Banking system strong but debt too high

By BRIAN FALLOW economics editor

Stress-testing New Zealand banks' vulnerability to various hypothetical shocks has shown the banking system overall to be resilient, says the head of an International Monetary Fund team which has been assessing the health of the country's financial system.

The Reserve Bank had co-ordinated a far-reaching stress testing exercise looking at the banks' ability to cope with scenarios such as a foot-and-mouth outbreak or a sharp rise in the funding costs of debt, Anne-Marie Gulde said.

"This was a very thorough exercise and it showed the system overall is very resilient. That is partly because of a good starting base - the banks have been very profitable for a long period and are very well capitalised - and partly because of good conservative practices," she said.

"The exposure to housing, for instance, is not excessive in terms of loan-to-value ratios. So there is a wide margin of price changes or interest changes that can be accommodated."

But one area of vulnerability the IMF has been looking at is New Zealand's high level of international indebtedness.

New Zealand's net liability position to the rest of the world is around $100 billion or 75 per cent of GDP, half of which is in the banking system. About 30 per cent of New Zealand banks' balance sheets is funded by non-residents.

"There's a macro-economic issue about the longer-term sustainability of household debt which we are aware of but which goes somewhat beyond the mandate of FSAP [IMF's financial sector assessment programme]," she said.

"But the overall vulnerability is not as much as in other countries with a similar debt structure because the debt goes to households, not the Government. It is market-driven."

Also the foreign-exchange risk - the risk that exchange rates will have moved against the borrower by the time the loan has to be repaid - is generally peeled off the incoming credit and hedged.

That risk had found quite a diversified market, Gulde said: New York hedge funds and retail investors in both Europe and Asia.

"There seems to be quite a steady appetite for New Zealand dollar risk. So the idea of funds drying up is not something I would think is imminent."

And a lot of the capital inflow is through the parent banks of New Zealand banks, which makes it somewhat less flighty than other sorts of capital.

"Overall we would say that New Zealand has a very stable, profitable financial system, no obvious short-term risks, and the areas in the medium term we feel should be addressed are being addressed."

Chief among them is preparing for a potential crisis, which, given the Australian ownership of all of New Zealand's major banks, is an issue of transtasman co-operation.

The issues are: "How do the regulators communicate with each other? How can the issue of Australian depositor preference be addressed? How can the hollowing out [of back office functions] of New Zealand subsidiaries and branches be addressed? So how likely is it that in the event of a systemic crisis the system can be stabilised in the short term?"

The IMF had had "very constructive" discussions with the Reserve Bank - which has been working on these issues for a couple of years - and with the Australian Prudential Regulatory Authority and the Reserve Bank of Australia.

"We found a good deal of interest in Australia on optimising the co-operation on these issues," Gulde said.

Now was the time to be working on these issues, when things were stable and the markets would not mistake it for a sign of weakness.

The FSAP report, which also looks at securities market regulation ("could be better funded") and transparency ("a model of best practice"), is expected to be completed by mid-2004. It will be up to the Government whether it is made public.