RBNZ says strong profitability has helped banks remain resilient during the recession and means they are well-positioned to cope with rising unemployment

New Zealand’s financial system remains resilient despite the economic downturn, although more households are expected to default on their loans as unemployment rises. 

The Reserve Bank’s November Financial Stability Report gave the country’s banking system a clean bill of health despite financial pressure and rising unemployment. 

Deputy Governor Christian Hawkesby said banks expected a slight increase in non-performing loans—despite falling interest rates—but were well prepared due to high profitability.

"The strength of our financial system means we are able to weather economic uncertainties and challenges, including increased geopolitical tensions,” he said in a statement.

A reverse stress test showed banks would only breach their regulatory capital requirements in a much more severe recession, perhaps triggered by a global conflict or natural disaster.

Debt servicing costs in New Zealand have likely peaked and the average mortgage rate is set to trend downwards from 6.4% today. However, unemployment will continue to increase and cause more borrowers to default on their loans over the next six months.

“Banks have reported to us that many highly indebted households have little incomes or savings buffers available. This makes them vulnerable to unanticipated costs or losses of income,” the Reserve Bank said in the report. 

Banks benefit from 'an abundance of cheap deposit funding'

Unlike households, the banks have been able to use their strong profitability to build financial buffers that will help them maintain the supply of credit even if losses grow.

Banks have benefitted from “an abundance of cheap deposit funding since the pandemic” as interest rates fell and customers stockpiled money in their transactions accounts. 

More recently, soft lending growth means banks have not needed to rely on more expensive forms of funding, like wholesale market funding.

High levels of profitability, less exposure to particularly weak sectors like construction and hospitality, and stronger lending standards means banks are weathering the downturn much better than during the Global Financial Crisis. 

This means the financial system remains sound despite some recession measures, such as consumption per person, giving similar readings to that downturn in 2008.

“Businesses have put investment plans on hold. The weaker outlook for demand and high borrowing costs are key reasons for the pause. Government expenditure is expected to decline as a share of the economy. Lending growth has been weak across sectors,” the report said.

Barely sustainable

The cost of buying a house continues to pose a risk to this financial stability with prices sitting at the upper end of the Reserve Bank’s sustainable range, even after big declines. 

Average prices nationwide fell 14% from their peak in November 2021, while Auckland and Wellington prices dropped 20% and 23%, respectively. Despite this, few households have negative equity as prices were only elevated for a short time. 

“New Zealand house prices have seen rapid growth and decline in recent years. After a run-up in prices and sales over the first two years of the pandemic, the market experienced broad-based price declines followed by a period of stabilisation,” the report said. 

“Houses and land account for most of New Zealand households’ wealth, and home loans make up over 60% of bank lending. The sustainability of house prices and the risk of correction therefore matter for financial stability”. 

It was still a stretch for prospective buyers to get a house and prices were “round the top of our estimate of sustainable levels”. The Reserve Bank assesses prices and mortgage costs relative to household incomes and renting as an alternative. 

Still-high interest rates means purchasing a new house was unfavourable compared to long term averages, and renting was often the better value option.  

The Reserve Bank said NZ’s house prices had risen and fallen more rapidly than many “booms and busts” in other advanced economies, including those during financial crises. 

“Debt-servicing stresses are currently elevated and non-performing loans continue to climb. However, New Zealand has not yet seen the same widespread household balance sheet distress experienced in countries with similar house price boom-bust cycles”.