Financial stress in the dairy sector is easing but the Reserve Bank is urging the highly-indebted wider agriculture sector to keep repairing its balance sheet because risks loom.
In its November Financial Stability Report the Reserve Bank said agriculture accounted for about 14 per cent of all bank lending at nearly $70 billion.
This level of debt limited the sector's capacity to withstand market downturns and invest and adapt to the longer-term challenges ahead, including the impacts of climate change.
Two-thirds of agriculture's debt or $41.5b is in the dairy sector, which had become highly indebted following a run of strong investment, an increase in land prices and two major milk price downturns in the past decade, the Reserve Bank said.
Dairy farm balance sheets remain stretched but milk prices had been supportive of profitability with incomes improving during the 2018-2018 season.
However prices had fallen by 20 per cent since May.
Most dairy farms were expected to be profitable this season but further falls in global dairy prices could put profits under pressure, the bank warned.
Debt in the sector remained concentrated with some farms carrying disproportionately large debts.
"Financial stress in the sector has fallen but the sector is vulnerable to another price downturn as well as longer-term challenges," the central bank said.
Improved milk prices had allowed farmers to pay down debt and banks were increasingly structuring loans on principal and interest repayment terms.
Under longer-term challenges facing the agriculture sector the Reserve Bank counted the cattle disease Mycoplasma bovis, currently the focus of a nearly $1 billion Government-industry eradication effort.
Compensation was limiting the financial impacts on infected farms but might not cover all costs of the disease and many would need to improve their biosecurity practices.
"The financial impacts could be more material if eradication is not achieved. The agriculture sector is already bearing the costs of tighter regulation to reduce pollution of waterways and to mitigate other environmental concerns."
Climate change consequences should be on agriculture's radar, the report said.
Farms needed to be ready to invest and adapt to the challenges ahead as well as the opportunities they might bring.
Given agriculture's debt levels limited its capacity to withstand market downturns and invest to adapt to these longer-term challenges, it was encouraging to see many dairy farms paying down debt, the bank said.
"Banks have a role to play in ensuring their lending decisions reflect relevant risks, including longer-term risks. Where prudent banks may need to fund investments that farms must make to improve sustainability."
Banks were diversifying their lending to agriculture which may help to counter the risk that any one sector posses to the financial system, the Reserve Bank said.
In the past two years, banks had expanded their lending outside the dairy sector with lending growth to horticulture "particularly high" at about 15 per cent in the year to September. Lending to dairying had grown only slightly.