The risks facing New Zealand's financial system have stabilised as house price inflation and credit growth slow due to tighter macroprudential tools implemented by the Reserve Bank and higher lending rates, Standard & Poor's says.
S&P Global Ratings classifies the New Zealand bank sector as AA/Stable/A-1+ in group '4' under its banking industry country risk assessment, alongside nations such as Estonia, Israel, Kuwait, Malaysia, Mexico, Saudi Arabia and Taiwan, it said in its latest banking industry country risk assessment for New Zealand.
"We expect New Zealand's economic growth to be solid over the medium term," S&P said, adding that growth in fiscal 2017 was 2.7 per cent and is expected to remain in this range over the next few years.
"We consider that the risks facing New Zealand's financial system have stabilised, reflecting the slowdown of a rapid rate of increase in residential house prices and private sector credit extension and the credit cycle maturing.
"House price inflation in New Zealand has moderated, indicating that vulnerabilities in the market seem to be stabilising," the agency said, noting that Auckland house prices have declined slightly over the past six months, while annual house price inflation in the rest of New Zealand has slowed to about 8 per cent.
S&P said it expects inflation-adjusted house price growth as a percentage of GDP to ease to about 8 per cent over the next few years with the slowdown in Auckland more noticeable than the rest of New Zealand.
"House prices remain elevated in some regions and underlying drivers of price growth remain strong," S&P said.
"Even though banks have improved the quality of their mortgage lending many homeowners appear vulnerable to an increase in interest rates or a fall in income."
The ratings agency said "the risks to the banking sector due to the possibility of a disruptive housing market correction remain elevated, but are unlikely to further heighten in the next two years" and over the longer term housing inflation will moderate as housing shortages are addressed by residential construction, lower immigration levels and as housing affordability bites.
Should a sharp correction occur, the impact on financial institutions would be amplified by the economy's external weaknesses such as persistent current account deficits and high level of external debt relative to other banking systems, at about 46 per cent of GDP.
It sees the current account deficit remaining in the range of 3 per cent to 4.5 per cent of GDP for the next few years.
S&P noted that the banking sector's funding profile remains a weakness despite a modest strengthening of banks' commercial deposits and a slight reduction in banks' dependence on external borrowing.
It said net external debt still funds about 27 per cent of domestic customer loans and support from core customer deposits remains limited, at about 51 per cent of domestic customer loans.
"Partly offsetting these weaknesses is our expectation of funding support for the banking system from the New Zealand government and central bank if needed in a stress scenario," the ratings agency said.
"We also consider the country's conservative banking regulation, stable industry structure, and banks' restrained risk appetite remain supportive of the banking industry."
S&P noted that the New Zealand dollar remains "elevated", driven by higher export prices and low global interest rates.
"It is our expectation that the New Zealand dollar will depreciate as the spare capacity of New Zealand's trading partners is absorbed and global monetary policy stimulus is gradually withdrawn," the ratings agency said.
S&P said it expects the policy environment in New Zealand to remain stable and predictable following the change to a Labour-led government.