KEY POINTS:
Reserve Bank Governor Alan Bollard is confident about the state of New Zealand's financial system, during a time of turmoil on world markets and after the failure of several finance companies.
Releasing the Reserve Bank's twice-yearly financial stability report today, Dr Bollard said this country's financial system was sound and had been "reasonably resilient" against the backdrop of worldwide market volatility.
"In recent months global financial stability has been severely tested, with turmoil in financial markets," Dr Bollard said.
Failure by borrowers in the US sub-prime mortgage market to meet their payments had led to more widespread financial market volatility. The cost of risk had increased and liquidity had reduced.
Liquidity in the New Zealand dollar foreign exchange and interbank markets was tightly stretched in August, and, as did many other central banks, the Reserve Bank stepped in to ensure the interbank market could trade normally.
"Recent events highlight the importance of liquidity for institutions and the financial system as a whole, and there are important lessons to be learned," Dr Bollard said.
"New Zealand is heavily reliant on foreign capital markets, given its large external debt. These markets may not be as secure and liquid as previously thought."
The Reserve Bank was starting work on a specific liquidity policy for banks, which it expected to introduce in 2008.
Reserve Bank deputy governor Grant Spencer said banks' asset quality remained in good shape, and profits continued to increase in line with growth in bank lending.
Despite that, risks to financial stability remained due to low household saving. Debt and debt-service ratios continued to rise, making households and the financial sector vulnerable to a housing market correction.
In the non-bank financial sector, covering finance companies, failures had been caused by underlying solvency problems related to asset quality, connected lending, and credit management, Mr Spencer said.
But recent liquidity pressures had been a trigger for closure in some cases, and many companies were under continued liquidity pressure because of reduced deposits by households.
"Despite the substantial impact of recent events on non-bank depositors, the failures are unlikely to have broader negative effects on the financial system and the economy," Mr Spencer said.
Dr Bollard said the non-bank financial institution sector was undergoing its most significant change for many years.
In response to stability risks in the non-bank sector, a new supervisory and regulatory regime was planned to enhance minimum prudential requirements and improve the quality of information available to investors, he said.
In the housing market, signs of easing had been seen recently following interest rate increases through the first half of this year.
Slower growth in housing market activity and strong commodity prices, particularly for dairy products, were expected to contribute towards a shift in the composition of growth from the non-tradable to the tradeable sector, Dr Bollard said.
- NZPA
