5 per cent reduction in both credit and house price growth, the agency “believe[s] a sustained slowdown in prices beyond 5 per cent would be necessary to support a reversal of the increase in risk weights [it] recently applied”.

The authors said it is “increasingly likely some form of debt-to-income measures will be introduced, in a similar capacity to the minimum serviceability requirements introduced in Australia more recently. These could prove effective in shoring up financial stability across the board as wage growth remains subdued and interest rates remain very low.”

On a scale of 1 (lowest risk) to 10 (highest risk), S&P Global Ratings has classified New Zealand’s banking sector risk as a 4 in its Banking Industry Country Risk Assessment (BICRA).

Other countries in this group include the Czech Republic, Israel, Kuwait, Malaysia, Mexico, Saudi Arabia, and Taiwan.

The BICRA highlights that there was low risk to economic resilience, institutional framework, and competitive dynamics, but intermediate risk to credit risk in the economy, high risk to system-wide funding, and very high risk to economic imbalances.

S&P said: “We expect New Zealand's economic growth to be sound over the medium term. Nevertheless, we consider that the risks facing New Zealand's financial system have increased.”

It added: “We consider that New Zealand's resilient economy, conservative banking regulation, and low risk-appetite support its banking sector. In our opinion, partly tempering these strengths are the country's moderately high private-sector debt; material dependence of the banking system on offshore and wholesale funding; imbalances resulting from strong growth in private sector debt and house prices; and New Zealand's high external debt and current account deficit.”

[Analysis: Lending curbs around the world]

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Annie Kane

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