Bollard says risks to financial sector increasing

Reserve Bank governor Alan Bollard

New Zealand's financial system is well placed to weather a slowdown in the economy, but faces increased risks and may be tested by a sharp adjustment, the central bank said today.

A Reserve Bank report on the stability of the financial system said the New Zealand economy, after several years of strong economic growth, was imbalanced with an unsustainable current account deficit, inflated house prices, unprecedented levels of household debt, high farm debt, and land prices stretched.

"All in all, the risk conditions facing the financial system over the next six months could be more testing than during the past six months," Governor Alan Bollard said in the six-monthly report.

An economic slowdown is expected and that could result in lenders trying to sustain earnings by lowering credit standards.

"Adjustment to these imbalances, if abrupt, could test the resilience of the financial system.

"We do not see those strains as spilling over to the financial system on a scale that would undermine its overall stability -- though specific stresses cannot be ruled out."

The bank also warned that higher interest rates may have a greater impact on households than in the past, as debt in that sector was at unprecedented levels, and there was evidence of an increase in bad and doubtful loans.

However, the corporate sector appeared to be well placed to cope with potential economic headwinds, the report said.

The report echoed the sentiment of the second report issued in May, which has been repeated several times since in the central bank's monetary statements and speeches made by Dr Bollard, that the heavily indebted could be vulnerable if there was a sharp downturn.

Low interest rates had previously led households to increase their borrowing but had also eased debt service burdens. Strong housing investment has been a key driver of economic growth over the past three years.

The New Zealand dollar foreign exchange market had been functioning well, although turnover was expected to decrease as the economy slows and New Zealand's interest rate advantage over other countries narrows.

The liquidity of the NZ dollar foreign exchange market could be tested by any abrupt correction in the current account deficit, with added danger from an event such as a flu pandemic.

The bank was also looking at the its "open market operations" to ensure there was enough scope for the trading of government securities.

- NZPA