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Financial Stability – risky, safe or just right?

reserve bank of new zealandThe challenge with financial stability is how to maintain a strong, resilient and efficient financial system in the face of changing and emerging risks said Deputy Governor and Head of Financial Stability Geoff Bascand in Sydney today.

“Ten years on from the pain and enormous costs of the Global Financial Crisis (GFC), it’s clear that prevention is better than cure. Reducing the risk of a crisis in New Zealand demands that we understand the domestic and global risks relevant to us. For example, snake bites are unpleasant but not pertinent to most New Zealanders. The challenge is assessing what is too risky, too safe, and just right?” Mr Bascand said.

New Zealand’s financial sector is sound and well regulated. It weathered the GFC better than most, but there was no room for complacency, Mr Bascand said.

New Zealand has two main vulnerabilities: our high levels of indebtedness (in the household and dairy sectors) and our reliance on foreign sources of funding. We will publish our next assessment of those risks in the Financial Stability Report on 28 November.”

The Reserve Bank uses a wide range of tools to manage risk and promote a sound and efficient financial system, drawing on self-discipline, market-discipline and regulatory discipline.

“The Bank is reviewing many of its tools to evaluate their fitness for the risks we face.” Mr Bascand  agrees with the International Monetary Fund’s Financial Sector Assessment Program (FSAP) report that while there are many positives in the current framework, the regulatory pillar should be stronger.

“We are strengthening our supervision of individual institutions. We are making more frequent use of thematic reviews on areas of heightened risk, and we continue to increase our collaboration with the Australian Prudential Regulatory Authority,” Mr Bascand said.

“The Reserve Bank’s capital review will shortly address the question of what is the right baseline level of capital for banks. There is a good case that both soundness and efficiency gains can be achieved by requiring banks to hold a high level of capital at all times.

“Even with a strong baseline level of resilience, there are circumstances when we need greater vigilance and reduced risk tolerance.  Loan-to-value ratios (LVRs) were introduced to address elevated risks in the housing market. We keep LVR settings under regular review. The question we are assessing in the upcoming Financial Stability Report is whether the same restrictions are needed in the current environment.

”While remaining alert to our structural vulnerabilities of indebtedness and banks’ reliance on overseas funding we also scan the environment for emerging risks such as climate change, cyber attacks, fintech, and conduct risk.  The Bank’s role and oversight of the broader financial system mean that it is well placed to do this.

“Resolving what is risky, safe or just right is challenging. In the end, it is a judgement that’s based on experience, analysis and consultation,” he said.