UPDATE: RBNZ's Orr sees a 'resilient' financial system

UPDATE: RBNZ's Orr sees a 'resilient' financial system but some elevated risks

(Updates story throughout with further details and comment)

By Jenny Ruth

May 29 (BusinessDesk) - Reserve Bank governor Adrian Orr is less concerned about housing loans but is still fretting about a third of dairy debt and is also flagging the rapid growth in lending to the horticulture sector.

“Most dairy farms have been profitable for the past three seasons as dairy prices and production have been good,” Orr’s latest Financial Stability Report says.

“But some farms struggle to make profits at current prices, particularly those with large debts,” it says.

Around 35 percent of dairy farm debt is to farms that have more than $35 of debt per kilogram of milk solids produced annually, it says.

On average, it says those farms require a $6.20/kgMS just to break even while Fonterra is forecasting a milk price of $6.30-6.40/kgMS for the season ending this month.

Fonterra is forecasting a price of $6.25-7.25/kgMS for the season starting next month.

“Vulnerable farms must reduce their debt to improve their resilience to further downturns,” the FSR says.

“However, options for addressing problems at financially stressed farms appear constrained at the moment as demand for dairy farm land is low.”

The FSR notes that lending to horticulture grew 19 percent in the year ended March while lending growth to dairy farms was less than 1 percent.

“Diversification reduces risks to banks by lowering their exposure to downturns in individual sectors. But rapid lending growth to a sector could be a sign of overly fast expansion and should be monitored by banks,” it says.

Farm lending accounts for about 14 percent of total bank lending while loans to households account for about 60 percent of bank lending and most of that is mortgages.

The report notes that tighter lending standards, helped by its loan-to-valuation restrictions, have meant a decline in riskier mortgage lending.

“The proportion of new mortgage lending to households with DTI (debt-to-income) ratios above five is large but has declined in the past two years. Fewer new mortgages are now provided on interest-only terms and the share of mortgages going to investors has been fairly flat for the past two years,” the report says.

It notes house prices grew about 2 percent in the year ended April and says RBNZ expects house price growth to remain subdued.

But the vulnerability of households remains elevated and “must continue to be closely monitored and managed."

Orr says the current LVR settings remain appropriate.

These domestic concerns aside, the New Zealand financial system remains resilient to a broad range of economic risks, he says, noting that similar challenges exist globally, “given current high public and private debt levels, and stretched asset prices in many of New Zealand’s trading partners.”

He says the capacity for some foreign governments and central banks to respond to unanticipated negative events is also limited by their current high government debt and low nominal interest rates.

“It is imperative to improve New Zealand’s financial system resilience while conditions are conducive,” Orr says.

“Increasing financial institutions’ capital positions is central to ensuring that they can withstand severe shocks,” he says.

“We have proposed higher capital requirements for banks, and are currently reviewing public submissions on this proposal. There is also a need for some insurers and non-bank deposit takers to improve their capital buffers. We will be reviewing insurer solvency standards in the months ahead.”

Orr says financial services providers need to have a long-term customer outcome focus to both maintain confidence and promote sound resource allocation.

“We will ensure banks and insurers respond to the issues identified in our recent review of their conduct and culture,” he says.

Financial firms also need a longer-term focus to adapt to the changing competitive, regulatory, and natural environment.

“Insurers are changing how they manage their exposure to natural disaster events, which is altering affordability,” Orr says.

“Risks associated with climate change are also impacting on the accessibility of insurance, with potential flow-on effects on bank lending. These risks must be appropriately identified and priced, so as to best ensure a stable transition over coming years,” he says.

(BusinessDesk)

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