The Reserve Bank says the cattle disease Mycoplasma bovis has the potential to result in losses for banks, which should remain prudent in their lending to dairy farmers.

The central bank's May Financial Stability Report said the spread of the disease was an emerging risk to the highly indebted sector as it could mean loss of productivity and profitability.

The sector remained a big borrower, which left it exposed to a future downturn in dairy prices and made it a key vulnerability for the economy, the six-monthly report said. The sector has debt of more than $40 billion.

Dairying also faced other longer-term challenges, including the impact of the response to environmental concerns, the bank said.


The report was written before this week's government-agriculture sector decision to continue an eradication effort by killing thousands more dairy and beef cattle.

The Reserve Bank expected about 90 per cent of dairy farms to remain cashflow-positive in this season just ending, but warned bank lending should stay prudent.

In the 2015/16 season, at the worst of the milk price downturn, just 40 per cent of farms were cashflow positive.

With dairy prices since increasing and stabilising, more farm businesses were moving from loans with interest-only terms to repaying principal, the bank said.

About 20 per cent of dairy sector loans, by value, were being closely monitored by banks due to concerns about borrowers' financial strength, it said.

ANZ senior macro-strategist Philip Borkin said the fall in the Kiwi dollar and relatively good international dairy prices were to some extent cushioning the blow to the industry from the M. bovis disease.

Prime Minister Jacinda Ardern visited Leo Bensegues’ dairy farm at Morven in South Canterbury today after M. Bovis was found and more than 1000 cows were culled.

"From an overall industry standpoint at the moment we don't see too much of a big macro economic impact, mainly because our trading partners say they are going to continue buying our product. And there's no human flow-on (food safety).

"In that regard the overall impact on the economy is relatively small but certainly it adds to some headwinds growing for the industry whether it be from an environment compliance cost perspective or in the way the industry is structured and stock moves across the country (post-eradication effort).


"But that doesn't change the fact that for those individual farms impacted it's going to be a pretty distressing time," Borkin said.

The ASB said the Reserve Bank had noted that dairy debt was becoming more concentrated, and therefore vulnerable to shocks, an example being M.bovis.

"The transition towards lower leverage is starting though, with outstanding dairy debt largely flat for 18 months."

Aside from noting the emerging risks from M.bovis, the Reserve Bank had judged that dairy-related risks had not changed materially since the November report, the ASB said.