The Reserve Bank remains wary about the risks posed to the financial system by high levels of dairy farm debt, despite the recent dramatic turnaround in farm gate milk prices.

The bank, commenting in its latest financial stability report, said dairy farm debt now accounts for 10 per cent of the New Zealand banking system's gross lending as farms increased their borrowings for working capital needs after two years of sub-par prices.

Dairy prices have turned around dramatically in the last few months, with most dairy companies now offering farmgate milk prices of around $6.00 a kg of milk solids - well above Dairy NZ's breakeven point of $5.05 per kg.

The central bank said financial conditions for dairy farms have begun to improve, with prices for whole milk powder increasing by 69 percent between July and November, but that farm debt remained a big issue.


"While the average farm is expected to have positive cash flow this season, some still face losses and have accumulated debt," it said.

Dairy sector bank debt increased from $20.10 to $21.50 per kg of milksolids produced between September 2014 and September 2016, it said.

"It is likely that the most indebted farms account for a disproportionate share of this increase as they typically have higher costs and, therefore, have had larger borrowing requirements to meet working capital needs," the bank said.

"These farms are of particular concern from a financial soundness perspective, as they are most vulnerable to low dairy prices and are the farms to which banks are most exposed," the bank said.

Banks' dairy non-performing loans and provisions have increased as a proportion of total dairy lending since Reserve Bank's last financial stability report in May.

Commercial bank economists noted the Reserve Bank's wariness about dairy farm debt.
Westpac said the report showed parts of dairy sector remained under pressure.

"In particular, high debt levels - which have increased over the last couple of seasons - mean the sector remains vulnerable to weaker dairy prices further down the track," Westpac said.

ANZ economists said they had thought that the RBNZ would consider that the risk profile had eased, at least relative to its May report.

"That doesn't appear to be the case," they said in a commentary.

In its financial stability report, the Reserve Bank said banks need to maintain strong capital and funding buffers to ensure they were resilient to existing and emerging risks.