FXStreet (Mumbai) - New Zealand’s latest financial stability report released today noted that the financial system is “sound”. The RBNZ acknowledged that the banking system is well-capitalised, profitable and operating well above required liquidity and funding requirements. Also, there remains more capacity within the system to manage a range of negative shocks. However, the RBNZ believe there exist risks to the system and these risks, according to it, have increased since its May Report. In the current report it has once again highlighted the obvious risks with regard to Auckland housing, dairy and the global scene. The pendulum in the balance of concern appears to be shifting to Auckland’s housing from dairy issues. In addition, the RBNZ also highlighted more concerns over China developments. RBNZ worried about rising investor participation in Auckland housing market The RBNZ noted increased investor participation in the market of late. International evidence suggests that investor loans have a higher tendency to default in the event of a major downturn in the housing market. This has led the central bank to believe that a significant downturn “could challenge financial stability”. House price growth in Auckland has increased strongly and the house price-to-income ratios in the region are now comparable to those seen in some of the world’s most expensive cities. Some regional housing markets are being closely matched by the RBNZ. It is likely to re-tighten LVR restrictions if pressures there were to intensify in the regions. The recent policy changes are expected to help moderate pressure on Auckland house prices as well as improve the resilience of bank balance sheets to a housing downturn. Dairy sector concerns The RBNZ has been watching farm prices very closely. Low international dairy commodity prices have resulted in weak cash flow in this sector. It is true that prices have shown some recovery since August. Many indebted farms will however come under increased pressure if low dairy prices are sustained or dairy farm prices fall significantly. While the RBNZ says credit losses are “manageable”, it has stated that it is currently conducting stress tests on the largest dairy lenders “to assess the resilience of their portfolios to a prolonged period of low milk prices”. Global economic outlook not favorable for NZ Concerns over China developments have increased lately. The economy will now have to battle the impacts of falling commodity prices, capital flow pressures in emerging markets and recent equity market volatility. Uncertainty over the China’s economic and financial adjustment policies has further hurt commodity prices and has added to financial market uncertainty. The major central banks have opted to keep their interest rates at historic lows. This might result in a build-up in risk in international asset markets. This increases risks for the New Zealand banking system, which is reliant on the global markets for funding. The RBNZ appears concerned that an extended period of low interest rates is resulting in the mispricing of risk. Reserve Bank Governor, Graeme Wheeler while releasing the financial stability report expressed confidence in NZ’s financial system, which he said continues to perform well despite a grim outlook for global financial stability and increased risks related to the dairy and housing sectors. The report has however warned that “A sharp downturn could challenge financial stability, given the large exposure of the banking system to the Auckland housing market.” For more information, read our latest forex news.