When it comes to the economy, the news lately seems to be all doom and gloom. So how stable is our financial system, and should we be worried?
The Reserve Bank’s latest Financial Stability Report provides a picture of where we’re at and any concerns or threats it anticipates for our financial system. We look at the key points from the latest report (November 2024).
The good news: inflation and interest rates are dropping
Both here and overseas, interest rates are falling as inflation starts to go back into its box. As a result, the cost of mortgages and other borrowing is nearing its peak, and starting to fall, the Reserve Bank Deputy Governor Christian Hawkesby said at the report’s release. The Bank describes New Zealand as “nearing the bottom of the economic cycle”.
But there are still difficulties afoot, with households and businesses still doing it tough. Households were cutting back on their discretionary spending, with consumption per person dropping by a similar amount over the past year as during the Global Financial Crisis. Meanwhile, businesses were putting their investment plans on hold. Weak demand and lingering cost pressures have made trading difficult for firms.
Meanwhile, rising unemployment was creating issues for borrowers, meaning banks were anticipating a “slight” increase in ‘non-performing loans’ as a result. However, Hawkesby says the banks are in good shape to handle this.
“New Zealand banks are well positioned to continue supporting households and businesses, including effectively handling any potential loan defaults,” he says.
“Our financial institutions are well prepared to ensure that credit remains available for households and businesses. The strength of our financial system means we are able to weather economic uncertainties and challenges, including increased geopolitical tensions.”
While business confidence was picking up as inflation and interest rates fall back, the Reserve Bank says a severe recession remained the key risk to New Zealand’s financial system.
Housing and insurance
In the housing market, construction of homes was dropping due to lower demand and while house prices were lower, the high interest rates meant the costs for potential home buyers were still high. However, there was some light at the end of the tunnel for residential insurance premiums, which the Reserve Bank said were likely to ease overall, other than for high-risk properties.
“Global reinsurers have benefited from fewer events with large claims costs over the past year, helping to ease cost pressures faced by local insurers,” the Reserve Bank said.
However, the Bank warned that flood-risk premiums were becoming more common for vulnerable properties.
Indeed, a new report from the Helen Clark Foundation and engineering consultants WSP, titled Premiums Under Pressure – How climate change will reshape residential property insurance, and what to do about it – found that, without intervention, residential insurance premiums for flood-prone properties will continue to rise steeply and become unaffordable for many, with insurers eventually expected to withdraw flood coverage altogether for the most at-risk properties.
This report suggests an estimated 10,000 coastal properties in Auckland, Wellington, Christchurch, and Dunedin could become uninsurable by 2050 due to coastal erosion and inundation. Properties located in flood-prone areas inland are similarly at risk, the report says.
Geo-political risks a concern
Things like Russia’s invasion of Ukraine, US-China tension and conflicts in the Middle East are all examples of geo-political risks that could have flow-on effects on our banks and economy, by impacting our trade and creating economic uncertainty. This in turn affects how much households and businesses spend. Supply chains can be disrupted, migration and commodity prices can be affected, and these things can then impact economic activity, business costs, unemployment, and inflation here at home. There can also be impacts on our banking sector through the exchange rate and banks’ ability to access money from overseas.
Last year most banks identified geopolitical shocks as the biggest threat to their business in the Reserve Bank’s 2024 Reverse Stress Test.
In this vein, BMI, a unit of research and rating firm Fitch Solutions, says incoming US President Donald Trump’s trade policies could reduce New Zealand’s economic growth next year, and even force an increase in interest rates in a worst-case scenario, its updated outlook for New Zealand in 2025 says.
Financial system resilient
Regardless of the positive and negative forces at play, the Reserve Bank’s report says the country’s banks remain in a strong financial position and profitable. They also remain comfortably above the Bank’s minimum capital requirements, to help ensure they can ride out the rainy days.
